We believe growing U.S. natural gas export volumes bode well for midstream energy infrastructure. Most importantly, the opening of global markets to U.S. natural gas should allow domestic natural gas production volumes to continue to grow at a healthy pace. Since midstream revenues typically follow volumes rather than commodity pricing, what bodes well for volumes bodes well for midstream revenues. Not only do we expect existing assets to benefit from improving utilization over time, we also expect substantial additional midstream investment and buildout opportunities to accrue to midstream operators.
How the United States Is Becoming an Export Giant
The rise in the country’s oil and gas production capacity over the past decade reflects both the ingenuity of U.S. producers and the benefit of a robust network of pipelines and other midstream assets operated by highly responsive midstream companies. As a result, the economics of U.S. shale are competitive on a global scale. In other words, when a well is drilled in the middle of West Texas, the oil, natural gas, and natural gas liquids that are produced can each reach a point of sale reliably, cheaply, and safely, which enables the producer to maximize the economics of the well.
While shale is present the world over, these favorable economics mean that U.S. producers can bring their products to market with an efficiency that few geographies on the planet can match. As a consequence, U.S. shale is likely to continue to be an economically competitive and secure supply source for the foreseeable future. Further, the scale and efficiency of U.S. infrastructure is prohibitively expensive to replicate. Consider, for example, that the United States has approximately 3 million miles of natural gas pipelines in comparison with Russia’s 163,000, China’s 74,300, and Mexico’s 18,000 miles. As a result, U.S. operators have been successful in securing long-term purchase offtake commitments from overseas counterparts to support U.S. natural gas export facilities.
Notably, natural gas is exported overseas as liquefied natural gas (LNG), meaning natural gas is super cooled into liquid form, which results in a significant reduction in volume to enable the economic transport of natural gas by ship. These liquefaction facilities can take years and many billions of dollars to construct. A handful of LNG terminal projects at Sabine Pass in Louisiana and Cove Point in Maryland have recently been placed into service. Additional large-scale LNG terminals currently under construction will be brought online over the next two years and will more than triple current domestic export capacity. In total, this first wave of U.S. LNG terminals represents approximately 10 BCF/d of natural gas export potential. For context, U.S. natural gas production is currently approximately 85 BCF/d.
As discussed in a recent blog by the OppenheimerFunds Global Equity Team, global demand for LNG is growing rapidly. LNG as a fuel has numerous advantages: It emits far less carbon dioxide (CO2) and other pollutants than coal, and it avoids the safety and hazardous disposal concerns of nuclear energy. Further, gas-fueled power plants have relatively low upfront capital costs and can be sized and located for local needs. In addition, as renewable power continues to grow, its inherent intermittency (i.e., the sun doesn’t always shine and the wind doesn’t always blow) combined with a lack of reliable, cost-effective utility scale power storage options, means more easily dispatched power will be required. Natural gas power plants have proven to best fulfil this role.
To meet the growing demand for reliable, easily dispatched power, new LNG export terminals are being contemplated all over the world. Due to the magnitude of the investment required, the projects that ultimately get built will be the ones with proven operators, ample and low-cost sources of natural gas supply, and in locations with limited political risk. As such, U.S. locations are well positioned to garner interest. In fact, several new contracts for U.S. LNG supply have recently been announced, which will likely lead to additional capacity expansions. In total, over the next decade, the United States could become a major LNG export force. According to IHS Markit, the United States could represent approximately one-third of future LNG supply growth through 2030. By that time, the U.S. will have gone from a net LNG importer to one of the largest, if not the largest, suppliers of LNG globally.
U.S. Midstream Could Benefit Materially from LNG Growth
As LNG exports increase, it requires additional supporting infrastructure to gather, process, and transport natural gas from the wellhead and to LNG terminals. Therefore, assets across the natural gas logistics chain stand to benefit. In addition, even with the impending first wave of LNG terminals about to enter service, certain bottlenecks in the domestic midstream infrastructure system are already evident and highlighted by the presence of wide pricing spreads between certain locations. For example, natural gas at the Waha Hub in West Texas, where the Permian Basin is located, is currently priced at an approximately 50% discount to natural gas prices at Henry Hub in Louisiana.
Therefore, feeding a second wave of LNG terminals requires new natural gas gathering systems, long-haul natural gas pipelines, and natural gas processing plants upstream of these facilities. Further, an increase in natural gas production also means an increase in associated natural gas liquid (NGL) production, which would also require additional fractionation plants, NGL storage, and NGL export terminals. In aggregate, the current and future infrastructure opportunity could easily exceed $200 billion as estimated by Interstate Natural Gas Association of America.1
Midstream companies such as The Williams Companies (NYSE: WMB), Energy Transfer LP (NYSE: ET),2 MPLX LP (NYSE: MPLX), and Targa Resources Corp. (NYSE: TRGP) could be among the biggest beneficiaries of this LNG theme. These companies have extensive, unreplicable infrastructure assets spanning the value chain that are located in resource basins that will be most heavily relied upon to supply the natural gas that will feed LNG terminals. Because these companies have billions of dollars already invested in the ground, they are also best positioned for future growth projects as additional infrastructure is required.
Though largely underappreciated at home, the rise of U.S. shale is driving massive changes in global oil, NGL, and natural gas markets, with equally meaningful derivate impacts on global petrochemicals, industrials, and manufacturing. This market rebalancing has not always been smooth, as highlighted by the energy downturn that began in late 2014. However, as global inventory levels have normalized and provided greater price stability, the domestic energy sector – midstream especially – is well positioned to benefit from this new energy world order.
Despite healthy price performance for the midstream MLP sector over the past two quarters (the Alerian MLP Index gained 19.1% between 3/31/2018 and 9/30/2018), the group continues to trade at a historically low multiple. However, we believe the sector’s outlook continues to improve. In fact, operating performance for the midstream sector has been reflecting these positive trends for some time. For example, for the second quarter of 2018, 77% of midstream sector participants reported results that were in line or better than consensus, and sector EBITDA was 2.4% higher than the preceding quarter and up over 20% from the same period last year. Aided by exports, the outlook for domestic crude oil, natural gas, and natural gas liquids production growth appears likely to be healthy for some time, which should continue to bolster midstream volume expectations.
- ^Source: Natural Gas Association of America, North America Midstream Infrastructure through 2035, June 2018.
- ^Pending a unitholder vote, Energy Transfer Equity, L.P. (NYSE: ETE) and Energy Transfer Partners, L.P. (NYSE: ETP) are expected to combine in October 2018. As currently contemplated, the surviving entity will be named Energy Transfer LP and its common units will trade on the NYSE under the new symbol “ET.”
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