The Path Carved by Conventional Midstream Shows the Way to Growth and Sustainability
The rapid emergence of the water midstream sector has resulted in explosive and transformative growth in a relatively short period of time. This evolution is not surprising given the critical importance that sound and comprehensive water management practices play in extracting a valuable resource in the safest, most environmentally conscious and cost-effective manner possible.
Likewise, it is just as critical that we, as a collective industry, consider the historical lessons to be learned from the recent past in maintaining and accelerating the present growth trajectory of the sector.
This article is intended to provide insight as to how the industry can methodically and logically work with all stakeholders to ensure sustainability of the industry. Given the transformation of the energy industry since the advent of the shale play revolution fifteen years ago, we should consider ourselves blessed. Blessed because we work in an industry that provides such incredible benefit and value to essentially every human who inhabits the globe.
A RESILIENT INDUSTRY
In reviewing how far the petroleum industry has come in the last decade and a half, it is simply remarkable and, in many ways, awe-inspiring. The shale play renaissance has come about through human ingenuity and innovation that spurred great technological advancement. However, that did not occur without significant headwinds and adversity.
Typically, the industry rises to the occasion when its back is against the wall. Even in uncertain times and unforeseen downturns, the industry invariably transforms and carves out a path to reinventing itself and supplying inexpensive energy and value creation for the common good.
The virtually endless list of products, services and conveniences that many take for granted are evidence of the industry’s continuous transformations. The question facing the industry is can it find the means to better educate the public in a manner that illustrates the benefits this industry provides? Most decidedly it can, and it must ensure that an accurate representation of industry is conveyed sincerely to those unfamiliar with the inner workings and complexities of the oil and gas industry.
The nature of shale resource plays across the country is dynamic and will continue to be, which makes the growth of this sector that much more compelling. The emergence of the water management sector is critical to current and future growth and ultimately, the success of the industry as a whole. The very fact that the United States is a net exporter of natural gas and, in the near future will become a net exporter of crude oil is nothing short of a stunning achievement, particularly considering the downturn that began in 2014 when crude oil fell from more than $100 bbl to less than $30 bbl in a matter of months.
The industry invariably transforms and reinvents itself to supply energy and create value.
An important metric of the industry’s growth has to do with its environmental impact. According to Energy Information Administration (EIA) data from 2018, the shale revolution and the emergence of natural gas as the primary fuel source for electricity generation is directly responsible for the lowest per capita air emissions levels in the U.S. since 1950 (see links at the end of this article for more data and information).
QUICKLY EVOLVING SECTOR
In the short two to three years since the words “water” and “midstream” were first strung together, we have witnessed expansive growth of the sector. Interestingly and not at all surprisingly, each of these emergent water midstream companies have different sets of assets and execution strategies all geared to becoming successful.
The Restructuring Rule deregulated the natural gas industry practically overnight.
Whether it is through organic growth or through strategies of aggressive asset acquisition, water midstream companies are looking to gain the trust and earn the business of their respective, and prospective, upstream operator customers. Similar to the advent of the conventional midstream sector back in the early 2000’s, independent water midstream companies and their private-equity backed investors must continually strike a proper balance between building or acquiring the proper infrastructure based on each individual upstream operator’s unique and distinctive needs. In this article, the term “conventional midstream” refers to the transportation, gathering, processing and marketing of crude oil, natural gas, and natural gas liquids.
It is easy to recognize the logic and advantage of an upstream operator outsourcing its water management requirements. Doing so relieves the operator of the capital burden of building water management infrastructure.
From an upstream operator’s perspective, operating within cash flow and avoiding spending precious capital on anything other than drilling wells is the new paradigm. Certainly, it is what Wall Street is demanding from E&P operators today on a quarter-by-quarter basis.
The water midstream sector, more than anything else, must continue to prove itself to the upstream sector in the same way the conventional midstream companies have proven their value. A review of how the conventional midstream sector earned the confidence of the upstream sector may be instructive.
