Midstream Business: Construction, Courts and the Future

[Editor's note: A version of this story appears in the September 2020 edition of Midstream Business. Subscribe to the magazine here.]    

The last twinkle of Fourth of July fireworks had barely faded from the television screens of a quarantined America when the country learned that the Atlantic Coast Pipeline (ACP) project, a key element in plans for its growing energy infrastructure, would be canceled.

How could this have happened? ACP, a joint project of Dominion Energy and Duke Energy, was as all-American as an industrial project can get. It possessed the American fondness for size: final cost estimate of $8 billion; length of 600 miles from West Virginia through Virginia to eastern North Carolina; and diameter of 42 inches (36 inches in North Carolina), allowing it to move about 1.5 Bcf/d of Marcellus Shale natural gas to generate electricity, and heat homes and businesses.

There was the love of money: communities along the route would collect as much as $30 million per year in property taxes, and electricity consumers in those three states would save about $377 million per year in energy costs.

And there was our workaholic nature: the economic activity from the pipeline would support an estimated 17,000 jobs—no small thing at any time but especially needed during a recession.

Presumably, those workers would at some point dine on hot dogs and apple pie as well. The only element of Americana missing from ACP was the rocket’s red glare (due to the need to keep it a safe distance from the natural gas it would be transporting).

And then, with the sudden click on the “send” button for a press release, it was gone. This, despite $3.6 billion having been pumped into the project in the last six years. This, despite a 7-2 decision just three weeks earlier from the U.S. Supreme Court allowing the pipeline to cross below the Appalachian Trail. The anticipated litigation had injected so much financial uncertainty into the project that the economics no longer made sense and the partners called it quits.

Such was July 5. ACP was gone and consumers in three states would need alternative options for their natural gas, but at least it was a one-off disappointment for the pipeline sector. What more could crazy 2020 do to the oil and gas industry? Shut down an operating pipeline? Revisit the struggle over completion of the Dakota Access Pipeline (DAPL). No, things couldn’t get that bad, could they? And after all, tomorrow was another day.

Then tomorrow arrived and the answer to what more 2020 could do to the industry came: DAPL was ordered to cease operations owing to an improper permit approval by the U.S. Army Corps of Engineers. Ouch.

A U.S. appeals court on Aug. 5 said DAPL does not have to be shut and drained per a lower court order, but a legal battle continues over the permit that allows the line to be finished. U.S. regulatory officials may still need to issue another environmental assessment for DAPL before deciding if the pipeline can keep operating, the U.S. Court of Appeals for the District of Columbia said.

‘Different Animal’

It’s too easy to lump the cancellation of ACP with the subsequent ordered shutdown of DAPL simply because of their proximity on the calendar.

“It’s apples and oranges comparing operating pipelines with projects in development,” Stacey Morris, director of research with Alerian, told Midstream Business. “Obviously, with production generally declining, there’s not as much interest in building brand new pipelines at the moment compared to a couple years ago, which mutes some of the readthrough to the industry from ACP’s cancellation.”

There was also the issue of Dominion’s sale of its natural gas pipeline and storage assets to Berkshire Hathaway on July 6 for an enterprise value of $9.7 billion.

“I think there are a lot of unique circumstances surrounding that pipeline project as well, including the fact that the project was being led by utilities and Dominion was getting out of the pipeline business altogether,” Morris said.

What struck Kenneth B. Medlock, senior director of the Center for Energy Studies at Rice University’s Baker Institute for Public Policy, was that the plug was pulled on ACP after so much money had already been invested. 

“At some point, you’re so far in that you just want to see it finished,” he told Midstream Business. “You need to recover something out of it. But I think the costs were mounting to the point where it was, ‘We’ve got to do something in the interests of shareholders’ and I think that’s what drove the decision there.”

External decisions made first by the Corps and then by the court, ambushed DAPL, not those made by operator Energy Transfer Partners.

“Dakota Access is a totally different animal because it was already operational,” Medlock said. “It’s one of those things that I don’t think anybody expected to happen, and when it did, it kind of made you catch your breath a little bit because it does signal trouble on the horizon for lots of other potential infrastructure regardless of whether it’s completed. It also signals that if you want to build something, you’re going to do a lot of front-end work and you still might have a risk. As a developer, you might think you did everything you needed to do. You get the facility constructed and in operation and then there’s something that’s brought against one of the regulators involved in the process along the line.”

Fighting Back

Judge James Boasberg of the U.S. District Court of the District of Columbia ordered Energy Transfer to shut and empty the 570,000-bbl/d line by Aug. 5, which would close the biggest pipeline moving crude oil from the Bakken Shale to Patoka, Ill. The ruling stated that the Corps violated the National Environmental Policy Act (NEPA) when it failed to complete an environmental impact review—“despite conditions that triggered such a requirement”—before granting the easement that allowed Energy Transfer to begin construction in 2017.

