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McClendon noted for midstream impact

The petroleum industry lost an iconic figure with the death of Aubrey McClendon in a tragic single-vehicle crash in Oklahoma City. The March incident occurred shortly before he was due to make his first court appearance to answer conspiracy charges of alleged bid rigging on leases in northwestern Oklahoma.

He was most closely identified with the upstream side of the business. He was founder and CEO of American Energy Partners LP and earlier had been co-founder and CEO of Chesapeake Energy Corp., which he left in 2013.

But McClendon’s role in pushing Chesapeake to develop unconventional shale plays helped spur the ongoing buildout of North America’s midstream infrastructure. At its zenith, Chesapeake was the nation’s second-largest natural gas producer with a significant demand for gas processing and transportation services and a large midstream subsidiary.

Chesapeake spun off those midstream assets as Access Midstream Partners in 2012 with Chesapeake executive J. Mike Stice named as its CEO.

A Raymond James & Associates research report said of McClendon, “If there was a Mount Rushmore of the shale revolution, his face deserves to be etched in stone.” Tudor, Pickering, Holt & Co. called him “one of a kind” in an analyst report.

Alan Armstrong, president and CEO of The Williams Cos. Inc., told Midstream Business that “Aubrey was a man of action whose vision for creating a North American energy renaissance came true. His hard work had a pro-found impact in shaping our industry’s ability to develop our domestic natural gas resources while strengthening our nation’s economy.”

Beyond business accomplishments, Stice is one of many who noted McClendon’s contributions to the community—particularly to benefit his home town.

“Oklahoma City lost a truly great man,” Stice told Midstream Business. McClendon was “a visionary entrepreneur who loved people and the quest for excellence in everything he did. I loved this man and was proud to call him my friend.” Stice is now dean of the Mewbourne College of Earth and Energy at the University of Oklahoma.

Tom L. Ward, chairman and CEO of Oklahoma City-based Tapstone Energy, called McClendon’s death “heartbreaking,” and added, “I have never met a man who worked harder or had more love for his state than Aubrey McClendon.”

Oklahoma Gov. Mary Fallin said that “Aubrey will be remembered for his innovations in the oil and natural gas industry, his civic generosity and being a driving force to help grow economic opportunities for Oklahoma. He was a visionary who raised the profile of Oklahoma City.”

Sabine ruling reveals sector’s Achilles’ Heel

A judge’s recent ruling in the Sabine Oil and Gas Corp. bankruptcy case—while unlikely to devastate the midstream industry as feared—nevertheless exposes the sector’s near-term vulnerability in its contracts with struggling E&P companies.

U.S. Bankruptcy Judge Shelley Chapman of the Southern District of New York authorized Sabine to reject certain gathering and processing agreements with Nordheim Eagle Ford Gathering LLC and HPIP Gonzales Holdings LLC. Sabine had argued that it was no longer able to deliver minimum amounts of natural gas and condensate and was subject by contract to deficiency payments that would cost the company $35 million. Drilling an uneconomic well to avoid payments could cost it between $2.5 million and $80 million.

Mark Sherrill, a Houston-based partner specializing in energy bankruptcy issues for the Sutherland Asbill & Brennan law firm, anticipated the ruling given comments made by the judge a month earlier. But the decision still stunned many in the midstream who believed the sector could, for the most part, ride out this downcycle because contracts locked in cash flow, hydrocarbons or no hydrocarbons.

“I think that we shouldn’t necessarily interpret this as a wide-reaching, universal ruling, either,” Sherrill told Midstream Business. “The decision reached in the Sabine case is to some extent just based on the exact language that was in the contract and the way that gets treated under Texas law, so there could be different results if the same issue got litigated in different cases.”

A number of other cases are being closely watched by the industry, with Sherrill expecting the tactic introduced by Sabine’s counsel, Kirkland & Ellis LLP, to be repeated.

“It’s already pretty far underway in one bankruptcy case, the Quicksilver Resources case, and … it was commenced in another bankruptcy case, which is the Magnum Hunter case,” he said. “It’s clearly, to some extent, given a green light to other producers to drive this as a tactic, and even if they don’t bring it fully before the court, it gives them a strong negotiating chip with the midstream companies, unfortunately.”

It remains to be seen how those cases will be determined, Sherrill said, and rulings could vary based on the individual contract language and the state law that governs the agreement. Until then, it’s unclear what midstream operators need to do to improve contractual language to avoid unfavorable rulings in the future.

