Permian 2.0

The computer industry is well known for its short product life cycles, with new versions and upgrades launched yearly if not more frequently. In fact, the World Wide Web, whose information framework computers rely upon, is now on its third iteration—or version 3.0 in the industry’s parlance.

On the surface, there doesn’t seem to be much similarity between that industry and the oil and gas business. After all, there are plenty of 50+-year-old pipeline systems and natural gas processing plants still in operation. However, as the shale revolution has matured, new technologies and different approaches to old challenges have emerged.

Call it oil and gas 2.0.

The early years of the shale revolution in North America focused on unlocking plays that had a lot of potential, but had largely been untapped by producers since the first U.S. oil boom at the start of the last century. However, as drilling technology has advanced, producers have been returning to formerly prolific plays to unlock new reserves.

“It’s been an amazing transformation,” Robert Dunn, president of Prism Midstream LLC, told Midstream Business. “If you go back 15 years or so, everything in the Permian was about consolidation, downsizing, reducing costs and getting prepared for a long decline. Over the past few years, the Permian has been all about growth. It’s been a dramatic shift driven by the technological change and improved results from horizontal drilling.”

Size matters

The size of the play, at 250 miles by 300 miles and encompassing more than 15 million acres, is one of its popular aspects as it includes several multistacked formations like the Spraberry, Wolfcamp, Bone Spring, Avalon, Yeso, Glorieta and Delaware. The Texas Railroad Commission stated that the recoverable crude and gas reserves in the basin will exceed the region’s production from the last 90 years.

“The Permian Basin is the largest crude oil and natural gas-producing basin in the U.S.—three times larger than the Bakken Shale in North Dakota,” Sheridan Swords, senior vice president, natural gas liquids, ONEOK Partners LP, told Midstream Business.

According to the U.S. Energy Information Administration (EIA), the Permian is the most prolific oil-producing area in the country with production at nearly 2 million barrels per day (bbl/d) with 500 rigs in operation. That is quite astounding when compared to the 2007 production level of 850,000 bbl/d and even more so when the downturn in prices is factored in. The most recent data from the EIA as of press time had the Permian up 30,000 bbl/d on a month-over-month basis with gas production up 53 million cubic feet per day (MMcf/d) in February compared to January.

Where producers go, the midstream soon follows. That truism has been spot-on when it relates to the Permian. The play is among the top three oil plays in the U.S., along with the Bakken and Eagle Ford, and it may even become the largest of the three.

“The Permian Basin has grown at a pace unsurpassed in the U.S. My belief is if prices come back to sustain drilling it, the Permian will dwarf the Bakken and Eagle Ford,” Robert Milam, president and CEO of EagleClaw Midstream LLC, told Midstream Business.

Milam is very familiar with the region, having worked in the Permian since 1993. Prior to helping co-found EagleClaw with COO Curtis Clark, he served as vice president at Southern Union Gas Services, including coordinating the design, funding and construction of a 200 MMcf/d cryogenic processing plant along with an amine treating plant in the Permian.

Relationships matter

These relationships and experience matter in the region. Being new to the area certainly doesn’t preclude companies from finding success, but having well-established relationships is a definite positive, Milam said. “The Permian is definitely a relationship basin. When Curtis and I started EagleClaw in 2012, we decided to focus on the Permian Basin because of the many long-lasting and well-established relationships we have with producers and supply companies in the area,” he added.

Midstream companies like Canyon Midstream Partners LLC, which owns the James Lake system in Ector County, Texas, became a first mover in the play due to its flexibility.

“The decision-making process is a little faster in a private company because of the relatively flatter organizational structure than a larger organization,” Michael Walsh, president and CEO of Canyon Midstream Partners, told Midstream Business. “Part of the interest may be the willingness of a smaller company to seek higher risk-higher return potential projects than more traditional public midstream companies.”

Unlike most public companies, private equity-backed companies can also afford to stick with a project longer while it is at a smaller size. Prism Midstream and Kinder Morgan Inc. created the Pecos Valley Producer Services to explore gathering, processing and transloading opportunities in Reeves County, Texas. Kinder Morgan chose to withdraw from the joint venture (JV) but Prism is sticking with the project.

“We were unsuccessful with the gathering and processing opportunities and the rail opportunity is a slower one to develop so Prism kept on with it, but we no longer have the JV with Kinder Morgan,” Dunn said. “Kinder Morgan doesn’t see it growing to the size in the near future to be an opportunity that really fits them.”

