With more institutional money chasing midstream deals than in recent years, private equity sponsor Energy Spectrum Capital points to several factors—including a strong track record, good upstream intelligence and a capacity to exercise patience when appropriate—in attracting sound investment opportunities with seasoned management teams.

From a long-term perspective, there is good visibility for infrastructure projects that need to be funded in the midstream sector. One industry estimate suggests that during the next decade, there may be as much as $200 billion to $300 billion of capital needed to build out new infrastructure to carry energy sources flowing from unconventional resource
discoveries.

How far along is the midstream industry in relation to its projected long-term infrastructure needs?

Tom Whitener, president and a founding partner of Dallas-based Energy Spectrum Capital, says he expects the infrastructure build-out in the U.S. “is going to take decades,” with occasional periods of both faster and slower growth.

“There will be times when the activity is surging, and then there will be a pullback, and it will go slower for a while,” he says. “It’s not going to be consistent.”

How is that cyclicality showing up in current market conditions?

‘A deliberate phase’

“Currently, we are in a bit of a deliberate phase with producers,” says Whitener. “The pace of deals that are actually closing has slowed down considerably from a couple of years ago. Midstream-solution decisions are taking longer than they used to with producers. They’re progressing, but at a more deliberate pace.”

Whitener cites several factors for the slowdown, including the pre-heating season weakness in dry natural gas prices and a re-evaluation by exploration and production firms of aggressive acreage positions acquired in the unconventional shales land grab. But the more recent shift in economics favoring crude oil has also seen producers take their time before giving up the “optionality” on short-term takeaway alternatives, such as rail or pipe, if it involves a long-term acreage dedication, transportation contract and/or purchasing contract.

With the slower deal flow, and greater capital drawn to midstream by attractive liquids economics, Whitener says, “there’s not enough deal flow for all of the capital Energy Spectrum targets pre-tax internal rates of return by percentage in the mid-20s and a cash-on-cash return of at least 2:1. Whitener says its track record has been to deliver those types of returns pretty consistently across the ebbs and flows of market conditions since closing its first fund—the first U.S. midstream-focused private equity fund—in 1996. The fund targets lower middle-market investments, typically in the $25 million to $150 million range, although it can do larger deals.

Investment targets

Energy Spectrum combines greenfield projects, which are typically needed in shale developments, with a buy-and-build strategy often involving underutilized assets with organic growth potential. Projected returns on buy-and-build are typically lower at the time of entry into a basin (e.g., high single digit/low teens) and move higher as expansion opportunities are realized.

“It’s very important to be a first mover in an area,” says Whitener. “If you are, the barriers to entry for a competing system are pretty high.”

Energy Spectrum is now funding management teams from Fund VI, in which it raised about $1 billion. One recent investment has been with Velocity Midstream Partners LLC, which also was a partner through an Energy Spectrum Fund V investment in 2008. Velocity’s Fund V project scope included construction of a condensate gathering system and two terminals in the Eagle Ford for E&P customers, including Shell, Rosetta Resources, SM Energy, Chesapeake Energy and Talisman Energy.

In Fund VI, Velocity is working with Kinder Morgan and NOVA Chemicals on projects related to the reversal of the Cochin pipeline, which is being converted to carry 95,000 barrels (bbl.) per day of light condensate to oil sands producers in western Canada. The project includes Velocity’s construction and subsequent operation of a gathering system and two lines dedicated to carrying natural gas liquids (NGLs) from the Utica and Marcellus to connect with the Cochin line at Riga, Michigan, near the Ohio border.

Cochin East

The latter project has two parts. One is the Cochin East Extension, a 12-inch line to transport natural gasoline and condensate to Riga and then west to be used as diluent by Canadian oil sands producers. The second is a 10-inch parallel line to carry ethane and ethanepropane mix to Riga and then east to Windsor, Ontario, for use by the petrochemical and fuel markets. The latter is called the Utica to Ontario Pipeline Access (UTOPIA) project, with an initial 50,000 bbl. per day capacity, expandable to more than 75,000 bbl. per day, and with a mid-2017 in-service date.
“Velocity has significant experience with condensate from the Eagle Ford, and they’ll bring that expertise to bear here in the Utica,” said Ben Davis, a partner with Energy Spectrum, speaking at Hart Energy’s Marcellus- Utica Midstream conference in Pittsburgh in January.

The addition of the UTOPIA line, providing a future outlet for Utica NGLs, is attributed to NOVA’s incremental demand for ethane and propane as it has moved away from heavier feedstocks and toward an all-NGL feedstock of an ethane/propane mix. Meanwhile, for condensate, the reversal of the Cochin line, coupled with the existing Southern Lights pipeline, will represent combined takeaway of 275,000 bbl. per day when the Cochin reversal comes online in June.

Whitener describes Spectrum as having a deep bench of management teams among its portfolio companies, pointing to five repeat management teams in Fund VI, of which two have received their third commitments from Energy Spectrum. The holding period for investments by Energy Spectrum has averaged about 4.5 years.

Although Energy Spectrum’s Fund VI companies are all in the growth stage of their life-cycle, one portfolio company from Fund V that was recently divested is Hoover Energy Partners, which established a good gas gathering, crude gathering and water disposal footprint in Reeves County, Texas. In terms of acquisitions, a Fund VI company, Azure Midstream Holdings, completed the purchase late last year of TGGT Holdings from EXCO Resources and BG Group for $910 million. The purchase involves more than 1,300 miles of gathering pipelines moving gas from
northern Louisiana and East Texas supply basins.

Chris Sheehan can be reached at csheehan@hartenergy.com or 303-800-4702.

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