“It looks like we will be able to make those fixes,” he said. “There’s reason for some optimism going forward but it might be a very messy situation with regard to existing contracts.”

Analysts covering the sector also focused on contract renegotiations as the major takeaway from the Sabine ruling.

“This ruling should give E&Ps significantly more leverage in these discussions, as the threat of filing and canceling these contracts is now likely more legitimate,” wrote Kristina Kazarian of Deutsche Bank. “While this is not necessarily the first step a producer would want to take, it may appear to be a more viable option for those with significant midstream commitments that they see as onerous.”

Tudor, Pickering, Holt & Co. noted that there were other midstream contracts held by Sabine that they did not attempt to reject. “These appear to be written with language that elevates them to a claim that ‘runs with the land’ status,” the analysts wrote, adding a warning: “In the current environment, a midstream investment decision should assume some E&P counterparty risk, particularly as it relates to above-market fees and/or minimum volume commitments above current production levels.”

What could be especially unsettling to many is the aggressive stance taken by an upstream producer against a midstream partner.

“Their statements in court suggest that they believe they have some alternatives, but certainly midstream companies will have some cause for concern,” Sherrill said.

“I think under more normal market conditions you might not see quite as aggressive a move from the producers,” he said, “but with the commodity markets as they are, I suspect that forced their hand a bit.”

Investors feeling more secure on midstream

The atmosphere at the third annual Capital Link Master Limited Partnership Investing Forum in New York City was one of uncertainty mixed with optimism. The feeling from the majority of the speakers was that there are still concerns over when the industry will begin to recover, but the MLP sector still represents plenty of solid investments.

The atmosphere at the third annual Capital Link Master Limited Partnership Investing Forum in New York City was one of uncertainty mixed with optimism. The feeling from the majority of the speakers was that there are still concerns over when the industry will begin to recover, but the MLP sector still represents plenty of solid investments. Fears over the impact of producer bankruptcies on the midstream were well founded given the decision by the U.S. Bankruptcy Courts that allowed these companies to reject midstream agreements. However, the feeling was that even if more bankruptcies take place, many midstream contracts would be honored since it remains economic to produce. In addition, the bulk of midstream operations serve high-quality customers that aren’t in trouble.

“The vast amount of production comes from investment-grade companies,” Kessens said while noting non-investment grade producers only make up about 1% of all domestic production. “If the recent $8 billion of successful producer equity offerings indicates anything, it’s that balance sheets are only getting healthier and bankruptcies are largely the exception.”

Kessens’ colleague at Tortoise, Brian Sulley, who serves as vice president, business development at the firm, added that there is still room for growth opportunities in the midstream. “There is a lot of short-term volatility, but long term there’s lot of need for infrastructure, especially with pipelines,” he said.

There was cause for concern over when a recovery would begin among speakers with many analysts advising that it would be prudent for some MLPs to maintain, or even slightly drop, distributions until the market improves.

Shneur Gershuni, executive director, equity research MLPs and natural gas at UBS, said that part of the downturn in the MLP sector has been caused by too many MLPs sending out too much of their capital and not maintaining enough of it to fund operations. While this move may have satisfied investors, it didn’t help the bottom line when that cash flow slowed down.

“An MLP’s stock price doesn’t allow them to pay off debt, which a distribution cut does,” Selman Akyol, managing director at Stifel said while agreeing with Gershuni’s assessment during a panel discussion.

The MLP market is unlikely to experience a full recovery in 2016, but there are positives for the sector as banks and other institutional investors are willing to allow companies to meet debt payments and provide access to capital during this downturn.

Finance expert says time to invest is now

Midstream gas operators at IHS CERAWeek in Houston, seeking to divine a strategy to return to the good old days, may have been startled to learn that those days weren’t all that great.

“We’ve had an amazing five years with a lot of growth in the energy industry,” Salim Samaha, New York-based partner with Global Infrastructure Partners told attendees of a panel on financing natural gas projects through the cycle. “What kind of returns have people actually generated?”

Samaha’s team crunched the numbers and found a median of 12x—not something, he said, to write home about.

“Now some people have done very well,” he said. “Others have done very poorly, but on average as an industry, the returns have not been as advertised, and we’re not even looking at the downturn we’re going to have in 2016 on some of the contracts and potentially, some of the upstream bankruptcies that are going to impact the sector.”