Dunn added that while small companies need to be cognizant of not spending too long on these projects, they do have a longer leash on trying to turn them into a profitable project.

“We’re more willing to nurse it along as a small operation to see if we can make it into something larger over time. As a private equity-backed company, we have the ability to be more patient with projects like this where you see the opportunity but face fairly weak economics in the near term,” he said.

Permian opportunity

Independent operators also have a better chance at success in the Permian than in some other shale plays, Dunn said. “There is more opportunity for smaller companies in the Permian. There have been some smaller companies successful in plays like the Marcellus, but overall I think it’s harder for smaller companies in that region because of the capital and regulatory barriers in place,” he added.

This isn’t to say that large MLPs aren’t playing an important role in the Permian’s re-development. It would be hard to ignore the likes of EnLink Midstream LLC, DCP Midstream LLC and Energy Transfer Equity LP that are investing huge amounts into the region via both their MLPs and related general partners.

EnLink Midstream is currently constructing a 120 MMcf/d processing plant that will increase the company’s total processing capacity in the region to 240 MMcf/d when it completes in the second half. DCP Midstream owns and operates 17 processing plants with more than 1.3 billion cubic feet per day (Bcf/d) of processing capacity and 130,000 bbl/d of NGL production capacity and is further augmented by the Sand Hills Pipeline that provides access to the Gulf Coast. Energy Transfer Partners has a strong presence in the play thanks to its soon-to-be-completed merger with Regency Energy Partners LP, as well as its Lone Star NGL LLC JV.

Best of both worlds

These larger companies also provide experience for the leaders of many of the independent companies that are creating additional growth in the Permian. Many of the executives at these companies are using the experience they’ve accrued with larger public companies to develop the midstream systems in the region. In many ways, these companies are combining the best of a large MLP with that of a startup.

“Big public companies like Southern Union, Phillips 66 and Williams train you to make sure that your processes are in place as you move forward and that you’re not making instantaneous decisions,” Milam said. “At the same time, being smaller allows you to move quicker and act faster to beat a large MLP to the punch on connecting a well. We understand the drawbacks to working with large procurement groups, and we’re a lot more agile,” he said.

An example of this speed and quick decision making can be found in the way that EagleClaw adjusted its strategy as it began operations. Milam told Midstream Business that the company planned on building greenfield projects, but wound up taking the opposite approach by starting with an acquisition.

“We made a very small acquisition of about nine miles of pipe, which had an El Paso Pipeline Partners residue tap. That gave us the ability to have a processing plant up and running much faster than others because we were able to bypass the long delay for a residue outlet,” Milam said.

EagleClaw then secured acreage dedications, built a gathering system and a 15 MMcf/d refrigerated Joule-Thomson (JT) plant, and then acquired 50 miles of pipeline along with another 15 MMcf/d JT plant. These two systems are in the process of being tied together.

The asset mix

While EagleClaw’s approach in the play is reflective of the nature of the Permian itself—a mixture of greenfield and acquisitions—Canyon Midstream’s entrance into the play was through a pure greenfield approach.

“The opportunities we saw in the Permian were unique in terms of the rapid growth the basin was experiencing and the existence of fairly large legacy systems that were not investing or growing quickly enough to accommodate that production. It offered an interesting proposition of low resource risk to the midstream company, but also an interesting competitive dynamic where a new entrant could benefit from growing markets as well as potentially capture existing market share,” Walsh said.

The rapid growth of the Permian is leading to new pipeline construction, but legacy infrastructure can hold up the development as midstream companies must build around older pipelines. Source: Energy Transfer Partners LP

Indeed, Canyon’s James Lake system was built after the company reached an agreement for ExxonMobil’s XTO Energy subsidiary to operate as an anchor customer on the system. XTO had been a customer on a legacy system and elected in 2013 to bring these volumes to the open market when their contracts expired in 2015.

“They wanted to see if there was a new midstream provider interested in proposing terms to process these volumes,” Walsh said.

The system is located on a 100-acre site in Ector County, Texas, and includes 60 miles of gathering links along with a processing plant. The plant was originally designed to be 70 MMcf/d and was upgraded to 105 MMcf/d in the developing and design phase after several producers expressed interest in the project. The facility can also expand to include several more trains to increase capacity.

