A slower and steadier trickle of midstream consolidation has continued since the upstream buying spree that began last fall, but energy executives and analysts warn there are still too many pipeline companies in a North American industry that is now producing less crude within an overbuilt infrastructure environment.
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After a race to build long-haul pipelines and gathering and processing systems in recent years, the effects of both the coronavirus pandemic and a stricter regulatory administration have brought most new pipeline and terminal projects grinding to a halt in the last 18 months or so.
During the second-quarter earnings season, executives bemoaned an excess of companies and pipelines, as well as a lack of big buyers and consolidators amid a newer mantra of fiscal discipline.
"Consolidation has been happening, but it's a slow process. It's kind of like a game of chicken," said midstream analyst and CBRE Clarion Securities portfolio manager Hinds Howard, adding that CEOs are essentially daring their peers to make moves. "It's not an environment where there are a lot of white knights. A lot of executives don't want to give up their kingdoms."
The biggest recent headline deals include Energy Transfer buying Enable Midstream, which is facing more regulatory scrutiny ahead of closing, and the Canadian bidding war for Inter Pipeline in which Brookfield Infrastructure Partners has seemingly outbid Pembina Pipeline. Counting crude-by-rail shipments, there was also an ongoing fight between Canadian National Railway and Canadian Pacific to win Kansas City Southern.
Otherwise, only smaller deals have taken place, such as master-limited partnership rollups of TC PipeLines by TC Energy and Noble Midstream Partners by Chevron. BP is currently planning to fold up BP Midstream without even offering a premium, and analysts wondered if Shell will soon do the same with Shell Midstream.
There are also individual asset sales and joint ventures. Plains All American Pipeline has won recent praise for its new JV to combine its Permian Basin assets with Oryx Midstream and have operating control over the resulting Plains Oryx Permian Basin JV without spending much money.
Plains would rather outright buy Oryx but, like everyone else, there is a lot of pressure to remain disciplined, Howard said, and the JV is an ideal compromise, so expect other companies to pursue similar deals.
"You're getting control of assets without giving up a lot of capital," he said. "They figured out a creative way to control the barrels."
US crude output has rebounded back to 11.2 million b/d, but that is still well down from a pre-pandemic record high of nearly 13 million b/d. S&P Global Platts Analytics projects US production to grow to more than 11.5 million b/d by the end of 2021 and to 12.4 million b/d exiting 2022.
The midstream sector is an unusual situation where the markets want to see consolidation occur, but investors do not want their companies to do the buying, according to Alerian midstream senior research analyst Mauricio Samaniego. Instead, the focus remains strictly on free cash flow, debt reduction, non-core asset divestitures, share buybacks and increased dividend or distribution payouts. And companies are trying to figure out whether they can afford to grow again without being punished by Wall Street, or whether they should just stick with buybacks and investor payments.
Unlike the oil products, the pipeline players can can better afford to wait, take their time and lean on their fee-based businesses for now, Samaniego said.
"The midstream sector has reached a stage of relatively mature growth, and this was happening some even before the pandemic, so scale is becoming more important," he said. "Consolidation makes some sense."
What the executives are saying
While there may not be a lot of big midstream buyers, some of the usual players such as Energy Transfer insist they will not change their strategies.
"We still feel very strongly that consolidation is the right path to go in the midstream space. We won't let our foot off the gas pedal," said Energy Transfer co-CEO Tom Long during an earnings call. "We think there's a lot of good drivers to bringing assets together, a lot of optimization that can be done."
Phillips 66 Chief Financial Officer Kevin Mitchell was also blunt: "Across the midstream sector, you will see consolidation take place."
In Canada, Pembina said it may stay an aggressive buyer even after losing out on Inter Pipeline, including possibly buying some Inter assets from Brookfield.
"While we are disappointed with this outcome, we will continue to seek opportunities for growth through focused acquisition," CEO Mick Dilger said. "I say that not as a signal for any imminent or specific targets, but as a reminder that such acquisitions have been part of Pembina's success story over many years and will continue to be."
Even a smaller player like Crestwood Equity Partners said it aims to grow through acquisitions after recently selling one of its top assets, Stagecoach Gas Services, to Kinder Morgan.
End of construction spree
In the meantime, midstream companies are finishing building a handful of major projects that have been in the works for years: Enbridge's Line 3 replacement project will relieve the crude pipeline bottleneck from Alberta to the US, Energy Transfer keeps increasing capacity on the Dakota Access Pipeline, and the ExxonMobil-led Wink-to-Webster system will come online from the Permian to Houston, adding even more capacity to the long-haul Permian Pipeline glut.
"One thing for sure is there's no demand for large mega pipelines," Samaniego said.
A relatively healthy crude export market should still remain, he said, which is why Enterprise Products Partners is still touting its Sea Port Oil Terminal project, called SPOT, to accommodate VLCCs from a deepwater export hub offshore of the Houston Ship Terminal.
However, as Energy Transfer co-CEO Mackie McCrea said, "The industry is so good at overbuilding ... and all of us have overbuilt. But we feel pretty good at where we're at."
The question now is whether more companies will invest more aggressively in energy transition projects, such as carbon capture or hydrogen facilities, or whether they will bide their time and wait for fossil fuel demand to pick back up in a few years before possibly plateauing for good.
"I think at the end of the day, it's a balancing act for the producers and the midstreamers," said MPLX executive Tim Griffith. "I think there's a lot of industry chatter out there that suggest maybe in the 2024-2025 time frame that takeaway capacity will once again be constrained."