Although there are some headwinds facing the midstream industry the positives outweigh the negatives, according to David Lundberg, analytical manager for Standard & Poor’s midstream energy and MLP team, as he points to a strong outlook for the industry in 2012.

“Crude and liquids prices remain high, liquidity and capital market access remain healthy, and there has been a decline in long-term capital programs that stretched out balance sheets,” he said during the rating service’s “Outlook for the Midstream Energy and MLP Industry” teleconference.

The negatives for the midstream are that natural gas prices remain low with narrow basis differentials. In addition, financial leverage is at the outer edges of tolerance levels in many cases, despite capital expenditures coming off the books.

“We didn’t think this would be the case. As a result, many companies have balances that are stretched. Many companies are pursuing good projects, but we will be mindful of how companies spend for these projects,” he said.

Constructive dynamics for crude

The biggest positive for the midstream has been the outstanding performance by natural gas liquids (NGLs), which has been supported by strong crude prices and increased demand from the petrochemical industry. S&P anticipates these positives continuing in 2012.

“It’s been pretty striking to us that, despite the economic slowdown and the material chance of a double-dip recession, crude prices have remained quite high at around $100 per barrel for West Texas Intermediate and $110 per barrel for Brent crude. We think the dynamics are relatively constructive for crude,” Lundberg said.

The agency set a base case outlook of about $70 per barrel for crude for the next few years, but Lundberg noted that S&P uses a very big cushion to predict where crude prices are headed. Therefore, this figure doesn’t really represent S&P’s forecast for crude prices but is used by the agency to determine ratings for companies long on crude.

“The supply and demand dynamic is very tight with OPEC spare capacity only being 3 million to 4 million barrels per day. That’s not a whole lot of spare capacity, particularly as demand in emerging economies grows,” he said. This dynamic will loosen up slightly once Libyan crude supplies come back online, but demand should remain strong globally.

“Looking at the longer-term price deck, one thing we really think about is what price point is needed to support the production of more marginal and frontier projects like deepwater drilling and some projects in the Canadian oil sands. We think that $70 to $75 per barrel is a reasonable expectation for what prices are really needed to justify longer-term investment decisions.”

NGL prices to continue to flourish

Meanwhile, strong crude prices will continue to support NGL prices, especially butane, isobutane and C5+, because of their close correlation with crude. Lundberg stated that propane prices were also somewhat correlated with crude and would continue to reap benefits from crude.

Propane prices also have the possibility of becoming decoupled from crude oil because of petrochemical demand, both domestically and internationally through exports.

The lone NGL that is becoming increasingly decoupled from crude prices is ethane, which has largely been driven by petrochemical demand for ethylene. “We feared that the petrochemical industry couldn’t take all of the ethane being produced, but that hasn’t happened,” he said.

Natural gas to continue to face headwinds

While crude and NGL prices are helping to support the midstream, natural gas prices are having a negative effect, which S&P anticipates continuing in the near-term. “There’s really no catalyst for gas prices being higher. Our pricing assumption is around $3.75 per million Btu (MMBtu) to $4.00 per MMBtu and a little over $4.00 per MMBtu in the outer years. The demand side really hasn’t been a bad story, it’s actually been up a little bit and we expect it to remain up in 2012 from increased industrial and power demand. The issue with gas prices is that they have been overwhelmed by the supply side due to technology and the industry continuing to find lots and lots more shale,” he said.
The great unknown remains whether production will come down anytime soon. Although the dry-gas rig count will decrease, the rig count in wet-gas plays is expected to grow at a rapid pace. This make is unlikely that production will decrease. While increased power demand will eventually help to work some of this increased production out of storage, this demand will take many years for a full realization of demand.

Infrastructure demand

With no end in sight for production from shale plays, the need for midstream infrastructure remains high, especially for pipeline take-away capacity in regions without the capability to process or refine this production. This built-in market for pipeline projects makes them very manageable from a credit perspective, according to S&P’s Bill Ferara, a senior member on the S&P midstream energy and MLP team. He noted that some of these projects are increasing in risk as some companies have begun to place high debt leverage on these assets.
There are also severe differentials involving crude oil hubs, especially at Cushing, where take-away capacity is severely restricted. According to Manish Consul, an S&P credit analyst, there are a combined 1.7 million barrels per day of crude shipped into the hub, only 600,000 barrels per day of outbound capacity and 500,000 barrels per day of local consumption. Consequently there is a great deal of demand for both takeaway pipeline capacity and storage capacity in the region.

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