There’s no doubt about it, times are tough in the midstream gasbusiness. Depressed NGL prices and unfavorable margins have kept atleast one player from selling its assets while the same factorscaused another to seriously rethink the wisdom of a recentpurchase. Executives and analysts predict a lot more horse tradingof properties as companies look to rationalize assets and buildpositions for better times (hopefully) ahead.
The most recent midstream acquisition, American Electric Power’s(AEP) purchase earlier this month of Louisiana Intrastate Gas (LIG)from Equitable Resources, is viewed as a strategic deal, anotherexample of gas and power convergence (See NGI Sept. 21, 1998).”What [AEP] bought was a platform to trade BTUs,” said one analystfocusing on the midstream who asked not to be named. He said theLIG assets give an adept trader something to trade around.Equitable was faced with a number of obstacles to capitalizing onLIG, exacerbated by a defection of traders following theannouncement of LIG’s sale. It remains to be seen, however, how AEPwill make out with its new midstream properties. “All of these guysbuy them with the intent of doing better than the old guy.”
PG&E has decided, after much deliberation, not to sell theassets of Valero Energy, which it bought for $722 million lastyear, and Teco Pipeline Co., which it also acquired last year for$380 million. In April, PG&E CEO Robert Glynn Jr. told NGI someof the Texas assets were losing money (See NGI April 20, 1998).”And we are interested in having discussions with interested buyerson those particular pieces” that might be of more value to someoneelse.
Since then things have changed. “We, as you know, took a realhard look in late spring and through the summer at all of ourbusiness in Texas in particular, and we have a strong interest inpower down there, and we have a strong interest in gas down there,”said Joe Kearney, CEO of PG&E Gas Transmission. “We still havethat interest, and we have no intention of selling any of the gastransmission assets we have down there. The gas transmissionincludes all our liquids assets.”
Admitting Valero has suffered from low liquids prices, Kearneyhastened to add the liquids downturn is purely cyclical. “Our viewis that this is at or close to the bottom of the trough, and thistrough may be a little longer than others. But we look at thisbusiness as a cyclical business that’s going to turn around.”
The $722 million price paid in an auction for Valero raisedindustry eyebrows. “PG&E paid well into a double-digit EBITDAmultiple, and they paid for a company that has a lot of natural gasliquids exposure, and we were close to the peak in liquidsmarkets,” remarked the unnamed analyst. Liquids exposure, thedissipation of the price spread between East and West Texas, andexpiration of above-market Valero citygate legacy contracts tookthe luster off Valero, the analyst said. PG&E “paid a highprice, a strategic price, to enter the business, and the numbershave been difficult. We’re dealing with trough numbers.”
Kearney admitted the West-East Texas basis differential likelywon’t improve. “I think that the dynamics of the marketplace downthere have changed fundamentally and that we are not anticipating a return to the large basis spreads that we saw in the 1996-97timeframe. That’s not to say that the business won’t provide usopportunities beyond that because I think there are emergingmarkets down there that our gas transmission system is in anexcellent position to serve.”
Looking ahead, Kearney said there are opportunities in gas-powerconvergence in Texas. “We’re going to be active on the power assetside there. There’s going to be an opportunity on the pipeline asthe electricity markets become more open to independent producersand wholesale electricity becomes more active and understood.”
While it considered selling assets, PG&E did not go as far asUtiliCorp United did with Aquila Gas Pipeline – a sale attempt thatwas eventually aborted. When Aquila was put up for sale in March(see NGI March 16, 1998), Aquila CEO Joe Becraft said, “Clearly weare in a good M&A (mergers and acquisitions) market right now ifyou have assets to sell.” His optimism followed the recentpurchases of USX Delhi by Koch Industries, TPC Corp. by PacifiCorpand Valero by PG&E. Becraft touted Aquila’s Oasis Pipeline andthe Southeast Texas Pipeline System in the Austin Chalk as well asa pipeline and plant in western Oklahoma.
The thrill is gone, for the time being at least. Aquila wastaken off the market in August (See NGI Aug. 10, 1998). “It’sdifficult right now, largely because of the low prices in naturalgas liquids, and we see that improving modestly but not reallysignificantly over the next few months. We do think it will returnto some strength over the next year,” Becraft told NGI last week.He said August probably was Aquila’s second best month in terms ofvolumes gathered – a little more than 500 MMcf/d – from the AustinChalk. “We’re operating pretty much at capacity there and arewrestling with the fun questions of how do we expand our assets.”He also pointed to “decent drilling” in southwestern Oklahoma whereAquila’s Elk City system gathers 70 to 75 MMcf/d. “That’s holdingup quite nicely, growing a bit.”
