Through a series of financial transactions with GE Energy Financial Services (NYSE:GE) and Southern Union Company, Energy Transfer LP (NYSE:ET) bought the Transwestern Pipeline for roughly $1.5 billion back in 2006. Southern Union Company would later get acquired by Energy Transfer LP in 2012. The 2,600-mile long Transwestern Pipeline routes natural gas produced in the Permian Basin, the San Juan Basin, and the Anadarko Basin to buyers in California, Arizona, Nevada, New Mexico, and Texas. With 2.1 Bcf/d of gas transportation capacity and bi-directional capabilities, the Transwestern Pipeline has been a key takeaway option for upstream players operating in the three basins mentioned above for a long time. Let’s dig in.
Energy Transfer purchased the Transwestern Pipeline to complement its existing pipeline operations and gain exposure to basins that at the time were considered prime growth opportunities for natural gas production. America’s energy landscape has completely changed over the past decade, and that caused Energy Transfer to adjust the focus of the Transwestern Pipeline.
BTU Analytics notes that gas production from the San Juan Basin has been on a downward trend since at least 2015. While the basin was still producing around 2.5 Bcf/d by the middle of 2017, low domestic natural gas prices over the past five years have made developing the play uneconomical in most regions. The few active operators in the San Juan Basin have been shifting drilling activity towards liquids-rich regions.
All is not lost though, as privately-held Hilcorp Energy has been pushing forward with tighter well density in the San Juan Basin. By allowing for more wells to come online per drilling spacing unit, it is possible Hilcorp Energy will be able to expand the core parts of the San Juan Basin by growing its drilling inventory in locations known to be prolific.
It is a completely different story in the Anadarko and Permian basins, where gas output is soaring. Gas output from the Permian Basin has grown from 4.5 Bcf/d to 12.4 Bcf/d over the past ten years. During that period, gas production from the Anadarko Basin has grown from 4 Bcf/d to 7.5 Bcf/d. An additional 11.4 Bcf/d of natural gas supplies creates a lot of opportunities for a firm like Energy Transfer. Note in both plays, this surge didn’t truly start until 2016. That was when the upstream industry started getting increasingly interested in the Anadarko Basin due to the prolific nature of Meramec wells, and very interested in the Permian Basin due to enormous size of the play’s easily repeatable top tier drilling inventory.
This information is important to know because midstream operators, like Energy Transfer, are only as good as their utilization rates. Building assets that at full capacity could generate X amount of cash flow per year means little if those assets aren’t be used by the industry.
Energy Transfer’s Transwestern Pipeline should be operating at a very high utilization rate. The pipeline not only gives gas producers in the Permian Basin (which is starved for pipeline takeaway capacity) and Anadarko Basin (which needs more pipeline takeaway capacity to support its growth trajectory) access to out-basin markets, but those markets tend to come with premium prices. Natural gas prices tend to be at least on par if not somewhat higher in California, Arizona, and Nevada when compared to the Henry Hub benchmark.
In 2008, the Federal Energy Regulatory Commission approved Energy Transfer’s plan to build a lateral from the Transwestern Pipeline to Phoenix, which at the time was only being serviced by El Paso Natural Gas. The El Paso gas pipeline is owned by Kinder Morgan, Inc. (NYSE:KMI).
This project involved upgrading the compression stations near the San Juan Basin along with some pipeline looping in the area, and constructing the Phoenix Lateral Pipeline than connected Phoenix to the mainline. Ultimately, the goal was to enable Phoenix to receive additional gas supplies from the San Juan Basin and increase competition in the region’s gas market. As things stand today, Transwestern has the capacity to ship 660 MMcf/d into the metropolitan area.
While it hasn’t been mentioned recently, it is possible that the Transwestern Pipeline offers growth opportunities for Energy Transfer. The pipeline has a lot of delivery points in the Delaware Basin and access to supplies from the Midland Basin, the two most prolific producing sub-basins with the Permian. Energy Transfer could leverage its existing Transwestern Pipeline to boost takeaway capacity out of the region through organic growth projects.
Gas flaring in the Permian Basin is on the rise as roaring production has filled pipelines to the brim. Rystad Energy expects flaring in the Permian to rise from 407 MMcf/d during the third quarter of 2018 to 600 MMcf/d sometime next year. For context, flaring volumes stood at 200 MMcf/d in the middle of 2017, according to Rystad Energy. Regional gas prices have occasionally turned negative and currently benchmarks like the Waha Hub are trading way below Henry Hub.
Energy Transfer would likely have to do more than just simply expand the capacity of the Transwestern Pipeline, it would also need to find new downstream markets to deliver gas supplies to. Increasing its gas transportation capacity to Tucson in Southern Arizona, expanding its ability to deliver gas to pipeline interconnections that route supplies to California and Nevada, and if the firm was bold, building an extension up to Salt Lake City in Northern Utah (or at least building a lateral than connects the mainline with the city of St. George in Southern Utah) are three possibility. Additional export capacity to Mexico via a lateral that runs to an interconnection along the border is another possibility.
The Transwestern Pipeline is a quality asset to have, and one that could in theory solve some of the Permian Basin’s takeaway problems. It is possible that it is too expensive to build new laterals to smaller markets, politically impossible to build larger extensions to bigger markets, and that the markets the Transwestern Pipeline is already servicing are well-supplied, leading Energy Transfer LP to decide there is no need for additional transportation capacity along the system. Maybe that is the case, but what is also clear is that pipeline exports to Mexico represents a golden opportunity if those gas volumes can reach markets other US export pipelines can't (particularly in Western Mexico and Baja California). Either way, due to very favorable macro trends, the Transwestern Pipeline is one of Energy Transfer LP's long-term cash flow cows.
We will have to see what Energy Transfer LP has in store for the Transwestern Pipeline, but it would be a shame to not seek out at least small organic growth opportunities along the system. The Permian Basin needs it. 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.