“G&Ps are writing checks for millions, leaving out take-or-pay terms, to get commitments from upstream companies to use midstreamers’ gathering systems and processing plants.”
Fierce demand for gathering systems and processing plants has forced aggressive midstream players toward structuring creative deals with their upstream cousins. As oil prices recover and rig activity picks up in areas like the Permian’s Delaware and Midland basins, midstreamers in some cases are stroking checks for tens or even hundreds of millions of dollars upfront to E&Ps in order to secure their commitments to energy infrastructure.
The typical “take-or-pay” arrangements, which require upstream players to pay midstream firms a monthly fee for access to their infrastructure over a period of time, are falling out of favor for “acreage dedication” deals in premium basins. Numerous market observers have noted that the competitive pressure to win the rights to bring a torrent of hydrocarbons to market has many midstream players coming up with creative terms to win G&Ps’ business. This includes waiving take-or-pay arrangements in exchange for cash prepayments in addition to the basin’s geological information and dedication.
“In fact, midstreamers have continued to apply even more creative provisions to win the business of producers. It became increasingly clear to both midstreamers and producers that the mere commitment of their acreage … has real and significant monetary value,” writes Housley Carr for the RBN Energy blog. “At that point, some producers determined that since committing, say, 25,000 or 50,000 acres of prime Delaware Basin land to a midstream company is very likely to create a lot of value for that midstreamer, why shouldn’t the producer get a piece of that action? Consequently, a few deals were done where the producer received an ownership interest in the gathering systems and processing plants built for it. That aligned the interests of both parties.”
Putting Cash to Work
This is an interesting development as it comes at a time when many upstream and midstream companies are shedding noncore assets to generate cash for development of core business operations. Ironically, as Carr points out, that cash is financing several Delaware Basin offers and deals that include pre-payments to producers for the right to build gathering systems and processing plants to serve E&P acreage, which inevitably will lead to corporate and asset tie-ups.
Pursuing “bolt-on” strategies, private equity firms that own midstream firms are seen as major catalysts for future consolidation between E&P and P&G assets.
Carr continues, “There is no doubt that a producer’s acreage commitment has monetary value, especially acreage in the best parts of the Delaware, and producers have become increasingly aware of this. The presumed goal for the handful of midstream companies pursuing the pre-payment strategy is to offer to pay less than the full value of the acreage commitments they are lining up — that way, the midstreamer could always decide to flip the committed acreage to another midstream company (for a profit). Some are reported to have already done so. However, as we’ve seen time and again in the Shale Era (and the Pre-Shale Era, for that matter), what glitters like gold today may dull tomorrow.”
Carr cited the deal between WPX Energy and Howard Energy Partners (HEP) – a leading midstream company – in which HEP eventually won the gathering and processing rights in a competitive auction by offering USD 300m upfront and another USD 263m for the JV’s capex.
Many market observers are expecting this type of dealmaking activity to accelerate in 2018, and I suspect this issue will be raised at Mergermarket’s annual Energy Forum on May 2 in Houston.
“Half of the 50 midstream deals this year (2017) focused on gathering and processing, which directly serve upstream regions, with the balance being pipelines, LNG, and storage. However, as exports continue to grow, investment in infrastructure serving the export market will likely become increasingly important. Moreover, Oil & Gas Mergers and Acquisitions Report – Yearend 2017 “Perhaps unsurprisingly, there was significant interest in gathering and processing assets, and to a lesser degree pipelines, around the major plays, especially the Permian and SCOOP/STACK,” notes Deloitte’s annual potential for integration with downstream terminal and process assets could provide operational synergies.”