Still, Becraft conceded the timing of the sale attempt “wasn’tthe most auspicious.” Again, the story was low liquids prices anderosion of basis differentials on the Oasis pipeline, which”spooked a lot of folks.”
Petrie Parkman principal Stu Wagner said potential Aquila buyerslikely fretted over high decline rates in Aquila’s home turf, theAustin Chalk. “The seller saw one environment. The potential buyerswere concerned about the opposite happening. In Aquila’s defense,this has always been a concern about this system. I think buyershave a hard time stepping up when there are these kinds oflong-term concerns in a weak price environment.” Becraft said hehas a bullish outlook on gas demand, and plans to sell Aquila havebeen scrapped. “I won’t say that subject will never pop up again.”
Still in the offing is the sale of Union Pacific Resources’midstream assets as part of the company’s extensive and ongoingde-leveraging program. “We are in discussions with prospectivebuyers and we’re at a very sensitive stage in all of this,” saidUPR spokesman Dan Sullivan.
UPR’s midstream business has attracted the interest of at leastone of the midstream’s 400-pound gorillas, El Paso Field Services.”We’re still involved with UPR. They have to raise capital,” saidField Services President Bob Phillips. Besides El Paso FieldServices, the big boys of the midstream include Duke, Williams,Shell-Tejas, Dynegy, GPM, as well as Conoco and Amoco among theproducers, Phillips said. Giving credence to the argument forconsolidation of the midstream among the largest companies, bigpipeline company El Paso enjoys synergy opportunities that smallermidstream players typically don’t have.
“We view gathering and processing both as a very solid,long-term, non-regulated complement to our regulated transmissionbusiness, but it also creates significant synergies with thosetransmission systems because we aggregate supplies.” Phillips saidabout 45% of Field Services’ throughput ultimately flows to ElPaso’s regulated pipelines. He said the company has not been asexposed to liquids prices as some others as about 75% of itsoverall gathering and processing portfolio is fixed-fee with onlyabout 25% of fees fluctuating with commodity prices.
El Paso Field Services has positions in the San Juan Basin,Permian Basin, North Louisiana, South Texas and the Gulf Coast.Expect more asset trading as companies like Field Services seek tobuild geographically diverse and balanced portfolios. Phillipspointed to asset swaps between Duke Energy Field Services and KochMidstream Gathering and Processing (See NGI Aug. 3, 1998), andField Services’ own recent sale of Anadarko Basin assets toMidcoast Energy (See NGI Aug. 3, 1998). “We’ll concentrate ourcapital and resources on geographic areas where we can be verysuccessful.”
For its part, Becraft said Aquila is “looking at a number of notmajor but nonetheless acquisition opportunities. grassrootsgathering in our general area of operation [Central Texas,southwestern Oklahoma]. We’re looking elsewhere also, but we’reseeing some opportunities in those particular areas.”
Predictions call for big oil companies to become more involvedin the gas midstream. Chevron is in with Dynegy; Mobil has Duke.And Shell has built itself into a significant midstream playeralong with Tejas. In the early 1990s, deregulation made themidstream attractive to Shell. Through a series of steps, thecompany created its midstream business unit in 1996. “In 1998, welooked around and said that our philosophy was that we had to bringour trading activity and the marketplace and the intelligence thatcame with that data. we had to bring those much closer together,both with the Shell midstream assets and the Tejas assets,” saidCurtis R. Frasier, Tejas Energy executive vice president. That ledto the Shell-Tejas combination.
As trading of midstream assets continues on the road toconsolidation and the convergence of gas and power, Phillipswonders what view Wall Street will take of the midstream. If theStreet looks past the short-term decline in earnings from depressedliquids prices and focuses on the quality of companies’ midstreamassets it will “see this segment as a segment that has significantearnings power, and they’ll see a segment that has significantgrowth capability. And that’s really what all these companies want.They want a business that has reasonably stable earnings power, andthey want a business that has significant investment opportunity.”
Joe Fisher, Houston
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