Midstream firms tout optimism despite transition to 'overbuilt, mature, boring' industry

Houston — North American midstream firms exceeded expectations during the second quarter, reporting better-than-projected earnings amid a maturing and pandemic-hit industry, according to executives and analysts.

Despite recovering global crude demand, the federal government projects US oil production will fall further on average in 2021, even as pipeline capacity continues to grow. Rising regulatory and legal hurdles jeopardize new pipelines such as the long-delayed Keystone XL project, as well as the currently operating Dakota Access Pipeline, which is threatened with a potential shutdown.

Midstream firms continued to cut capital spending -- for 2020 and beyond -- to help keep shrinking profits intact while pushing off new pipeline and terminal projects further into the future. The once-heated race to build a series of deepwater crude export terminals is on the backburner and was not discussed during earnings calls.

"The midstream pressures are reminiscent of what we saw back in 2015-2016 after the last price crash: Too many pipelines -- not enough crude," said Sandy Fielden, director of oil research at Morningstar.

During the peak of the global lockdowns from the pandemic, US crude production fell from an all-time high of nearly 13 million b/d down to a May average of just 10 million b/d, its lowest monthly average since late 2017. The EIA now forecasts crude production to average 11.3 million b/d in 2020 and 11.1 million b/d in 2021, compared to 12.2 million b/d in 2019.

Essentially, US volumes will remain weaker from reduced activity even as global demand is expected to approach pre-coronavirus levels by the end of 2021.

For instance, Permian Basin crude production peaked early this year at about 4.8 million b/d and, in August, has fallen to slightly more than 4.1 million b/d, according to the EIA. At the same time, Permian crude pipeline capacity is already at almost 6 million b/d after rapid growth in recent years and could approach 8 million b/d by the end of next year, once other major pipeline projects are completed, especially the ExxonMobil-led Wink-to-Webster Permian crude system.

"The big producers did a good job of ensuring there was plenty of capacity for them while the midstream guys were played against each other with a bunch of half-full pipelines," said Hinds Howard, CBRE Clarion Securities portfolio manager. "That's a story that's going to play out over time."

Even more challenging, the newer pipelines were backed by shorter-term contracts that are likely to expire before demand fully rebounds.

And all of this is assuming things don't get much worse with the pandemic.

"The most important item to watch remains the path of COVID-19 and its impact to oil and gas demand and producer volumes. This is the big wild card," said Pearce Hammond, midstream analyst for Simmons Energy.

Maturing in more ways than one

Industry analysts and executives agree the North American midstream sector is a maturing industry, but the companies also have begun to practice what they've long preached in terms of fiscal responsibility.

"They're touting such strong capital discipline, but its also because they had such bad capital discipline for so many years," Howard said.

Howard predicts a somewhat painful next few years for much of the midstream space as a wave of mergers and acquisitions consolidate the sector, such as what happened years ago with the railroad industry.

Some of the top potential consolidators include Canada's Enbridge and TC Energy, and the United States' Enterprise Products Partners, Plains All American Pipeline, Energy Transfer and Magellan Midstream Partners, analysts said.

"I think we've reached a level of maturity in many parts of this business, and M&A consolidation makes sense in that environment," said Magellan CEO Michael Mears during his earnings call. "We're not opposed to it. We actively look at that."

CEO Al Monaco only sees a slower, bumpy recovery from here that won't feel close to normal until the end of 2021.

"We're cautious on the timing of a full return. We see a more gradual pace of recovery from here," Monaco said.

Project protests

Enbridge's Line 3 and Line 5 replacement pipeline projects from Alberta to the US and eastern Canada count among those facing regulatory and legal fights.

Despite the pandemic being better controlled in Canada, the oil sands remain highly dependent on exports to the US. That dynamic is a big part of why, for instance, Calgary's Pembina Pipeline has indefinitely deferred more than $3 billion in new projects.

"If the US wouldn't have had all the cases, I'd be saying we'd probably have all those projects back," Pembina CEO Mick Dilger said.

Likewise, TC Energy's Keystone XL project was recently held up again by the US Supreme Court, even while allowing a fast-tracked, pipeline permitting process to resume. TC remains committed to a 2023 completion timeline.

But most concerning to the industry is the recent federal court order to shutter the Energy Transfer's three-year-old Dakota Access Pipeline, which was overturned at least temporarily in August on an appeal. The case remains pending, but a shutdown is no longer imminent.

Pipeline firms that aren't directly affected remain greatly concerned.

"It's an environment of uncertainty and one that we don't see the benefit of," said Plains CEO Willie Chiang.

And, despite some greater visibility for the rest of this year, predicting the future remains a guessing game. Potentially switching from a pipeline-friendly Trump administration to a Democratic White House next year would make things harder.

"Honestly, we haven't thought too much about 2021 at this point," said Mears, of Magellan. "It's too hard to project the rest of this year, much less 2021."