How do you put a value on experience, the ability to “connect the dots” from a prior career event and then utilize those findings to assess a brand new opportunity or undertaking?

The founding partners of Haddington Ventures LLC, based in Houston, have been investing together since 1984. The company’s current management team can collectively boast more than 150 years of midstream experience, spanning everything from operations and engineering to regulatory issues and marketing.

And the Haddington team clearly turned this midstream experience to its advantage in identifying a ground floor opportunity in the ever expanding Marcellus play. Moreover, management is parlaying its broad midstream expertise, including storage, to exploit new opportunities arising from the fast changing supply dynamics in the world of natural gas liquids (NGLs).

How did “connecting the dots” help Haddington in the Marcellus play?

Back when gas markets depended more heavily on storage (i.e. pre-horizontal drilling and hydraulic fracturing), Haddington’s founding partners wanted to complement two high-delivery natural gas storage caverns in the Gulf Coast supply area with a third located near key northeast markets. The proposed site would be at a location to be determined in Pennsylvania. The time was the early- to mid-1990s.

The founding partners were in for a surprise. Like the dog that didn’t bark in the Sherlock Holmes mystery, what was remarkable about Pennsylvania was what they didn’t find.

The subsurface geology in Pennsylvania could scarcely have been more different than along the Gulf Coast, where solution mining is often used to construct highdeliverability storage caverns. The practice involves injecting fresh water downhole and retrieving the resultant brine as a salt cavern is gradually hollowed out. Having salt-water disposal wells are key to the project.

“None of that geology existed in Pennsylvania,” recalls Haddington founding partner John Strom in a conversation with Midstream Business. “On the Gulf Coast there are literally thousands of salt-water disposal wells. But there was nothing in the way of brine-disposal capability in the deeper salt-bearing sands in Pennsylvania.”

More than a decade later, this finding served Strom well as he witnessed “the great land rush” under way in the Marcellus, following previous gas shale plays unfolding at speed in the Barnett and Haynesville.

“We were scratching our heads, wondering ‘They’re paying these huge royalties up there, but how on earth are these guys going to get rid of all the frac flowback water and their produced water?’ Based on what we knew, there wasn’t any way to do it,” given the lack of disposal wells so commonly found along the Gulf Coast, he says.

Seizing opportunities

Armed with this key fact, Haddington Ventures moved swiftly to gain a controlling position in Eureka Resources, a wastewater treatment provider whose customer base has grown to include 13 of the 15 largest energy producers in northeastern Pennyslvania. The company’s Williamsport, Pennsylvania, treatment plant is cited as the only facility treating Marcellus wastewater that meets the Pennsylvania Department of Environmental Protection’s (DEP) stringent standards for discharge into the state’s rivers and streams.

While noted for its acumen in such storage and water treatment investments, Haddington Ventures offers a full spectrum of midstream infrastructure expertise, covering gathering, refining, transport, storage, processing, treating, compression, pipelines and renewables. Since 1998, it has raised nearly $700 million in equity capital used to sponsor midstream asset acquisitions and development teams.

David Marchese, a Haddington director with 15 years of midstream industry experience, explains to Midstream Business that the firm differs from most private equity sponsors in that it approaches projects from more than a purely financial standpoint:

“One of the things Haddington is very good at is looking at the overall grid and asking, ‘Where does that asset need to be from a physical standpoint? Where does this gathering system, this processing plant, this storage facility need to be within the grid?’ Because if you put it in the right place, people will pay you to provide the service from that asset, even across extreme changes in prices, such as has occurred in the natural gas market.”

In its latest fund, Haddington Energy Partners IV, Haddington raised $350 million. The fund is expected to back six or seven portfolio companies, each with a typical investment size of $50 to $75-million. As of early 2013, four portfolio companies had been funded.

Investments are viewed in three categories, each with its own targeted hurdle rate, depending on perceived risk. Around 40% to 50% of the portfolio is earmarked to buy operating companies, with a targeted base-case internal rate of return (IRR) typical for private equity. The balance of the portfolio is expected to be invested in “greenfield” projects: 30% to 40% to build new facilities, with a targeted IRR above the base-case scenario; and 15% to 25% to develop new facilities. Often, these are in a prepermitting stage with a targeted IRR still further above the base case to reflect greater risk in development.

Strom says Haddington is agnostic as to a “buy or build” choice, noting that assets in the firm’s early funds tended to be split roughly evenly between the two strategies, given management’s prior history of developing assets itself.

“We have the skill set, which is unusual in the private equity world, to be comfortable with development risk,” Strom says. “But if we can acquire at reasonable multiples, we will acquire.”

Focusing on development vs. acquisition

However, with master limited partnerships’ (MLP) growing presence in the market for midstream assets, he notes that “it has become increasingly difficult for us to find value in the acquisition side and generate equity returns acceptable to our limited partners. And so over the past three to four years we have increasingly done more development, because we can find more value there, and there are fewer players.”

Based in Williamsport, Pennsylvania, Eureka Resources is a portfolio company in the most-recent Haddington Energy Partners IV fund. The latter has now provided Eureka with the growth capital needed to build a second plant in Bradford County, Pennsylvania, a county that has been in the lead of Marcellus drilling in recent years.

