Kinder Morgan Inc. (KMI), Apache Corporation (APA), and Blackstone-backed (BX) EagleClaw Midstream Ventures are teaming up to fix one of the Permian Basin’s great problems, a lack of gas takeaway capacity. Often the focus on Permian pipeline constraints is solely on the oil side of things, but that misses another major problem the region will need to come to terms with. Let’s go over this consortium’s strategy to alleviate one of the Permian’s most understated constraints.
All about logistics
Unlike oil, natural gas (in its gaseous state) can’t be easily transported. When oil pipelines are full, the upstream industry can turn to truck and rail to move those volumes. Yes, this strategy has its problems as those are more expensive modes of transportation so upstream realizations tend to suffer immensely, but at least those volumes can get to market. When gas pipelines are full, short of a major change in state flaring regulations, a lot of Permian wells will have to either be shut-in or future development activity will need to be curtailed to allow production declines to take hold.
Texas doesn’t allow for gas flaring to go on indefinitely, and in the current political climate, it would be a hard sell to change the RRC’s existing flaring rules to those resembling North Dakota’s several years ago (before those rules were changed to dramatically reduce gas flaring in the state). Here are the Railroad Commission of Texas’ flaring rules (click here).
What this means is that when the Permian Basin’s gas pipelines are finally maxed out, production growth will stall out until new capacity comes online because there are no straightforward workarounds. That creates an amazing growth opportunity for midstream players.
In late-June, Kinder Morgan, Apache, and EagleClaw announced they had signed a letter of intent on building the $2 billion Permian Highway Pipeline Project. That pipeline system will run from the Waha Hub in West Texas to markets along the US Gulf Coast and to markets in Mexico. Rising gas exports to Mexico are a big way the industry is ensuring rising Permian volumes can reach end markets. LNG exports are also playing a key role as new export facilities are brought online along the US Gulf Coast.
With 2 billion cubic feet per day of natural gas transportation capacity, the 430-mile long Permian Highway Pipeline is quite a large takeaway option, especially as it utilizes 42-inch diameter pipe. Initially, Kinder Morgan and EagleClaw will each own 50% of the venture with Kinder Morgan acting as the operator. Apache Corporation has the option to buy a 33% stake in the venture, which I assume would involve buying a 16.5% stake from both Kinder Morgan and EagleClaw. The pipeline is expected to be completed by late-2020.
The pipeline will give upstream players access to various gas pricing benchmarks that fetch much better prices than the Waha Hub, where gas realizations are trending ~$0.60/Mcf below Henry Hub. Those markets include the Katy and Agua Dulce hubs, the Coastal bend and Tejas headers, various connections to LNG export terminals (including the Corpus Christi and Freeport LNG facilities), and connections to third-party pipeline systems.
Why these firms
From Apache’s point of view, the reason it committed 500 million cubic feet of its future daily natural gas production to the pipeline is to support development of the Alpine High play. Located in Reeves County, TX, within the Delaware Basin, the Alpine High play comes with a large dry gas component that needs to be able to reach an end market.
As long-haul gas pipelines effectively act as toll roads, with the midstream owners pocketing a nice fee for each thousand cubic foot of gas moved through the system, Kinder Morgan gets an ideal cash flow generating asset with room for upside. That upside includes the ability to build-out the necessary infrastructure on either side of the pipeline (gathering systems, processing plants, storage facilities, LNG export terminals), or to boost utilization rates at across its existing asset base. Kinder Morgan also noted it was evaluating using 48-inch dimeter pipe to increase the capacity of this system, which will depend on market conditions.
Blackstone, through its EagleClaw Midstream Ventures, gets to directly invest in a quality midstream asset that will churn out a much better return than many other possible options with a similar level of risk (try earning a 10% - 15% ROR on a creditworthy bond in this climate). Teaming up with a well-run giant in the gas pipeline space reduces the level of operational and execution risk Blackstone is taking on as Kinder Morgan is spearheading the construction of the new pipeline as well as acting as operator once the system is complete.
What makes the Permian Basin different than other unconventional upstream plays is that the play houses a much larger inventory of “core” or top tier well locations than other plays. That enormous Tier 1 well inventory is why Permian oil & gas production has skyrocketed, and why most see that growth trajectory continuing as new pipelines are placed into operation. While some plays, like the Eagle Ford or the Bakken, are restricted by well inventories the Permian is different, it is restricted by logistics. This is the opportunity Kinder Morgan Inc, Apache Corporation, and Blackstone-backed EagleClaw Midstream Ventures are capitalizing on. Thanks for reading.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.