“Although mindful of the disruption such a shutdown will cause,” the opinion read, “the Court now concludes that … Clear precedent favoring vacatur during such a remand coupled with the seriousness of the Corps’ deficiencies outweighs the negative effects of halting the oil flow for the 13 months that the Corps believes the creation of an EIS [Environmental Impact Statement] will take.”

A little more than a week later, the Council on Environmental Quality (CEQ) released its final rule to update NEPA regulations. The act was signed into law in 1970 and its regulations were last updated in 1978. “The final rule will make the NEPA process more efficient and effective, ensure consideration of environmental impacts of major projects and activities, and result in more timely decisions that support the development of modern, resilient infrastructure,” said CEQ Chairman Mary B. Neumayr.

Energy Transfer countered swiftly. “We believe that the ruling issued this morning from Judge Boasberg is not supported by the law or the facts of the case,” the company said in a statement that day. “Furthermore, we believe that Judge Boasberg has exceeded his authority in ordering the shutdown of the Dakota Access Pipeline, which has been safely operating for more than three years.”

Energy Transfer filed a motion to stay the decision, arguing that regulations governing Corps property gives the Corps ultimate jurisdiction. The District Court rejected the motion but the U.S. Court of Appeals for the District of Columbia granted a stay on July 14. Native American tribes opposing the pipeline filed a response ahead of a hearing in late July.

How this plays out is uncertain. Wells Fargo Securities released a research note in early July citing Washington, D.C., consultants who believed it was unlikely that Energy Transfer would succeed in its appeal. However, Bloomberg reported that the company would not take action to shut the pipeline while pursuing its legal strategy. Consider the logistics of shutting and emptying a major pipeline like DAPL, which could make it impossible for Energy Transfer to adhere to the Aug. 5 deadline. If the appeals process continues for the 13 months the Corps needs to complete its EIS, Wells Fargo mused, would the pipeline continue to operate in the interim?

Less Safe

If it turns out that the District Court’s order is affirmed and DAPL must shut for the duration of the EIS, the impacts are myriad.

“It strands, potentially, resource in the Bakken,” Medlock said. “When you shut that down, you start to run out of pipeline points of access out of that shale play, which means you’re going to end up putting things on rail cars again. And that’s a much more expensive proposition than moving by pipe, and that’s going to change the economics of the wellhead for some players up there.”

It’s also not as safe, he said, adding that “the irony is that incidents are much higher when you increase the points of contact, and you have to when moving by rail car.”

The U.S. Energy Information Administration (EIA) data from April show the vast majority of crude-by-rail shipments in the country originating in the Midwest with 115,000 bbl/d moving to the East Coast and 157,000 bbl/d moving to the West Coast. Canada also ships more than 200,000 bbl/d of crude by rail to the U.S., most of which goes to the Gulf Coast.

Soon after the DAPL decision was announced, Crestwood Equity Partners assured customers of its Arrow gathering system in the Bakken that it was prepared to use the Hiland and Tesoro pipelines to get crude to market, and even use trucks to move oil to its COLT Hub in Epping, N.D.

“If DAPL is shut down, the industry will look at other options and ways to get that crude to market, but it certainly becomes more complicated,” Morris said. “Pipelines are the safest way to move crude. There are alternatives but they may not be as safe as putting crude into the pipeline.”

“Pipelines are the safest way to move crude. There are alternatives but they may not be as safe as putting crude into the pipeline.”

—Stacey Morris, Director of Research, Alerian

To a point, the loss of DAPL is mitigated in the overall market by the reduction of demand in an economy jolted by COVID-19. Higher breakevens in the Bakken in comparison with the Permian Basin mean many wells were shut in and will remain that way until oil markets recover.

“It’s kind of a double-edged sword,” Medlock said. “You might think, yeah, demand is down so price is down, so commercially it’s not that attractive to drill new wells anyway. Even so, if I have to take existing production and start moving it to more expensive transport, that negatively impacts my price. There still is a negative commercial impact associated with this.”

Wells Fargo estimated the cost basis in the use of rail rises by $10/bbl. Even in a world without the pandemic and its economic devastation, the higher price at the wellhead would be unlikely to fully compensate producers for the higher cost of rail or trucks in the absence of DAPL, he said. Either way, Bakken producers are going to hurt.

The EIA projected Bakken crude production of 1.095 MMbbl/d in July and 1.113 MMbbl/d in August. If DAPL is shut down, Wells Fargo expects production to decline to 1 MMbbl/d.

