Tuesday, July 28, 2009

Good Article on Pipeline Expansions

There was a good article in today's Wall Street Journal (link should be good for seven days) about the quandary facing pipeline companies. New drilling techniques for natural gas have created an opportunity for them, but it is one that comes with heightened risk in this low price environment.

Horizontal drilling techniques have made shale drilling economical, leading to huge new finds, such as the Haynesville Shale. At the same time, it has made existing fields suddenly appear flush with gas. Newfield Exploration recently announced finds in Oklahoma's Granite Wash formation that are yielding production of 22 MMcf/day with fairly low decline rates. Companies have been drilling Granite Wash since the 1950's but it's never produced like this!

Suddenly you've got tons of gas that's got to get to market (or storage). Much of it is coming from traditional gas producing regions like Oklahoma, Texas and Louisiana. This will require expansions of existing systems. This is doable because the rights of way are mostly in place and it's a matter of federal approval and capital investment. But a large amount of gas will soon come from places like the Marcellus Shale in Pennsylvania, West Virginia and New York where the takeaway infrastructure isn't in place to move that quantity of gas. This will be a more involved process.

This is a great opportunity for pipeline companies - it's what they pine away for: the opportunity to invest more money to move more product. Pipelines are mostly set up as Master Limited Partnerships (MLP), which are like REITs of the energy world because they invest lots of capital and must distribute most of their cash earnings to shareholders. As a result, they live for new projects.

Pipeline companies also make a point to investors that they get paid based on quantities moved, not gas prices, therefore they are more stable investments. While this is mostly true (I'm sure rates can get renegotiated during prolonged periods of depressed prices), they face a problem if gas prices stay low for a long time. With long-term low prices, drilling will be reduced and gas wells will be shut in. This could lead to depressed quantities in the new pipes. While most people expect prices to return to the neighborhood of an equilibrium level to help balance the supply/demand relationship, there are no guarantees.

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