The water midstream sector today is experiencing, in terms of attaining growth, credibility and maturity, what the conventional midstream sector faced in the late 1990’s and early 2000’s.
In the “old days” before the millennium, virtually all E&P operators owned and managed operations of the infrastructure from the wellhead to the facilities required to gather, fractionate, process and market the hydrocarbons being produced. At that time “midstream” was not even a term used in industry. Instead, an upstream operator’s assets were termed “producer services” or “gathering and processing.”
Due to a series of regulatory changes affecting the natural gas industry, there was distinct advantage and economic incentive in holding in-house those parts of the hydrocarbon value chain. In 1992, when the Federal Energy Regulatory Commission issued Order 636, referred to as the Restructuring Rule, the natural gas industry was effectively deregulated. Practically overnight, a new and lucrative industry was born.
Order 636 mandated the unbundling of sales services from transportation services of interstate pipelines across the United States. Deregulation of the natural gas industry gave industrial customers and local gas distribution companies full choice of natural gas providers, thereby opening markets to competition that was previously controlled by the interstate pipelines. This order spawned E&P-owned marketing affiliates and independent natural gas marketing companies and allowed them to directly market natural gas across the country. For the better part of a decade or so, natural gas marketing companies were significant revenue generators for E&P operators.
However, as profitability waned for producer-owned and independent marketing companies in the early 2000’s, a new crowd of publicly held and private-equity backed conventional midstream companies appeared. These new players began to aggressively acquire upstream operatorowned gas gathering, transportation and natural gas processing assets, officially kicking off the conventional midstream sector as we know it today.
Since then, the conventional midstream market has evolved to where upstream operators have outsourced all but approximately 10 percent of their midstream operations. Those operators who have outsourced 100 percent of conventional midstream services can now focus all their capital on the drill bit.
The abundance of conventional midstream companies has triggered fierce competition. Due to this intense competition and how it drives high levels of service, cost efficiencies through scaled infrastructure, expertise and confidence, operators have resoundingly embraced outsourcing to conventional midstream entities. Preservation of capital, reliable service and expertise are significant factors in the decision by E&P operators to outsource.
By contrast, it is estimated that upstream operators currently own, control and operate approximately 85 percent of water management infrastructure, operations and services across the industry. The water midstream sector is clearly in the early stages of its evolutionary cycle. The question remains how long it will take for upstream operators to show the same confidence in third-party water midstream as it has in the conventional midstream?
As noted above, upstream operators have embraced the conventional midstream sector for several important reasons:
1) Capital efficiency for the upstream operator;
2) Sector dominated by large public midstream operators and private-equity backed operators with experienced, proven management teams;
3) Lower cost-per-unit attributable to large, scalable pipeline, processing and multiple sales outlets for networks of interconnected pipelines;
4) Diversity of services offered. Conventional midstream companies, large or small, provide a full suite of gathering and transportation, processing, treatment, and marketing services.
Much success of the conventional midstream market can be attributed to the two decades of experience it has providing valuable services. However, the parallels between conventional midstream and water midstream are unmistakable. Consequently, the water midstream sector should find success by adopting similar approaches.
For water midstream, a case can be made for providing similar capital efficiency to the operator. The rising number of water midstream companies, most of which are backed by private equity, provides value through competition. Many of the water midstream companies formed three or more years ago are growing to scale, mostly through the acquisition and organic build-out of disposal and produced water gathering assets.
There are few doubts water midstream companies have gained traction with operators and built long-term credibility. That is being translated into execution of the long-term contracts necessary in underwriting new water management infrastructure.
Like the conventional midstream business, the most successful water management and midstream companies will likely be those that provide permanent, scaled networked infrastructure and bundle supply, reuse and recycling, and produced water handling and disposal. Successful water midstream companies will be those that build a balanced asset portfolio using organic growth and prudent acquisitions.
Despite similarities between the conventional and water midstream sectors, water is a unique commodity. As a result, the key to the water midstream sector maturing and flourishing can be summed up in one word: sustainability.
