Photographer: Shane Bevel/Bloomberg

Cash-Starved Oil Producers Trade Treasured Pipelines for Money

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Oil and natural gas producers confronting a cash drain are auctioning off the family silver: pipelines and processing plants.

Bakken shale billionaire Harold Hamm and Canadian gas giant Encana Corp. are among the latest to peddle some of their most valuable assets and steadiest earners. They don’t have much choice -- as the oil price collapse deflates the value of drilling operations, pipes and plants are about the only things attracting big payments for producers vying to stay afloat.

The deals for quick cash are another facet of the energy industry meltdown leading to more than $40 billion in spending cuts and thousands of job losses. The capital infusion comes with a trade-off because producers pay more to process and transport fuel over the lines and in the facilities they used to own.

“At some point they all get desperate enough,” said Michael Formuziewich, a fund manager at Leon Frazier & Associates Inc. in Toronto. Low prices will spur a rise in deals, he said. “The longer it goes on, the more we’ll see.”

Midstream operations, as they’re known in the oil and gas industry, have retained their value even with crude trading near six-year lows because they act as toll booths that generate dependable cash, regardless of commodity prices. Offloading them lets producers avoid selling the oil fields at the heart of their businesses at steep discounts.

Hamm’s Sale

The Hamm family’s Bakken pipeline network went for $3 billion, including debt, to billionaire Rich Kinder’s empire in a deal announced last month. Encana is reaping C$412 million ($328 million) from the sale of gas pipelines and plants in Western Canada’s Montney shale region to Veresen Inc. and KKR & Co., in a December deal.

Before the oil rout, Royal Dutch Shell Plc and Devon Energy Corp. were already cashing in on infrastructure built when the shale boom took them into new regions not connected to the existing grid.

Now, the incentive to give up pieces of these cash-generating treasure troves is that much stronger.

“The decline in commodity prices should free up some assets that are embedded in various producers,” said Salim Samaha, a partner at Global Infrastructure Partners, an investment firm based in New York.

Higher Value

For Hamm’s Hiland Partners LP, Kinder Morgan Inc. is paying 15 times what the assets will earn this year, before interest, taxes, depreciation and amortization, or Ebitda, according to RBC Capital Markets LLC. An exploration and production company would sell for less, between three and 10 times Ebitda, said James Sullivan, an analyst at Alembic Global Advisors in New York.

Hamm only agreed to the sale after being certain the Bakken producer he runs, Oklahoma City-based Continental Resources Inc., would have a good, long-term relationship with Rich Kinder’s Kinder Morgan, Hamm said in a Jan. 28 interview in Houston.

“Kinder Morgan is somebody we can work with,” Hamm said.

The swings in the two billionaires’ fortunes illustrate how the value of midstream assets is surviving the energy industry’s turmoil.

Shifting Fortune

Hamm, a 69-year-old wildcatter who pioneered extraction in the Bakken, has seen his net worth shrink almost $5 billion since November to less than $12 billion as Continental Resources’ value slumps along with crude’s price, according to the Bloomberg Billionaires Index.

Seventy-year-old Kinder, who built the world’s most valuable pipeline company shipping oil and gas across North America, has caught up with Hamm after becoming approximately $1 billion richer over the same period.

Pioneer Natural Resources Co., based in Irving, Texas, is seeking a similar windfall to Hamm’s Hiland deal with the sale of its EFS Midstream in the Eagle Ford shale, which it owns with India’s Reliance Industries Ltd. They expect to net more than $3 billion, people with knowledge of the process said last month.

“They need to plug a hole in the balance sheet,” Alembic’s Sullivan said of Pioneer. “In order to keep growing, they have to spend, and they have to way, way outspend their cash flow.”

Avoiding Spending

Encana’s sale to Veresen and KKR will allow it to avoid spending $150 million on required infrastructure expansions this year, Mike McAllister, the Calgary-based company’s chief operating officer, said Jan. 22 at an investor conference in Whistler, British Columbia.

“I’d rather be putting that money into wells and generating a better return than putting it into facilities,” McAllister said.

The smallest and most cash-strapped producers will be the most pressured to sell their midstream businesses, said Alembic’s Sullivan, suggesting U.S. shale operators Oasis Petroleum Inc. and Laredo Petroleum Inc. as candidates.

Permian shale producers Reliance Energy Inc., Diamondback Energy Inc. and RSP Permian Inc. said on Monday they’re selling their Coronado Midstream Holdings pipeline venture to a unit of Devon Energy for $600 million.

SandRidge Energy Inc., another small producer, could bring in more than $1 billion with its plan to spin off a water-handling business in Oklahoma and Kansas, according to Mark Hanson of Morningstar Inc. in Chicago.

Southwestern Energy Co., a larger operator, has a gas-gathering system worth about $3 billion, Hanson estimates.

Kinder’s Opportunity

Kinder Morgan is among the best positioned to pursue additional midstream acquisitions, particularly in Permian, Marcellus and Utica shale regions in the U.S., RBC analysts led by Elvira Scotto said in a Feb. 1 note.

“There will be some premium opportunities for the right asset,” said Tim Fenn, a Houston-based partner at law firm Latham & Watkins LLP. “The overall rationale has shifted since commodity prices have fallen, from opportunistic selling at high multiples to selling to fund drilling, at any cost.”

Richard Wheatley, a Kinder Morgan spokesman, declined to comment on potential deals.

Southwestern doesn’t have plans to divest of its pipelines, with the exception of a gas-gathering system in northeast Pennsylvania that it has been trying to sell, Christina Fowler, a spokeswoman, said in an e-mail.

Representatives for SandRidge and Laredo declined to comment and spokesmen for Oasis and Pioneer didn’t return messages.

Canadian Pipes

In Canada, there is more than C$5 billion of midstream acquisition opportunities as producers controlling about 75 percent of Alberta’s gas processing capacity seek to shore up balance sheets, National Bank Financial analysts led by Patrick Kenny wrote last month.

Canadian Natural Resources Ltd., the nation’s largest gas producer, is considering the sale of some midstream assets, though it’s wary of the higher processing fees it would have to pay in the future, Corey Bieber, chief financial officer of the Calgary-based company, said at the Whistler conference.

Tough Decision

“If it’s going to erode returns or increase costs so significantly that returns are eroded for the base business, it makes no sense to do,” Bieber said.

Like Shell and Devon, many of the largest North American oil and gas companies have already taken advantage of demand for their pipes and plants by selling or spinning them off before the price slide.

With midstream companies in the driver’s seat now, the challenge for producers that still have assets to sell will be garnering the same high prices of the last few years. Kinder Morgan’s Bakken deal with Hamm offers some hope, said Alembic’s Sullivan.

“That type of thing would incentivize people to think they can go out and get a similar valuation,” Sullivan said. “The question is whether they in fact can.”

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