“We’re continuing to look at stepout opportunities around the James Lake system. There continue to be incoming calls and opportunities we see for new and existing volumes looking for an alternative to incumbent midstream providers,” Walsh said. Ultimately, Canyon intends to add a second plant to the James Lake location in order to improve reliability through redundancy.

Public companies can typically raise larger amounts of capital than private equity-backed companies, but they also have to depend on projects having accretive growth where private companies only need to focus on total rates of return and the project’s overall success. This helps companies through downturns in prices, according to Milam.

Strong outlook, near-term challenges

The downturn in West Texas Intermediate crude prices has resulted in midstream development being dialed back around the country with energy companies cutting staff and delaying or canceling projects. The Permian has not been immune to these sorts of cutbacks, but continues to benefit from its long history as those working in the region are experienced in working with the cyclical nature of the oil and gas industry.

Lower prices may result in a decrease in drilling, but they have not had a widespread impact on midstream projects in the Permian as far as 2015 is concerned. Instead, midstream operators are taking a wait-and-see approach to decide on projects in the 2016 and beyond time frame.

“We’ve seen a couple of plants pulled off that were planned to be put in this year. As drilling slows, those decline curves start catching up and existing capacity starts being sufficient. I still think there are new areas being developed that are going to be drilled because the producers are going to have to hold their acreage positions. So there are opportunities for new facilities and new areas to grow,” Milam said.

Bargain hunting

There are silver linings presented to some companies in the region, as with EnLink Midstream, which is viewing this downturn in the cycle as a chance to expand while shopping for bargains.

In February, the company announced a $600 million agreement to acquire Coronado Midstream Holdings LLC, which includes three cryogenic gas processing plants and a gathering system in the North Midland Basin of the Permian.

“EnLink is a strong vehicle for sustainable growth, due in large part to our financial position, which allows us to effectively expand in times like these,” EnLink president and CEO Barry Davis said when announcing the deal.

Milam agreed with this sentiment as EagleClaw is also considering several other acquisitions to add to its current system. “We’re actively looking at some opportunities. I think we’ll see a lot of greenfield growth within our system, but we are not opposed to tacking on fairly large pieces through acquisition,” he said.

ONEOK Partners made a large investment in the Permian in December 2014 with the $800 million acquisition of an 80% interest in the West Texas LPG Pipeline (the remaining interest is held by Martin Midstream Partners LP) and a full ownership interest in the Mesquite Pipeline from Chevron Corp.

“We anticipate these assets will provide fee-based earnings to the partnership and further expand our NGL segment’s portfolio while positioning us for additional growth opportunities,” Swords said.

The acquisitions increased the company’s NGL gathering system by more than 60% to nearly 7,100 miles and increased gathered NGL volumes to about 830,000 bbl/d. The company is planning two expansions at a total of $500 million between 2015 and 2019 as these pipelines were at near full capacity when acquired.

“ONEOK would potentially be interested in adding additional assets under long-term dedication agreements, should this become a need of our producer customers,” Swords said while adding that the company has customers operating in the Permian that are also customers in other basins in which ONEOK operates.

New construction, strong legacy

The Permian is in a unique position to other shale plays that require new midstream infrastructure in that it can draw upon tremendous amounts of legacy infrastructure, which can also create challenges of its own.

“If you are building pipelines in that part of the world, you’re crossing a lot of pipe and pipe crossings can slow your pace of construction,” Walsh said.

However, the ability to draw upon a pool of experienced professionals and the positives associated with existing infrastructure combined with a local community supportive of the industry overcomes any challenges presented by legacy infrastructure, according to both Walsh and Milam.

“The Permian is certainly easier to work in from the standpoint of access to knowledgeable service providers and vendors, but some of the density of the existing infrastructure can be challenging,” Walsh added.

“Even with a commodity price increase back to drillable levels, I think we’re going to be able to stay in front of the growth since so much infrastructure is already out there. The Permian Basin will not be as limited as the Bakken or Marcellus,” Milam said while noting the experience service providers bring to the play as they’re more familiar with the industry than in other parts of the country.

The processing need

One piece of midstream infrastructure in high demand in the Permian is processing plants. Milam noted that in the decade this century, the midstream was consolidating in the region and shutting down processing facilities. This meant that as the Permian began to get hot again, production was outpacing processing capacity, which created the need for new facilities.

“You’re seeing processing plants being revamped and coming back online along with a lot of newer capacity,” Dunn agreed. Going back to 2010, most of the volumes coming out of the Permian were from the Wolfbone play in the Midland Basin. This wound up exceeding gas fracking capacities and subsequently outstripped the NGL takeaway capacity capacities.

