The robust appetite of private equity for capital to finance their growing portfolios of midstream oil and gas assets at various stages of development, construction and operation has led to a number of innovative financing structures in the sector of late.
Growth of Private Equity in Midstream Oil and Gas
The Midstream Sector At a Glance
With more than $770 billion in enterprise value in 2019, midstream continues to be a large component of the oil and gas sector in the United States.1
In terms of pipelines, the U.S. network is the largest in the world, extending about 3 million miles.2 This network contains an extensive sub-network of gathering lines, extending from main pipelines into regional producer areas.3 For crude, this sub-network extends over nearly 75,000 miles. For natural gas, whose development is a more recent phenomenon, the gathering line sub-network is less extensive, but growing quickly. Shipment of crude, natural gas and other related products by pipeline in the United States quite simply dwarfs all other means of transport. This sector is predicted to grow even more in coming years. The reasons for this growth are multiple.
Growth Factors
The extensive pipeline infrastructure in the United States has allowed the oil and gas industry to thrive, connecting regional markets to other regional markets, power plants, refineries and export facilities across the United States. This has been a decade-long process, leading to a situation in which 70% of all crude, natural gas and related products are shipped by pipeline. This also means that the pipeline infrastructure in some cases is ageing, leading to leaks, ruptures and spills. Over the past decade, there have been over 3,000 pipeline spills in the United States.4 Nearly half of pipelines are over 50 years old. Combined with the growth in the need for natural gas pipelines and gathering line networks stemming from growth in regions such as the Bakken, Eagle Ford, Marcellus, Permian and Utica shales, the need to replace ageing mainline pipeline infrastructure only points to increased capital needs for the foreseeable future.
Furthering this trend, the United States is predicted to account for more than half of worldwide growth in oil production capacity over the next five years. Fuelling this are a number of factors such as increases in oil output and the mismatch between U.S. crude production and U.S. refiner demand, discounts in U.S. crude prices relative to other producers driving export demand, and an increased demand expectation for so-called “sweet” crudes with lower sulphur content (the predominant type produced in the United States) due to international requirements and limitations on many refiners’ ability to remove sulphur from crude, further driving export demand.5
On the natural gas side, it is predicted that more than $150 billion in midstream assets are needed over the next decade to reduce bottlenecks and move shale gas from their basins to demand centres. Operators in the Marcellus, Permian and Utica shales are already investing in regional projects to provide capacity.6 Add to this the LNG facilities on the U.S. Gulf Coast in need of pipelines to feed exports. Over the coming two decades, nearly $800 billion is expected to be needed, given these trends.
In addition, there is continued build out of natural gas, NGL and oil pipelines to demand centres in the South Gulf Coast, such as South Texas and Louisiana. Much of the pipeline capacity added in 2019 was built to provide such capacity. These pipeline projects include Kinder Morgan’s Gulf Coast Express Pipeline (which is expected to transport hydrocarbons to the Gulf Coast), El Paso Natural Gas Pipeline’s Northern Delaware Basin Expansion Project, Cheniere’s MIDSHIP Pipeline (which will deliver natural gas from Oklahoma to the Sabine Pass LNG Facility) and Texas East Transmission Company’s Stratton Ridge Expansion (which will deliver gas to the Freeport LNG facility).7 The expansion of delivery pipelines to the Gulf Coast is expected to spur further development of new downstream facilities and storage terminal projects over the coming years, including methanol, ethylene, ammonia and LNG export facilities. As a result, new greenfield industrial facility developments would also require significant capital investments over the coming years.
Private Equity’s Search for Assets
The growth of the midstream oil and gas sector as a financeable infrastructure asset is largely the product of a number of simultaneous developments.
The first development is on the private equity side of the equation. Private equity’s overall capital pool has continued to grow over the past decade, and for infrastructure-focused funds the pool of available traditional (or “core”) infrastructure assets in need of capital – or more accurately, in need of capital in exchange for rates of return sufficient to justify certain types of private equity investment – has steadily decreased. These core infrastructure assets have most traditionally encompassed toll roads, airports, rail and electric power plants. In respect of electricity generation, the plants of the base load long-term contracted variety (e.g., natural gas and coal) were eventually joined by quick-start peaking plants as well as, over the past decade, renewable projects, such as wind and solar. Beyond just the expansion of the asset class to private equity and lenders, once-routine features underpinning their bankability on a non-recourse basis (such as long-term contracted offtake agreements) have become rather rare – these assets more often than not now are “merchant”, though revenues are backstopped somewhat by energy commodity hedges. But the returns for such assets have continued to move downward (absent a unique risk profile for a particular plant or a particular power market).
As the asset class has continued to mature and the inherent risks thereof have become more predictable, the market has driven down the return profiles. These developments have resulted in a search for infrastructure-focused private equity for new assets, the search for the next so-called “core plus”. Commercial lenders and long-term institutional investors that focus on infrastructure have seen the same developments over the past decade – more competition for bankable assets, driving lower yields and leading to stores of capital in search of deployment.
Reproduced with permission from International Comparative Legal Guide to: Lending & Secured Finance 2020, Global Legal Group Ltd, London.
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