(P&GJ)
– As chartered financial analyst with significant capital markets and merger-and-acquisition
(M&A) with experience spread over 22
years of positions in energy investment banking in Houston and portfolio
management and research in New York, Amol Joshi brings a broad perspective into
most any business discussion.
He
holds a mechanical engineering degree from the University of Bombay in his
native India and a master’s in finance from Pittsburgh’s Carnegie Mellon
University Tepper School. Since 2014, Joshi has provided his expertise to
Moody’s Investors Service in the Big Apple.
The
veteran analyst concentrating on exploration and production (E&P),
midstream and oilfield services has been watching the oil and natural gas
sector long enough to remember when the $80 billion Exxon-Mobil Oil merger was
the peak of a rash of mega-mergers.
At
the time of that 1998 combination it was considered the ultimate big bucks’
merger, but as one of Moody’s vice presidents and senior credit analysts today,
Joshi is observing and commenting on M&A in the midstream oil and gas sector
that could continue well into next year or longer. He can readily recite the
litany of combinations in recent months and years. These corporate marriages
are plentiful:
Dallas-based
fuel distributor Sunoco buying NuStar Energy in a $7.3 billion acquisition to
obtain the San Antonio-based last pipeline operator in a stock-swap transaction
in February.
There
were $12.5 billion of midstream deals announced through mid-March this year,
compared with $21.9 billion for all of 2023, according to researchers at
Enverus Intelligence Research (EIR). If the current pace holds, this year it
will be the biggest for midstream mergers and acquisitions since 2019, the EIR
researchers predict.
“Combining
complementary assets through M&A should offer significant integration
opportunities and increased connectivity, benefiting both producers and
shippers,” Moody’s Joshi said. “Rising regulatory scrutiny and increasing
difficulties in obtaining permits to build large projects such as interstate
pipelines, have slowed the investment that underpins midstream EBITDA [earnings
before interest, taxes, depreciation, and amortization] growth. M&A
activity is becoming much more appealing to midstream operators as a way to
provide growth, as traditional organic growth prospects slow.”
Joshi
adds the thought that sector consolidation does not necessarily add to
aggregate infrastructure, so he thinks it can be broadly beneficial to
individual companies’ credit quality. During his interview with P&GJ,
Joshi stressed that Moody’s considers the midstream M&A activity to be “accelerating”
currently, while for both E&P and midstream, organic growth opportunities
are limited now, driving more M&A.
Credit
Ratings Steady
In
adjusting credit ratings upward, Moody’s is looking for M&A deals that “create
efficiencies through scale and market share, enhance competitive positioning by
adding complementary assets, or improve access to export markets while still
achieving sound leverage metrics of the companies involved in the transactions,”
according to Joshi, adding that increased M&A in oil and gas has not caused
Moody’s to change its basic credit rating criteria.
“The
key factors we look at haven’t really changed, nor should they,” he said.
Organic
growth remains elusive for both E&P and midstream companies, Joshi said,
and it is largely equity investors preferring capital-disciplined companies,
meaning you only spend what you need to and don’t grow for the sake of growth.
So,
on the E&P side, that means capex has come down significantly, resulting in
the volume production growth being very modest,” he explained.
Underscoring
this fact, the U.S. Energy Information Administration (EIA) early in 2024 in a
short-term outlook projected flat growth for 2024, or essentially no growth in
’24 and modest growth in ’25.
“There
is little doubt midstream M&A is far from over if we recall recent history,”
said Joel Moxley, CEO of the GPA Midstream Association. “It’s clear that scale
is important – the ability to provide services across the midstream value chain
from the wellhead to markets in multiple basins. Consolidation in upstream
space [by producers] continues and is leading midstream M&A. As producers
increase in size and are active in multiple basins, they naturally look to
partner with midstream operators that can work with them in more locations –
both sides leverage their interactions to make the best commercial
arrangements.”
At
this year’s CERAWeek energy conference in Houston, presented by S&P Global,
various major financial news media, including Reuters News Service reported
that oil and gas midstream was becoming the focus of a lot of consolidation,
following all of the E&P action in 2022-23.
Reports
from CERAWeek described the midstream sector as in short supply of big
companies able to operate in multiple major basins, and thus, through
consolidation, more of the suppliers will be able to provide a fuller array of
processing, transport, storage and export services.
Importance
of Scale
“Scale
is definitely important,” Williams Companies’ COO Michael Dunn told Reuters at
CERAWeek. “Continuing to expand is certainly one of our goals.”