“No new processing capacity was being built until Lone Star Midstream and DCP Midstream Partners brought in their West Texas Gateway Pipeline and Sand Hills Pipeline [respectively], because there was nowhere to go with the product,” Milam said.

Despite the new infrastructure being built in the region, there is still a need for more gathering and processing capacity. Currently capacity is keeping pace with production, but this is due to the downturn in drilling. Once prices improve and drilling increases, production will once again exceed processing capacity.

“So many plants are being built, but producers can outstrip that processing capacity pretty quickly. I think the Permian Basin hasn’t even begun to see the growth it can see with supporting prices,” Milam said.

In the early days of the region’s renaissance, producers were able to take advantage of the older gathering systems in place. The need for new systems is growing as the Permian enters its redevelopment phase.

Legacy systems

“In certain areas older gathering systems can provide producers with a way to get production online quickly. Over time, some of the other systems will need significant upgrades or replacement, particularly as Permian producers start moving towards greater efficiency,” Dunn said.

This improved efficiency includes more multiwell pad drilling, which is bringing more volumes online at a single time compared to more traditional production the region has typically handled.

“The older infrastructure can buy you time as you get started, but you’re going to see a lot of the older infrastructure upgraded or replaced,” Dunn said.

Condensate’s rail answer

In addition to gathering and processing, another area with potential for growth is related to condensate and liquids takeaway. The long-term solution for crude takeaway capacity is fairly obvious with pipelines; most of the rail takeaway capacity being used is a short-term solution. However, rail has a longer lifespan when it comes to condensate.

“I think there is a better chance of rail takeaway being the answer because it’s more flexible and there is a very high cost to build a condensate-only pipeline,” Dunn said. “Rail also makes it easier for export because once you run the condensate through a distillation tower to make it an exportable product and put it on rail, you’ve kept it segregated from crude oil and have the ability to take it to a port and load it for shipping. Once you’ve made it an exportable product, if it touches crude again, you’ve lost that exportability.”

The one large condensate pipeline project in the region, Lone Star’s conversion of the West Texas NGL pipeline into crude oil/condensate service, will employ a 12-inch pipeline to ship 70,000 bbl/d from Midland to Corsicana, Texas, and 100,000 bbl/d to Sour Lake, Texas.

Committed to growth

Executives interviewed for this story said they remain committed to their growth strategies despite the pricing downturn. “We’ve recalibrated 2015 to reflect a little less growth in new production than we were planning for six months ago. It hasn’t really impacted our growth strategy in any way. We feel very good about our position and the volumes and producers we’ve been able to secure. The impact has moderated the pace at which we’re adding assets, but it hasn’t changed our expectations that those assets will ultimately be developed,” Walsh said.

DCP Midstream LLC Chairman, President and CEO Wouter van Kempen said that the company and its MLP, DCP Midstream Partners LP, are actively seeking to cut between $70 million and $100 million in costs as a response to lower prices. However, he compared this strategy to the company’s response to the 2008 and 2009 financial crisis.

“We took significant costs out of the business [then]. We deferred projects. We managed our headcount while maintaining a strong MLP. As prices recovered into 2010, we were well-positioned to capture the upside and expand our footprint in the DJ [Denver-Julesburg Basin], the Permian, and the Eagle Ford,” he said during a recent analyst and investor meeting.

Similar to DCP Midstream, Targa Resources has a super-system approach in the Permian that it anticipates will help it to withstand the price downturn as well as react quickly to producer needs when prices improve. Targa’s position in the Permian was improved through the completion of the $7.7 billion acquisition of Atlas Energy LP in February. The merger made Targa the second-largest processor in the Permian with 1.4 Bcf/d of processing capacity with more expansions on the backlog from both sets of assets.

“Our mindset is to be very efficient with the capital we’re spending on the field gathering and processing side while meeting our producers’ needs, and we will do that combined with the Atlas assets. For example, in the Permian, [we’re] even better because we’ve got an even bigger super system that can respond and have available capacity for whenever the uptick goes without having to spend as much capital early on,” Joe Bob Perkins, Targa’s CEO, said during an earnings call to discuss fourth-quarter 2014 results.

“The Permian will be a significant piece of the North American energy puzzle for decades. You’ll see a slowdown with the growth as a result of lower prices, but it won’t be an area that will fall by the wayside. After all, nothing cures low prices like low prices,” Dunn said.

