FORT WORTH, Texas—The big deal in midstream finance is that the big deals are on the way, an M&A expert indicated at the recent DUG Permian and Eagle Ford Conference & Exhibition.

“I think we’re heading into a constructive period after what has been a very painful period,” Pete Bowden, global head of energy and power at Jefferies LLC, said during a midstream finance roundtable.

Asset-level midstream transactions fell by about 14.5%, or $24.9 billion to $21.3 billion from 2019 to 2020, Jefferies found. What was striking, however, was the collapse of the gathering and processing share of transactions.

From 2015 to 2019, gathering and processing entities accounted for about two-thirds of annual midstream asset transaction value. It peaked in 2019 at $14.8 billion, which constituted almost 60% of that year’s transactions. That figure plunged 96% to only about $600 million in 2020.

So where did all the transaction money go? Jefferies found that M&A activity in transmission, storage and LNG more than doubled from 2019 to 2020, from $10.1 billion to $20.7 billion.

It won’t stay that way. Bowden’s experience of more than two decades in the sector has allowed him to observe patterns, and one is that midstream typically lags E&P by 12 to 18 months. He sees that as good news for midstream next year as rig counts ramp up and M&A activity moves closer to the wellhead. Gathering and processing companies can be expected to return to the transaction realm.

“We have done, at Jefferies, more E&P deals in the last three months than we did all of last year,” he said. “I see that trend continuing. I see better valuations and I think M&A will logically follow.”

Part of the reason is Bowden’s belief that cheap debt may be the most important feature in M&A.

“You’re going to see that really facilitate transactions and, I do expect, help the public companies with stronger balance sheets reenter the fray in terms of M&A,” he said.

Investing Climate

ESG and climate issues pervaded almost all of DUG Permian’s sessions. In some cases, operators have experienced the sting of rejection in their efforts to attract capital, even from investors who are anything but die-hard enemies of hydrocarbons.

“There are some investors that are steering clear of fossil fuels and they may not be brought back,” Brett Knowles, vice president of EnCap Flatrock Midstream, acknowledged during the discussion. “But I’ve had a lot of really rational conversations with individuals that understand the need for midstream, understand the kind of service we provide and it often does take a detour into ESG.”

The onus, he said, is on those who operate in the sector to continue to tell its story and continue to enhance ESG initiatives, as he said EnCap Flatrock Midstream endeavors to do.

Bowden said he sees it, too, and noted that the sector needs to confront that reality.

“Unfortunately, you’re seeing very little public activity in the market for midstream … and you’re seeing that in spite of improved valuations over the last four months and despite the fact that some of these companies have been profitable,” he said.

Bowden does not, however, perceive climate concerns as a problem for the midstream sector.

“I think [the sector] adjusted to the reality that it is actually a science,” he said. “It’s far from being the worst offender.”

Returns to the investormeaning not simply improved equity prices but also improving distributionswill come back to the sector because of what Bowden expects will be a 0% interest rate environment for the foreseeable future.

As frustrating as it may be to midstream operators, investors had good reason to keep their distance, he said.

“When you have equity values down by 30%, that’s a tough thing for the buy-side to get excited about,” Bowden said. “They were making money elsewherethey didn’t have to figure it out. With this rally, I think they’re going to have to figure it out and I think if we can actually improve this performance, we’ll see a return to an acceptable capital market environment in midstream.”

Bank Markets

To Bill Brown, managing director and executive vice president of energy banking for Cadence Bank, the downturn for energy began when prices started to soften in late 2019, before the COVID-19 pandemic shut down the global economy in first-quarter 2020.

When the rebound came, though, it was dramatic. Cadence has completed almost 30 deals in the last 18 months, but most of them were in the last six months. Brown broke down the banking activity environment into pre-COVID, COVID and post-COVID sections.

For example, midstream borrowers often took out revolver loans in the pre-COVID world. That was construction financing in which a portion of the project was funded up-front, contracts were signed and the borrower carried a balance via a revolving credit line.

“We did a number of those deals, had great success with them,” Brown said. “Those deals stopped during the COVID environment, in large part, probably, due to the lack of need for infrastructure. And frankly, it’s unclear whether that structure will come back. It’s been very popular with borrowers and we’ll just have to see if the market is receptive to that again.”

It is unclear which structures will prevail in the post-COVID environment, he said. They may include amortizing term loans based on the use of proceeds and capital structure. Amortizing term loans are paid off over the life of the loan, typically in equal payments.

“The hardest thing to judge is bank liquidity and capacity in the market,” Brown said. “Obviously, it was very strong for three or four years prior to COVID. All of this came to a dead stop last year, as you might expect.”

The future looks a little hazy at the moment. In June, ABN Amro Bank NV said it would withdraw from oil and gas lending in North America. Bank of Montreal (BMO) said in December it would wind down its U.S. oil and gas lending and focus on Canada.

“Frankly, it’s a little unclear right now,” Brown said, referring to the reaction in the wake of decisions by the two big banks. “There are some other banks that are trying to bring their exposure down and really just lending to a list of what they call strategic clients.”