In
its annual report on oil and gas consolidation drivers, Colorado-based East
Daley Analytics predicts the M&A activity will continue throughout 2024,
noting that publicly held midstream companies have been “on a spree” since last
year.
East
Daley cited examples of Williams and Cureton Midstream/Rocky Mountain
Midstream, along with Kinder Morgan, getting the NextEra Energy Partners’ south
Texas gas pipeline assets.
“As
the midstream sector transitions into a lower-growth environment with
increasing regulations, we expect M&A to continue,” according to East Daley
analysts. “Companies will use mergers to gain scale, better position themselves
to take advantage of growing export markets and optimize their existing assets
in the ground.”
Other
well-regarded analysts, such as Housley Carr, at RBN Energy, and an online
financial reporter Elle Caruso, at ETF Database offered similar breakdowns of
the midstream space and the prospective M&A activity.
“It
could be argued that conditions for large-scale midstream M&A have never
been better,” Carr wrote toward the end of 2023, citing publicly held companies
looking to gain more and more scale, and private equity firms seeking to cash
out some well-planned developments.
In
March, Caruso noted that midstream operators have a key role to play in the
global energy transition, emphasizing that growth opportunities “remain
constructive,” with the energy transition being a key long-term opportunity for
the space.
“Both
renewables and fossil fuels will be necessary to satisfy future energy demand,”
she wrote in a Morgan Stanley Capital International, Inc. report. “The
projected increases in both population and energy consumption can’t
be supported by renewables alone. Importantly, increases in energy
consumption enable quality-of-life improvements.”
From
the prolific Permian Basin to the northeast Appalachian region’s natural gas
gusher, officials told P&GJ that M&A is not negatively impacting
U.S. energy production, and it only bids to help stabilize growth during some
complex socio-political-economic times.
“Right
now, the pause of LNG exports, I would think, has a much greater impact on
production and thus midstream activity than the M&A market,” said Stephen
Robertson, executive vice president at the Permian Basin Petroleum Association
(PBPA).
Some
Contradictions
Early
in the second quarter of this year, Robertson saw some contractions for PBPA
members until WhiteWater/I Squared and MLPX LP’s 580-mile Matterhorn Pipeline
project was to come online later in 2024.
He
noted in April that he believed the next significant capacity addition for the
Permian Basin will be the Matterhorn, but pointed out that the project is not scheduled
for completion until the third quarter, so operators in the Permian Basin will
likely have to deal with discounts on natural gas production in the meantime,
or longer.
“It
is my understanding that several producers might be timing their development of
new production facility additions to coincide with not just pipeline additions,
but processing plant additions as well, so even with new [pipe] capacity coming
online via the Matterhorn or other projects, that capacity is likely to get
filled quickly.”
Shortly
before Robertson made his comments to P&GJ, Austin, Texas-based
WhiteWater (50.6%), MPLX (30.4%), and Enbridge (19%) jointly entered into a
definitive agreement to “strategically combine” the Whistler Pipeline and Rio
Bravo Pipeline projects in a joint venture. Enbridge retains its 25% interest
in Rio Bravo.
At
the time, industry commentators said the combined platform should provide
significant benefits to the joint venture's customers by connecting Permian
supply to incremental LNG export markets via Rio Bravo's connectivity with
NextDecade's Rio Grande LNG facility.
Additionally,
the creation of this platform is anticipated to support the development of
incremental pipeline projects connecting Permian supply to export markets along
the Gulf Coast.
The
Matterhorn is an intrastate pipeline designed to transport up to 2.5Bcf/d of
gas from the Permian Basin to the Katy area near Houston. It includes seven
compressor and 21 meter stations. Ancillary facilities include mainline valve
assemblies, launcher/receiver assemblies, riser assemblies and other
appurtenances.
The
137-mile Rio Bravo project consists of 48- and 42-inch pipe to carry up to 4.5
Bcf/d of gas from the Agua Dulce supply area to Next Decade’s Rio Grande LNG
export facility in Brownsville, Texas. It has an in-service target date for
2026, and the LNG facility would start later this decade.
“The
combination of Whistler Pipeline and Rio Bravo Pipeline assets confirms the
importance of our Rio Grande LNG project as a major market for associated gas
from the Permian Basin,” NextDecade CEO Matt Schatzman noted at the time of the
joint venture’s creation.
