n October 16th, Kinder Morgan Inc. (KMI) announced its intent to purchase El Paso Corp. (EP) for $37.8 billion, becoming the continent's largest operator of natural gas pipelines. The next day Norwegian state-controlled Statoil ASA (STO) announced plans to buy U.S. onshore crude oil and natural gas producer Brigham Exploration Co. (BEXP) for $4.7 billion.

Thursday, that same week, mid-cap producer Quicksilver Resources Inc. (KWK) said that it would establish a master limited partnership (MLP) comprised of 18% of its Barnett natural gas production with targeted proceeds in excess of $400 million.

KMI ended the week 9% higher even though shares of an acquirer usually fall on dilution fears, as investors were bullish that the merger would be immediately accretive. EP surged 28%, slightly less than the 37% premium for which it was purchased, suggesting a modicum of concern about antitrust roadblocks to completing the deal. STO and BEXP shares ended the week with healthy gains, but KWK fell 11%.

Despite the different market reactions, the deals highlight several tradable themes in the energy space: opportunities for expansion of the MLP market and new upstream activity in natural gas liquids and shale oil.

Bullish on gas

The KMI-EP merger is yet another example of corporate management betting on natural gas as the fuel of the future in the U.S. We've seen corporate bullishness about unconventional gas ever since ExxonMobil Corp. purchased XTO Energy Co. for a 25% premium in late 2009. M&A has been a prevalent theme in the E&P space since then, the most recent transaction being BHP Billiton's July 2011 acquisition of Petrohawk Energy for a 65% premium.

While these deals varied in scope, they all revolved around the acquisition, for rich premiums, of onshore gas producers. However, the KMI-EP deal focuses on midstream assets: the infrastructure for gathering, processing, transporting and storing the commodity.

In fact, KMI plans to sell all of EP's upstream assets, valued at roughly $8 billion to $9 billion, as soon as practical and to drop down the remaining pipeline assets to Kinder Morgan Energy LP (KMP) and El Paso Pipeline Partners LP (EPB), the subsidiary MLPs. Although KMI did not provide a breakdown of its $37.8 billion offer, it is clear that the driver of the transaction was EP's midstream rather than its upstream portfolio.

The terms of the deal show that while producers of natural gas have struggled to turn profits amid low futures prices, the surge in supplies has created greater demand for infrastructure. Yet the deal is also fundamentally bullish about the long-term prospects for gas demand as the newly-created company would operate a network of 67,000 miles of pipelines to bring more than 1 million barrels per day from producing to consuming regions.

During the conference call with investors, Rich Kinder, chairman and chief executive of KMI, said, "We've never been a believer in size for size's sake but the advantage of being large, is it gives you the opportunity to do expansions and extensions and tuck-in acquisitions…You look, for example, at what Tennessee Pipeline will be able to do coming out of the Marcellus."

In this sense, the deal helps de-risk relatively newer upstream activity in the Bakken, Eagle Ford, Marcellus and Utica basins as it can enhance take-away capacity in these areas where drilling has been delayed by poor logistics. Importantly, though, the KMI-EP deal is not a bullish bet on the long-term strength of gas prices, as the new network of pipelines will be largely interstate and therefore backed by capacity-based contracts without direct commodity price sensitivity.

MLP valuations

As opposed to simply selling assets in order to raise funds, the highly-levered KWK opted to take advantage of the persistently low interest-rate environment that has driven yield-seekers to incur extra risk, bidding MLPs higher. The new MLP, with its higher market valuation and lower cost of capital than its c-corporation parent, will purchase the asset drop-downs using initial-public-offering proceeds, enabling KWK to reduce its $2 billion debt by $400 million.

The driver behind STO's acquistion of BEXP was the access to high-quality tight oil and liquids of the Bakken, showing that capital-constrained companies with long-lived inventories of undeveloped shale resources are candidates for take-over. The KMI-EP deal adds the nuance that companies with assets that could achieve higher valuation on an MLP balance sheet are even more likely to be takeover targets. And the KWK announcement supports the idea of increased MLP formation for purposes of asset drop-downs not simply for new midstream assets but for upstream ones as well.

Tamar Essner is associate director of energy advisory services for Thomson Reuters Advisory Services and can be reached at tamar.essner@thomsonreuters.com, 646-822-3646.