Will Midstream be the Next Best Way to Play US Shale?

Michael Teague |

Much of the narrative concerning the US Shale boom seems to encourage the notion that recent leaps in domestic unconventional oil and gas production are as good as a guarantee of American energy independence.

Certainly, few would doubt that the yields from unconventional plays over the past decade have been anything but phenomenal; after all, according to the US Energy Information Administration, the nation will become the world’s number one oil and gas producer by 2015, if it hasn’t done so already.

In any event, there are many realities lying in the way of a “foreign oil”-free future, and investors should be aware of them in order to protect their investments, but more importantly so that they don’t end up losing out on the next growth-phase of the shale boom that will likely arise from the midstream segment of the industry.

Indeed, the US currently has 2.6 million or so miles of existing pipeline to take oil and gas products from one part of the country to another. Though this is the largest midstream network of any nation in the world,  it has fallen far behind in supplying the needs of a soaring unconventionals market. Analyst estimates for how much will be invested in pipeline upgrades and construction over the next two decades vary greatly, but if Deloitte is to be believed, top-end projections for midstream spending through 2035 is at just over $200 billion.


Pipeline Basics

Pipelines are classified according to their three main functions.

Gathering lines are the smaller and short network of pipes that bring oil, gas, and other liquid products from production wells to treatment plants and processing facilities; Transportation lines are typically the larger pipes, and in some cases long enough to transport product across national boundaries; Distribution lines provide the means by which one of several refined products reach their end-uses, and this category includes the lines carrying product to storage facilities and tankers. Compressor Stations are the machines responsible for maintaining the continuous flow of product through the lines.

Natural gas and natural gas products take up the vast majority of these pipeline network, with the rest devoted to crude oil, as well as the various products derived from it.

Breaking Down Infrastructural Needs

It would be diminutive to describe the inadequacies of the current network as “demand,” because pipelines are more of a condition of the industry’s very ability to function. Over 60 percent of the nation’s natural gas pipes were laid earlier than 1970, with some 37 percent of them installed prior to 1950.
Safety issues aside, the Interstate Natural Gas Association of America not long ago detailed the upgrades that will be necessary over the next 25 years:

●     43 billion cubic feet per day of natural gas transmission pipeline capacity

●     414,000 miles of new natural gas gathering lines

●     14,000 miles of new lateral pipelines to and from power plants, processing centers, and storage facilities

●     12,500 miles of transport of natural gas liquids

The need for better and more infrastructure can be seen from the perspective of crude oil production as well. Though most of the nation’s shale assets produce natural gas, there are notable exceptions, such as Texas’s Eagle Ford, and North Dakota’s mighty Bakken formation.

At the latter, surplus natural gas is already being burnt off as a result of the lack of storage and transport capacity, and the pipelines transporting precious and valuable crude are nearly 200,000 barrels per day short of the 600,000 barrel capacity that is currently necessary. Bakken producers have increasingly turned to rail tankers to move their product to the refineries, but as it turns out the oil from that shale is far more volatile than previously thought, a fact that has been a major determinant in the fallout from the recent spate of rail accidents.

Future Demand for Pipelines is an Existential Issue for the Natural Gas Industry

This is all to say that the demand for pipelines is there, and midstream companies all the way up and down the market-cap scale could very well stand to benefit. The industry would certainly prefer the pipeline route because it is a much cheaper and safer method of moving resources around than rail, for instance, and ultimately it is the best way to deliver lower prices to end-users.

But this need goes much deeper. The effectiveness and lower relative costs of pipeline transportation are also vital if the shale gas and gas liquid portion of the industry is to remain economic. Shale wells have shorter life-spans than their traditional counterparts, and are far more expensive to operate, making the most cost-effective means of transportation a matter not only of profit margins, but also of life and death, given the enormous discount at which natural gas sells on the market. The surplus that is the largely expected result from the current production scenario for gas will only compound this problem.

A Bullish Scenario?

For the major integrated oil and gas giants, the midstream business is one of the lowest-margin segments of the value chain, and companies like Chevron (CVX) and Royal Dutch Shell ($RDS.A) have recently been selling off their pipes to smaller independent companies, in order to free up cash for shale plays.

Meanwhile, capital expenditures from the midstream segment have ballooned. Pipelines spent $7 billion on construction activity in 2006, and had soared to $26 billion by 2012. In the period between 2003 and 2012, industry profits had nearly doubled for oil pipelines and 50 percent for gas pipelines.

Horizontal drilling and hydraulic fracturing certainly are fascinating and impressive technologies, and their consequences will be playing out for years to come, but exploration and production is already becoming a very crowded and expensive space for stock-pickers, and pipelines could end up being the next best growth opportunity to arise from US shale.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer


Symbol Name Price Change % Volume
CVX Chevron Corporation 101.87 -0.40 -0.39 4,806,710
LTSHY Lotte Shopping Co Ltd GDR (Sponsored) 144A 18.60 0.00 0.00 0
RDSA Royal Dutch Shell Plc ADR Sponsored Repstg A Shs n/a n/a n/a 0


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