The new plant, due to come online this October, is designed to treat 10,000 barrels (bbl.) per day of multiple fluids—drilling muds, flowback water and produced water. This adds to the base capacity at the Williamsport plant, which previously had been expanded threefold to 8,000 bbl. per day and has produced a fourfold increase in EBITDA from the asset.

Eureka’s strong market position reflects its use of an industry-leading treatment process that allows for the complete recycling of Marcellus and Utica shale water for use at future well sites. In addition, Eureka can offer customers the flexibility of outright disposal of wastewater, as may be needed in, say, winter, if decreased fracing activity leads to reduced rates of waste water recycling.

These options, given the unique regulatory environment in Pennsylvania, are all the more attractive if one considers the main alternative: trucking wastewater some 10 hours or more away for conventional disposal in Ohio at a cost of $10 to $20 per bbl., depending on the field location in northeastern Pennsylvania.

In addition to expanding capacity, the new facility in Bradford County will include a brine crystallizer, which will both raise the percentage of wastewater that can be recycled and, importantly, allow for the recovery of some key by-products. Incorporating the value of by-products, the facility’s operating costs are expected to be lowered by approximately 50% with the crystallizer.

Additional portfolio companies

Other portfolio companies fit the more typical midstream mold of gathering, treating and processing. For example, Tristream Energy, in the earlier Haddington Energy Partners III fund, has approximately 400 miles of gathering assets in northeastern Texas. Gas is gathered from the Smackover trend and taken to state-of-the-art gas treating and processing facilities in Eustace, Texas. The assets were acquired in 2010 from Regency Energy Partners.

The Tristream management team is led by Ken Purgason, who previously headed up Sago Energy, a portfolio company backed by both the Haddington Energy Partners I and II funds. Both funds took profits on the sale of Sago Energy in 2004. The assets acquired by the Tristream team include facilities in Eustace to strip out hydrogen sulfide to make sulfur, a cryogenic NGL recovery plant and a 1,800 bbl. per day condensate stabilization unit. Also included in the package is a 3,000 bbl. per day condensate stabilization facility located in Myrtle Springs, Texas.

Tristream has taken advantage of previously underutilized capacity to capture growing volumes of liquids, both NGLs and condensate, stemming primarily from the upsurge of drilling in the Eagle Ford. NGL volumes extracted from the Smackover are now supplemented by rising NGLs coming out of the Eagle Ford, which are then shipped on to the Mont Belvieu, Texas, NGL hub while fast-growing condensate volumes from the Eagle Ford are blended with heavier crudes and then shipped to Gulf Coast refiners.

One of the Tristream’s key strengths is that it is “very good at finding new opportunities for neglected assets and re-purposing them,” says Marchese.

Fairway Energy Partners, a Haddington Energy Partners IV fund company, has a similar focus, albeit at an earlier stage of development. Marchese describes the projects Fairway is undertaking as brownfield acquisitions and re-purposing of assets, with some construction. The two parties have been working together for almost two years, with the goal of identifying and acquiring midstream assets that will be advantaged by the growing wet gas and liquids supplies reaching the Gulf Coast/Texas market.

Burgeoning NGL supplies in the Bakken have similarly created opportunities that Magnum Energy, a Haddington Energy Partners III fund company, is looking to exploit. In essence, whereas supplies of Bakken-derived propane and butane have historically been absorbed by regional demand (e.g. home heating and blending by refineries, respectively), the projected growth in supplies augurs well for demand for NGL storage capacity designed to exploit higher-priced seasonal western region and Asian markets.

While originally focused on high deliverability natural gas storage in Utah, Magnum Energy pivoted toward NGLs with continuing gains in Bakken supplies. Customer interest is said to be at a level such that, subject to final project financing, construction of two initial salt caverns to store propane and butane is expected to commence in the coming months. With control of hundreds of acres, plans could, over time, call for as many as three to six NGL caverns, although capacity dedicated to natural gas and compressed air energy storage also remains a consideration.

Seasonal factors obviously play a part in the markets for propane and butane, especially in regions lacking easy access for exports, where limited storage fills up quickly in summer. Conversely, in winter, in addition to seasonally stronger demand for propane, there is higher consumption of refinery-grade butane due to changes in the Environmental Protection Agency’s vapor pressure specifications.

As a result of the latter swings in demand, westernregion refineries can provide a “core market” for western NGL storage to serve today, according to Strom. Also, as Bakken supplies grow over the next three years, the rising NGL surplus is expected to justify “staging” of shipments via West Coast ports to higher-priced Asian markets, providing a more economic export route than via the Gulf Coast.

Without having to ship product through the Panama Canal, “West Coast ports have the potential to take half the shipping time to Asia,” observes Strom. “We would marry our storage to existing or perhaps expanded West Coast capacity to export.”

Strom suggests the project is more “greenfield” in nature, but with “brownfield” components related mainly to its proximity to a 2,000 megawatt power facility “next door” and access to Union Pacific rail via a 7-mile spur. Importantly, “we’re going to have unit train capability here.”

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