What happened to the shale boom?

It was still there, but the benefits largely accrued to those with well-structured, cost-effective projects. In the current down-cycle, those companies continue to be positioned for growth.

“If an energy company does not have a conservative capital structure and access to liquidity, which is very important, then not only will they not survive, potentially, but more importantly they are going to miss some very interesting opportunities,” Samaha said. “Today is an incredible investing opportunity but if you don’t have the liquidity or the capital structure, you’re not going to be able to take advantage of that.”

Execs warn that some MLPs won’t survive downturn

The stretch until midyear will be brutal for the midstream, but the sector’s survivors can expect both stronger commodity prices and a stronger industry.

A trio of leading executives mixed optimism with a cold, hard reality check at IHS CERAWeek: Well-run companies will make it through this rugged downturn intact and others will likely either be absorbed or die.

“The next 120 days probably will be as difficult as anything we’ve seen in the last 30 years,” said Greg Armstrong, chairman and CEO of Plains All American Pipeline LP. “Because of that, I think we come out the other side a little bit healthier as an industry.”

Echoing Jim Teague, CEO of Enterprise Products Partners LP, Armstrong insisted that the low prices were not sustainable and would result in production cuts that will trigger a rebound.

“We’re actually pretty optimistic in the latter part of ’16, first part of ’17 that we’ll be in the $55 range,” Armstrong said. “I don’t think we’re believers that this is a three-to-four-year cycle.”

The three, which included Gregory Ebel, chairman, CEO and president of Spectra Energy Corp., agreed that strong business structures would endure, while relatively recent, debt-propelled MLPs would struggle.

“You can’t use financing vehicles for the wrong purpose,” Ebel said. “If you’re going to use something that pays out 100% of its cash flow, or even 80% or 90%, you better be darn sure that the cash flow comes in. And when they get abused then you see them get eliminated.”

Ebel repeated his long-held prediction that a massive consolidation or elimination of many MLPs in those circumstances would happen at some point, either through mergers, acquisitions or consolidations by general partners or bankruptcy.

Teague’s mantra, “We build systems, we don’t collect assets,” is how he explained the strength of Enterprise Products as an integrated company serving customers along the value chain.

“(The product) comes out of our plants, goes into our pipe, goes into our storage and our downstream system,” he said. “It gives us the ability to bundle services for either producers and consumers. Our job is to sell the product that the producer wants and the consumer wants, and we’ve got the tools to do that even in this kind of environment. Those companies that can’t do that—they are the ones at risk.”

The executives hinted that while their companies grew in accordance with solid business plans over time, the newcomers may have had it too easy.

“In 2011, we had about 70 MLPs and today there’s over 120,” Armstrong said. “The chances of there being, just in that short time period, 50 or 60 MLPs that were developed with very solid business plan and a cohesive asset base and the ability to execute it is pretty slim.

“What happened was, there was a lot of cheap capital out there and all you had to do was spell M-L-P—you didn’t even have to get the letters in the right order—to raise a ton of money.”

The difference between the young MLPs and a company like Plains All American is that the latter offers a business value chain and end-point market. Armstrong said he believed these qualities would allow his company to thrive in any structure.

“There are other MLPs out there that have one asset over here and one asset over here and it may be oil here and it may be gas here and processing up there,” he said. “They’re not integrated, but they are of the market, so I think what you’ll see is that the MLP model is broken.”

Despite their positions of relative strength, the executives were not enjoying the low-price environment.

“People keep calling it a cycle,” said Teague. “I call it pure hell.”

Global chemical M&A activity to remain robust in 2016

Mergers and acquisitions (M&A) activity in the global chemical sector experienced a strong year in 2015 with 612 announced transactions worth $148.8 billion. Sixteen of those deals each amounted to more than $1 billion, helping to set a record for total deal value exceeding the previous year.

Building on the robust momentum experienced in 2015, global M&A activity is expected to remain strong this year with continued portfolio realignment and consolidation plays in various segments, according to a recent report, titled “2016 Global Chemical Industry Mergers and Acquisitions Outlook,” from Deloitte Touche Tohmatsu Ltd. (Deloitte Global).