For
the future, the jury is still out on how regulation and investment in the
midstream will unfold, but they are definitely intertwined as both Moody’s
Joshi and GPA Midstream’s Moxley point out. Larger midstream companies should
have access to capital to construct midstream infrastructure as long as
permitting time is reasonable and there are sufficient customers for the
projects, according to Moxley.
“Effectively, it means no new pipe is getting built, aside from some pockets in Texas and Louisiana; regulatory and siting issues are ongoing that affect the new pipe builds.”
– Amol Joshi, analyst at Moody’s Investors Service
“There
are few ‘build it and they will come’ investments in midstream – the customers
have to commit for long enough terms to make capital projects work,” he said.
And
as Joshi sees it, in addition to the volumetric slowdown, there is some heavy
regulation bearing down on the midstream side.
“Effectively,
it means no new pipe is getting built, aside from some pockets in Texas and
Louisiana; regulatory, and siting issues are ongoing that affect the new pipe
builds,” he said. “Given these two factors – volumes and regulations – M&A
activity becomes that much more attractive,” Joshi said.
It all amounts to the current limited avenues
to growth, as far as the Moody’s team is concerned. If the pie is not growing,
you always want to gain market share or get a bigger slice of the pie.
Midstream
is running a little behind E&Ps, according to Moody’s, but it has considerably
more public companies.
“Midstream
companies get the E&P companies’ product to market, so they continue to be
impacted by consolidation of the E&Ps,” Joshi said. “As the E&Ps get
larger and stronger, it means the counterparty or customer strength of the
midstream companies gets better, benefitting the midstream as well.”
Moxley
notes that the drivers for M&A are higher interest rates for debt and the
reduction in private equity investment in midstream, estimating the interest
rate hikes over the past year increased borrowing cost by 0.5%-1% as older debt
matured.
“This
increased cost goes directly to the bottom line as there are few ways to offset
this added cost with higher revenues,” he said.
During
CERAWeek, Jefferies Financial Group’s Peter Bowden noted that there now are few
privately held midstream operations of any meaningful scale following the many
sales in recent years. Hence, he thinks more public midstream consolidations
are “inevitable.” And the coming consolidations will most likely skip the
initial phase of private company deals that once was common for shale
companies, diving directly into strategic combinations, according to industry
observers like Bowden, the global head of Jefferies’ industrial, energy and
infrastructure unit.
In
the Williston Basin in North Dakota where the Bakken Shale continues to produce
more than 1 million b/d of crude oil and 3.5 Bcf/d of natural gas, producers
and midstream players are feeling the effects of the M&A trend, according
to Lynn Helms, director of the state Department of Mineral Resources.
“Producers
drilling budgets are definitely disrupted, especially if they are fully active
Bakken companies,” Helms said in mid-April when he reported that the state had
passed 6.9 billion barrels of oil production, with more than 5 billion coming from
the Bakken.
“With consolidation, operators have a tendency
to go back to the drawing board and reorganize their rig schedules and
reprioritize, so you have an entirely new rig schedule trying to coordinate
with the midstream folks to come up with gas capture plans,” Helms told news
media on a monthly production webcast. “We tend to see the merger of two very
different rig schedules and contracts, so everything gets reprioritized there,
and typically we will see one or two rigs fall off the schedule short term, if
not longer.”
GPA
Midstream’s Moxley said there are “normal adjustment periods” after an
acquisition when staff must be realigned to cover the new assets.
“Usually,
fewer people cover the newly acquired assets than at the old one, so some time
is lost as new people get up to speed,” he said.
New
assets must be integrated into the company’s culture, records systems, safety
programs, maintenance programs, etc. — all of which can take several months as
integrating the new assets into the existing business takes time to study,
evaluate, implement, and come online.
Moxley
noted that an important factor driving midstream companies’ hunger for larger
scale is the increasing costs of complying with new regulations, including
methane fees and greenhouse gas emissions disclosure requirements. He said “massive
amounts of data” are now required by the new rules.
“Complying
with these new rules requires resources – staff and systems – that reinforce
the importance of scale,” according to Moxley.
Generally,
Moxley and other midstream officials view the continuing consolidation as not
tipping the scales on capital spending up or down. If added service is needed
and the financial numbers crunching adds up, they say multiple companies will
usually bid for the work.
In
this regard, midstream M&A is not just likely, they say, it is inevitable. P&GJ
Richard Nemec is a Los Angeles-based writer and long-time contributor to P&GJ. He can be reached at rnemec@ca.rr.com.