“It’s possible that production could be constrained at the 1 MMbbl/d mark if basis widens to such a degree that incremental development in the Bakken becomes uneconomic,” Wells Fargo analysts wrote. “Alternatively, if oil prices continue to increase, the impact to Bakken production may not be as significant as rail becomes economic.”

That’s a big if. The economic factors with a chokehold on the oil and gas industry are directly tied to the collapse of the global economy, which is tied to the advent of the COVID-19 pandemic. By midsummer, COVID-19 cases had surged to record levels in the U.S. and millions remained out of work.

Strategy of Delay

Not everyone was dismayed by the onetwo punch to ACP and DAPL. The Sierra Club loved it. “This is a story of grassroots resistance,” Kelly Martin, director of the Sierra Club Beyond Dirty Fuels Campaign, proclaimed during a July 6 press conference called to discuss ACP.

“This is a story of relentless organizing. It is a victory for racial justice. It is a victory for environmental justice and for addressing the climate crisis. For six years, grassroots communities all along the proposed 600-mile route of the fracked gas Atlantic Coast Pipeline from West Virginia through Virginia into North Carolina have refused to give up. They held steadfast in their opposition to this ill-conceived, unnecessary, dirty and dangerous project. This is a story of holding agencies accountable for upholding environmental laws.”

Tudor, Pickering, Holt & Co. analysts did not endorse Martin’s heroic depictions but they did acknowledge the Sierra Club’s strategy of persistence.

“While the decision does not have any direct read-throughs to other energy infrastructure projects under development,” the analysts wrote, “it will likely embolden existing opposition and validates the strategy of delay.”

This Isn’t Over

The setbacks represented the difficulties of building new pipeline projects even when there is actual consumer demand for the projects, Dulles Wang, a director on Wood Mackenzie’s North America gas team, said in an analysis. Of particular concern was a decision in April from a federal court in Montana involving Nationwide Permit 12 (NWP 12). The court ruled that the Corps violated the Endangered Species Act in reissuing NWP 12 for the crossing of the Yellowstone and Cheyenne rivers by the Keystone XL Pipeline. The judge in the case vacated NWP 12 and ordered the Corps to reconsider its issuance based on compliance with the act.

“Northeast pipeline projects such as Mountain Valley and Penn East need to overcome NWP 12 hurdles,” Wang wrote, “but Permian projects such as Permian Highway Project are not immune as well.”

API expressed its displeasure in a statement from Mike Sommers, the organization’s president and CEO: “Between the Atlantic Coast Pipeline cancellation and now the ruling to shut down the Dakota Access Pipeline, we are deeply troubled by these setbacks for U.S. energy leadership.”

The following week, though, things were looking up from API’s perspective.

“NEPA modernization will help America streamline permitting to move job-creating infrastructure projects off the drawing board and into development,” Sommers said on July 15. “Today’s action is essential to U.S. energy leadership and environmental progress, providing more certainty to jumpstart not only the modernized pipeline infrastructure we need to deliver cleaner fuels but highways, bridges and renewable energy.”

Does that glimmer signal that perhaps the dark days of midstream’s summer of discontent were not as dark as feared? Remember that since 2007, the U.S. has added almost 200 Bcf/d of natural gas pipeline capacity. Medlock urges some perspective because oil and gas opponents have not shown themselves to be absolute world beaters.

“So they shut down one, but we added a significant amount of infrastructure,” he said. “I wouldn’t want to trumpet [cancellation of ACP] as a massive success too much because if their goal is to stop all infrastructure then they’re still lagging.” Canceling projects invariably will lead to that familiar refrain of the shale revolution: pipeline constraints.

“I actually think there’s going to be a point—when demand does begin to recover—when there’s going to be some significant concern raised about availability of supply,” he said. “We saw an indicator of this. You think back a year and a half ago [and] a lot of people in Washington were up in arms because an LNG tanker that had reloaded at the Isle of Grain in the U.K. with Russian molecules delivered gas to Boston.”

Medlock was in Washington in February 2018, testifying before the Senate Committee on Energy & Natural Resources, and he was asked how the U.S. was forced to import from Russia. He explained to the senators how these markets work. If pipelines are not allowed to be built and the Jones Act prohibits U.S. tankers from delivering LNG, then the next least-cost opportunity is what’s out there on the water. At that time in January 2018, it just so happened to be a cargo of gas that originated in Russia.

And that is where we are—a country with a superabundance of natural gas on course to failing to meet future demand because it insists on binding itself in political knots.

“That issue’s not going away,” Medlock said. “I think there’s going to be an interesting to-ing and fro-ing on this for years to come. I don’t think it’s going away any time soon.”