Frank Nieto can be reached at fnieto@hartenergy.com or 703-891-4807.

Rangeland’s RIO Hub Gains Early Rail Foothold

The Delaware Basin, located within the Permian’s western boundary in Texas and New Mexico, serves as a microcosm of the Permian’s overall story.

Similar to the Permian, the Delaware Basin was a play whose best days were assumed to have been in the past. Like the Permian, it has been reborn thanks to new drilling technologies and efficiency. While the Permian has felt the impact of the downturn in crude prices, the Delaware has remained one of its most active zones.

“The industry is more bullish on the Delaware Basin,” Christopher Keene, president and CEO of Rangeland Energy, told Midstream Business. “For the longest time, it was the stepchild of the Permian with most of the activity in the Midland Basin. As the industry began exploiting the Delaware, it discovered a large number of stacked pay zones in the area and now the basin is one of the most economic production zones in the country.”

Rangeland’s crown jewel in the Permian is its RIO System in the Delaware Basin, which includes a 300-acre rail terminal used to handle inbound frack sand and outbound crude oil and condensate. The company is also building the RIO Pipeline that will connect the hub to its State Line Terminal on the Texas-New Mexico border via a 30-mile leg and then connect State Line to the RIO Midland Terminal via a 104- mile leg.

A Permian barbell

“We look at this as sort of a barbell with the RIO Hub on the far west side, State Line Terminal in the middle and Midland Terminal on the eastern side. All connected by the RIO Pipeline, a system capable of moving the region’s production to western or eastern markets, by either pipeline or rail. Once the initial footprint is established, we will aggressively grow the system organically through extensions and expansions,” Keene said.

The RIO Hub in Loving, N.M., was the first part of this system to be constructed and, while its ultimate primary role in the play will be to transport crude and condensate to market, its initial usage has been to bring frack sand into the region. This effort has been supported through anchor customer Halliburton.

“Frack sand really established the footprint for the RIO Hub. We know we’re early from a crude oil and condensate production standpoint, but we believe in the geology of the Delaware Basin. The production will come online and we’re standing ready for when the oil opportunity arises. I like to say we service producers on the front-end with frack sand and on the back-end by providing multiple options for exporting their production to high value markets. That’s our competitive advantage,” Keene said.

This initial use of the hub to transport frack sand is one of the main differences between the RIO Hub and Rangeland’s previous railroad terminal project in Epping, N.D., the COLT Hub. The location of each hub is similar on a population-density basis with RIO slightly larger. However, the COLT Hub is focused entirely on crude oil.

Sand, then oil

“We came into the Delaware with RIO a little earlier in the basin’s exploration and production cycle, so the initial demand for RIO was sand to support fracking activities. Producers needed sand in significant quantities, which means unit trains and a large-scale facility like RIO has the capacity to store and stage sand on a large scale,” Keene said. “We will also be able to store and stage crude and condensate when the time is right.”

Rangeland has applied a lot of lessons from the COLT Hub, which it sold to Inergy Midstream LP (which merged with Crestwood Midstream Partners LP in 2013) in 2012, to develop the RIO Hub. These include the engineering and designing of the facility, as well as the commercial aspects of working with customers and railroads.

“Even though COLT worked extremely well, and continues to work extremely well, it’s always easier the second time around,” Keene said. Another similarity between the two hubs is the inclusion of truck receipt capabilities. This is something that Rangeland does with each of its terminals in order to provide further optionality for customers.

One thing that is likely to be different between the two projects is the amount of time they spend in Rangeland’s portfolio.

“The COLT Hub was a bit of an anomaly for us—it was the right asset in the right play at the right time. The market responded and a very rapid exit was the end result. We’re in for a longer run with the RIO Hub. We’re going to develop it, operate it and grow it along with the industry over the years,” Keene said.

Rangeland has quickly made a name in the midstream for its rail terminal projects, but Keene noted that pipelines will remain the transportation source of choice.

“I’ll be the first to tell you that even though Rangeland owns and operates rail terminals, in most cases pipelines are the most cost-effective and efficient way to move crude oil,” he said. “However, in those cases where either a pipeline doesn’t exist to a refining center or doesn’t have a chance of being constructed because of cost or environmental reasons, rail provides a viable opportunity for refiners to tap into low cost crude supplies.”

—Frank Nieto