Sustainability is an all-encompassing term that can be defined in several different contexts. An individual water midstream company could define sustainability as being able to grow its business across multiple business lines, thereby diversifying its capability to create multiple revenue streams across a multi-customer base. Another company could define it as developing a business that builds scale, moves to an IPO and then uses its platform as a public company to scale up even more quickly and consolidate others within the sector.
Perhaps the ideal way to define sustainability is that, in the long-term sustainability is achieved by collectively addressing the vastly different water solutions required in a particular basin, by any given E&P customer. As an example, a brief review of the stark and interesting dichotomy between the Delaware and Midland basins provides insight.
From the perspective of a water midstream company, the solutions required to serve an upstream operator will vary widely based on the water-to-crude ratio, not only between the two basins, but also within different areas of the same basin. The Delaware Basin is estimated to average a waterto-oil ratio of approximately 4:1. In parts of the Delaware, the WOR can be as high as 10:1 and as low as 2:1. By contrast, the WOR in the Midland Basin averages 1.5:1.
These differences in WOR strongly suggest that to succeed, water midstream companies must evolve to meet the needs of their upstream customers and recognize that different solutions will be required within the same basin and often with the same customer, depending on location and target formation.
Water midstream companies must also consider how future regulatory and environmental changes can potentially shape the operating landscape for their businesses.
PATHWAY TO SUCCESS
If Texas were to see a recurrence of the protracted drought experienced from 2010 to 2015, how long might it be before the use of freshwater for oil and gas development was curtailed? Or, what if freshwater sourcing was significantly restricted or perhaps banned altogether? What impact would that have?
Induced seismicity, regardless of the root cause, is a valid concern for regulators, legislators and the industry. Over-pressurization of reservoirs across certain areas of the Permian are also of interest. These issues, and others, highlight a pathway to success for the industry. By being as proactive as possible and collaborating with all key stakeholders to ensure sustainability for the environment and for the industry, continued viability for business is protected.
Given the volumes of produced water, particularly in the Delaware Basin, it is understood that reuse and recycling are essential if there is to be sustainability for the water midstream sector.
In the future, the industry may find itself in the role of solutions provider for entities outside of oil and gas sector. For example, it is plausible water midstream companies could provide beneficial use projects for agricultural and municipal customers alike. Nothing should be considered outside of the realm of possibility. Also, water treatment and reuse technologies of the future could form the building blocks for drought-proof water resources for an entire state or region.
Remember, where there is a mission and a vision, there is a way. That belief comes to mind as we celebrate the 50th anniversary of the first moon landing in July. The moon landing was accomplished by NASA utilizing technology that amounted to less computing power than the smartphones we use every day.
Success for the water midstream sector will become evident over time in the following manner:
1) Prove to the E&P sector that water midstream can deliver unfailing reliability, flow assurance and safety standards, just as conventional midstream has achieved;
2) Collegial and collaborative partnerships with regulatory and legislative stakeholders to align interests for the benefit of the general population and the industry;
3) Demonstrate an unwavering commitment to protection of the environment and the communities served. Ensuring the sustainability of water resources for generations to come is the goal.
Sir Winston Churchill once stated, “the price of greatness is responsibility.” In guiding America to energy independence, the industry has added tremendous value to our national security. This can be seen as an embodiment of both our greatness and our responsibility.
Members of this industry should be exceedingly proud of its vision and innovation. As the industry continues to evolve and mature, it holds the key to its own future success. Preservation of our environment and perhaps, providing a framework for beneficial use projects outside of the energy industry, will help shape that success.
The links below describe the vital role the energy industry plays in our everyday life. These stories can help those not familiar with our industry understand how the oil and gas industry positively impacts our standard of living and ensures that America remains the greatest country on our planet.
INFORMATION & PERSPECTIVE
Independent Petroleum Association of America
Energy in Depth
Authored by John R. Durand, President of XRI