“I think it’s the lack of growth in the industry,” Duane Dickson, global and U.S. chemicals sector leader for Deloitte, told Hart Energy. “We started to see a tapering off of growth rates and we started to see earnings announcements in the industry that would suggest that the outlook for growth is all kinds of tepid. If organic growth is coming, then the growth usually comes best from acquisition or inorganic growth.”

Companies are increasing their focus on developing core strengths and are looking to use M&A as a tactic to deliver growth and greater shareholder value, and also to counter challenging business conditions, according to the report.

The fertilizers and agriculture chemicals, diversified and industrial gases segments are all likely to see a boost in M&A activity this year with expected higher deal volumes, the report noted.

According to Dickson, the agriculture science sector is one that’s expected to see the most activity in 2016. “No. 1, I think it’s more of the attractive segments. Also, there are companies that really do see the advantages of the scale and breadth of technology being important,” Dickson said. “That, plus the actual end-market, has a very good outlook for the next 10 to 30 years. We are going to see consolidation and strategic buying in that area.”

Tax-free spinoffs and divestitures are notable trends driving portfolio change, according to the report, as companies position themselves for growth and innovation.

“My read on portfolios changing the industry: it’s certainly at a 30- to 40-year high right now. It’s happening differently with spinoffs and a lot of divestitures and mergers. I think we are seeing a rate of portfolio change, and that’s really being driven by the need to focus. The fundamentals are becoming very clear,” Dickson said.

The outlook reported that strong spin-off activity is expected to continue this year into 2017, following similar levels experienced in 2014 and 2015.

According to Dickson, digital design and advanced manufacturing will also open up new boundaries for materials innovation.

“New technologies are much more flexible and they have a faster cycle time to market than they have had in past decades. We’re sort of dealing with a three- to five-year cycle time vs. greater-than-10-year cycle times for innovation. They use existing materials and advanced processing technologies, and that also allows the programs to be targeted much more at specific solutions and specific end-markets. When you start to see that, that’s where the acquisitions are going to start coming,” Dickson said.

However, Dickson explained that new technology deals will most likely be on the smaller side, but will be profound as companies position themselves to take advantage of growth and solutions in some of the key end-markets.

Studies affirm petrochemical promise of Marcellus-Utica

A series of four academic studies have concluded that not only can the Ohio-Pennsylvania-West Virginia region support a downstream cluster, but in significant ways the area boasts advantages over the massive petrochemical complex on the U.S. Gulf Coast.

Andrew Thomas, who runs the Energy Policy Center at Cleveland State University as its executive-in-residence, told attendees at Hart Energy’s recent Marcellus-Utica Midstream Conference that, despite the buzz in the region about construction of new crackers, the economic development agencies supporting the research see the potential for long-term growth from a cluster of operations. What they needed to support their claims was hard data that the studies provided.

The researchers found that the region’s potential for ethane production was better than expected. Some of the earlier data relied on results from wells away from the sweet spots. More recent data, recorded from high-pressure zones of the Utica, allowed projections of about 9.3 billion cubic feet per day (Bcf/d) of wet gas by 2020.

Assuming 6 gallons of liquids per thousand cubic feet of wet gas, and assuming 60% ethane and 20% rejection, the researchers reached a likely production total of about 638,000 barrels per day (bbl/d) by 2020. However, the region’s fractionation capacity is only about 371,000 bbl/d.

“That means there’s a shortfall for fractionation, and we have to reject more of the ethane if we don’t build additional fractionation capacity,” Thomas told the Pittsburgh conference. “From speaking to the industry experts, our conclusions were that if there was a market for the ethane, it would not be difficult for them to add the additional infrastructure and get the de-ethanization up to the 600,000 range for the capacity.”

The region’s location is a major plus. Researchers used a rule of thumb of one day’s truck drive from the region, or about 500 miles, and discovered that 56% of the nation’s gross domestic product (GDP) was within that radius. By comparison, only 35% of GDP is generated within a 500-mile radius of the Texas Gulf Coast, only 42% of the Louisiana Gulf Coast and only 7% in the radius of California.

Many of the leading states for bulk chemical commodities are in that radius as well, including Ohio, Indiana, Illinois and North Carolina, not to mention Pennsylvania and New York.

Among other draws for companies wishing to build a cracker, Thomas mentioned:

Water access: “The four crackers that have been proposed for our region are all located on the Ohio River. The reason for this is obviously important for purposes of margin and finished product, but it’s also important for bringing in large equipment from Japan. It’s easier to barge them in than to try to take them in by pieces in trains.”

