With the slowdown in drilling due to several issues, including quarantines related to the coronavirus, combined with frantic construction of pipelines over the last four years, pipeline shortages may soon be over. A trade agreement with China, which had promised to jumpstart petroleum exports to that country, has been dampened by that same virus due to the fact that quarantines have crashed energy use there.
There is still cause for optimism in the midstream sector, said Permian Basin Association of Pipeliners President Jason Wolf. Takeaway capacity should catch up with production this year and, said Wolf, “I think the midstream companies are pretty excited about it because now there’s more opportunity for the joint ventures to tie in some more local midstream capacity with a broader global capacity.” This would transport production to the Gulf more freely, to where “you’re no longer constrained on supply.”
Price stability would be the goal as long as “that price is at a higher point that allows more producers to open up their fields. It’s a big domino effect from the ports all the way back to the wellhead.”
Oil expansion is good, but with concerns about gas flaring on the rise, Wolf is especially excited about the boost in gas takeaway capacity. He discussed new LNG export facilities from Chenier and other firms at the Port of Corpus Christi. “Being able to get the gas out of the Permian—that’s huge for us—and get it over to the European markets, some of those places that are getting $8 or $9 per mcf,” as opposed to the under $2 prices in the United States.
He hopes new takeaway capacity will create a marked reduction in flaring by the end of 2020.
Having China return as a customer is important. “It’s good to be seeing some of those tariff wars in our rear-view mirror,” he said, “and some of the agreements coming together so that we can take advantage of those emerging markets.”
Maybe those export options will restore investor faith in midstream, he added. “I’m thinking it still remains a great location for people to invest dollars into and have optimism about the future.”
Although environmental groups have protested various pipeline projects around North America, Wolf countered, “The pipeline industry remains the safest form of transportation. It’s better than the rails, it’s better than trucks, it takes vehicular traffic off the road and rail cars off the lines, and it puts [product] safely, from one point to the other,” in a format that’s out of sight most of the time.
Engineering the Future
Perhaps the most visible effect of the lack of takeaway capacity is the yellow glow of the night sky as flares burn associated gas that can’t be sold. Gulf Interstate Engineering, a Houston-based firm that does pipeline design and oversees construction, is helping midstream companies catch up with the takeaway needs. Shari Davis, the firm’s director of midstream processing, said depressed gas prices are slowing pipeline growth for that commodity.
“They are a little bit slower coming in than oil pipelines because the economics are not there. It’s supply and demand,” she said.
Much of the gas that does enter the system flows to the Gulf Coast to be chilled into LNG for export, to Europe and China, she noted, where—due to coronavirus quarantines, demand is less than expected.
Long term, however, Davis sees a bright future for natural gas. “Over the next 20 years, the demand for natural gas will dramatically increase to support electrical power requirements. As the world population continues to grow, the demand for electricity will increase. New power plants will be built that use natural gas instead of other sources like coal.”
Environmental approvals are hard to obtain for all types of pipelines and regulatory issues are more stringent for gas pipelines, further slowing the process. “For new gas pipelines, priority is given to obtaining the Federal Energy Regulatory Commission (FERC) permits required to construct these pipelines. Unfortunately, it is difficult to speed up that part of the construction process,” she pointed out.
Davis’s view of the China trade situation is that the tariffs accomplished their purpose.
“The whole point of that tariff was to drive pipe purchases back to the United States, where the U.S. mills would get the orders and we would produce more pipe here,” Davis said. “In that respect it worked, because our clients are definitely buying U.S. pipe.”
Whether tariff relief will have an impact remains to be seen—if midstream firms will switch back to Chinese mills or not. U.S. mills do have the advantage of lower shipping costs, from mills in Pennsylvania and elsewhere in the northeast as opposed to thousands of miles across oceans, then traveling by train or truck overland from ports like Houston.
The shift to U.S. mills did improve product integrity, Davis noted. “It’s really important that we have the materials of origin when we’re dealing with pipelines, or any materials we’re using in the oil and gas industry. In the past, we were having integrity problems with materials coming out of China. With U.S. products, we still track materials of origin, but we’re not as concerned as we are with materials coming over from China.”
Shifting to U.S. product created a de facto price increase because the Chinese were significantly undercutting U.S. prices in order to get the business. This shift, combined with lower market prices for oil and gas, created a challenge for the midstream sector. “There was actually a double whammy during this time [2018]—steel prices increased, but oil prices also plummeted,” Davis recalled “We saw many projects cancelled because the economics were no longer viable or deferred until oil prices recovered.”
Steve Reese, Expert
It’s sort of like when you’re speeding down the highway to an urgent appointment and you suddenly slam on the brakes upon learning that the upcoming bridge is out—that’s since mid-March in the oil patch, and pretty much everywhere else.
But the pain is not equally distributed along the up-, mid- and downstream sectors, said Steve Reese of Steve Reese Consulting. “I don’t think midstream has been hurt nearly as bad as the producing side,” he said.
In fact, for some midstream firms, this price-based panic stop is a buying opportunity. “Thankfully, all my clients are still swimming with their heads above water, and a couple of them are very actively and aggressively pursuing acquisitions.”
Though things are and have been a challenge for under-capitalized companies, Reese says a recent spate of private equity (PE) backed midstream companies are in a better place. “On any of the newer deals that they did on any sizeable scale, they had throughput guarantees,” which would involve paying a penalty if certain production volumes are not met.
Contracts for large fields may extend out 10-15 years, with throughput commitments are triggered annual, with a focus on the first 3-4 years, when the midstream company wants to recoup its capital expenditure.
The only risk for those pipeline companies would be if a producer could neither meet the throughput quota nor write a check for the penalty.
Another helpful factor for midstream is that production has outstripped takeaway capacity for more than two years, so some dropoff in production would only balance the equation. And, said Reese, some midstream companies are delaying or cancelling new projects.
“People like OneOk have suspended some greenfield projects, but the ones that are pursuing building new assets are probably seeing prices for different services come down,” he noted.
Every pipeline has two ends—input and output. Midstream decisions are driven not only by what is or is not coming it, but also by whether there is anyone to take it at the output end. With worldwide quarantines and travel restrictions, will that reduce the market for U.S. oil and gas?
“I think it will some,” Reese said, “but I’m seeing a mixed bag…. I see LNG firms continuing to ratchet things up and get ready. They’re still putting money into land and assets, liquefaction.” Also, natural gas prices were already cheap, so that also creates a buying opportunity for domestic end users looking to reduce fuel costs.
LNG exports pointed toward Japan, China, and elsewhere in the Far East will be hurt, at least temporarily. Which is ironic in light of the recent trade agreement in which China agreed to greatly ramp up imports of crude and refined petroleum products from the United States.
Low prices will also make natural gas much cheaper than wind and solar, creating at least a short-term setback for those renewables.
Tea leaves; crystal balls; fortune cookies. Are these the commodities to own stock in these days? Yogi Berra is quoted as saying, “The future ain’t what it used to be.” We all see that it’s not what we thought it was going to be—who could have predicted quarantines and the fallout from all that the new decade has brought in?
But for the prepared, there are still opportunities. There always are. And that’s the hope for the future
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By Paul Wiseman