• Rail infrastructure (with a need for 2,000-2,500 rail cars): “A lot of this relates to the legacy in West Virginia and the Ohio Valley region in terms of the chemical industry that was once very active there.”

• Competitively priced electricity: “This is very important to the chemical industry. We’re going to get more and more gas generation that will constrain the cost of electricity.”

• Skilled and educated workforce: The Gulf Coast also has a skilled and educated workforce, but that it is largely taken up with expansion of that area’s petrochemical industry. In the Northeast, the workers are available now.

A significant drawback is the lack of storage available in the region, but midstream operators have developed strategies like pipeline redundancy and line packing to compensate. Ultimately, the proximity of companies that buy the products will sharply reduce transportation costs, resulting in a cost savings advantage of 14 cents to 20 cents per gallon over the Gulf Coast.

Vitol CEO: cheap oil prices to last at least a decade

In one of the most bearish calls yet, the head of the world’s largest oil trader, Vitol Group BV, said that cheap crude oil prices could last another decade due to a slowing Chinese economy and the ability of U.S. shale producers to ramp up production whenever prices do rise.

“It’s hard to see a dramatic price increase,” CEO Ian Taylor said in an interview with Bloomberg Television, adding that “we can’t say for sure that the price has bottomed out.”

Taylor believes that oil prices will trade within a range with $50 per bbl as the midpoint.

“We really do imagine a band. I can see that band lasting for five to 10 years. I think it’s fundamentally different,” Taylor said.

He estimates a price band of roughly $40 per bbl to $60 per bbl.

“You have to believe that there is a possibility that you will not necessarily go back above $100 per barrel, you know, ever,” he warned. However, Taylor said that he predicts Brent prices to rebound to around $48 per bbl by year-end.

When it comes to the downstream, Taylor admitted that 2015 was a good year for refining margins, positing that they were “much better than probably we all thought it was,” particularly when it comes to gasoline.

For 2016, however, Taylor sees a challenging margin environment for the global refining sector relative to 2015.

“I think 2015 going into 2016, if we assume, which is probably what we all feel at the moment that demand isn’t going to be quite as strong as it was 2014 vs. 2015, in other words we think the demand numbers in 2015 look like they’re going to be something like 1.5 million barrels per day, probably not quite as strong in 2016,” Taylor said.

“My overall feeling is that margins will be a little less than they were in 2015, so we’re going to have a slightly tougher time in 2016 than we did in 2015,” he noted.

Pending regulations: brace for impact

A step change on the part of industry to reduce methane emissions has failed to fend off new federal efforts to regulate it, which will result in a huge impact on the midstream sector, a senior official with the Gas Processors Association told attendees at the Marcellus-Utica Midstream conference.

“We’ve seen methane emissions decrease—not because of EPA [U.S. Environmental Protection Agency] but because of industry—by 35%, yet at the same time they’ve increased production since 2007, in the same time period, by 22%,” said Matthew Hite, the trade group’s Washington-based vice president for government affairs.

“Just get out of the way and let industry do its job,” he said. “The reductions haven’t been based on the EPA’s efforts. They’ve been based on industry getting out there, stepping up and reducing emissions.”

The proposed methane emissions regulations are part of the Clean Air Act and are what Hite called one of the pillars of the Obama administration’s efforts to meet guidelines of the agreement signed at the United Nations COP 21 climate change conference in Paris last November and December.

But it’s not the only pillar, he said. The Clean Power Plan, the final version of which was introduced last August, inserts a type of “cap and trade” mechanism into the regulatory process. In the 14 months of negotiations leading to the final version of the rules that would be enforced by the EPA, natural gas lost out to an intense lobbying effort by the renewable energy industry, Hite said. This despite U.S. Energy Information Administration statistics that showed gas surpassing coal in use for power generation during parts of last year for the first time.

“The fact that you’re going to have a decreased role for natural gas for no reason whatsoever is extremely problematic,” Hite said. “This is something to keep an eye on.”

Another issue that will likely sneak up on many operators involves the federal Bureau of Land Management (BLM). New rules mandate upgrades to measurement equipment that gauge production on federal land. Hite noted that many in the industry will not pay much attention to this, assuming that the regulations do not apply because their measurement points are on private land. Where the measurement equipment is located, however, is irrelevant if the hydrocarbons are flowing from federal lands.