Unexpectedly cool summer weather, low natural gas prices and increased imports of liquefied natural gas (LNG) are pushing gas-in-storage levels toward new highs, nearly full levels, much to the delight of gas-storage companies such as Falcon Gas Storage Co. Inc., Enstor Inc. and Spectra Energy Partners LP, and private-equity investor HM Capital Partners LLC.

July's temperatures turned out to be about 8% cooler than the five-year average, according to a report from A.G. Edwards & Sons, so as of late July, working gas in storage was also high-about 2.7 trillion cubic feet, according to a U.S. Energy Information Administration (EIA) estimate. This represented about 16% more gas in storage than the five-year average for late-July.







"It's a good time to be in the business," says John Hopper, chief executive of Houston-based Falcon Gas Storage Co. Inc., one of the largest independently owned, fully integrated developers and operators of gas-storage capacity in the U.S.

"Storage is in high demand right now and if you build facilities correctly and in the right place, the returns on investment capital can be very attractive."

Falcon's strategy is to build greenfield storage or redevelop brownfield facilities. The company's two North Texas projects, collectively called NorTex, consist of the Hill-Lake and Worsham-Steed facilities. Both are fully subscribed.

Falcon plans further expansions to each for a combined 33.3 billion cubic feet (Bcf) of working gas capacity. NorTex, along with Falcon's other projects being developed in the Southeast and Southwest U.S., will represent more than 100 Bcf of aggregate storage capacity.

The more popular strategy during the past couple of years, particularly for salt-cavern projects, is to acquire the salt rights, do some engineering, get a storage certificate from the Federal Energy Regulatory Commission, and then flip the project.

"We don't typically do that," Hopper says. "We buy, develop and operate. We may sell at some point in the future, but our strategy is to develop and monetize facilities by operating them."

Falcon and its customers buy gas during the off-peak season when prices are low, then sell it forward in the winter months. The optimal price differential is captured through the use of storage and futures contracts and hedges.

"There is a lot of debate about when and how often to turn over inventory, but we think the sweet spot is somewhere between three and five cycles a year. We've seen activity in hot summers when we might have turned it five or six times a year. We don't normally turn it that much, but we have the capability to do it."

Near-month gas prices have been lower than winter prices, an event that has increased the price arbitrage spread. Hopper notes that the price between this summer and two winters from now is higher than the price between now and this coming winter.

"Storage gives you the ability to roll your hedge positions out of one winter and into the next and generate revenue without ever moving any gas, which is always nice to be able to do," he says.

Falcon plans to put that revenue to good use by expanding gas transportation and processing, and getting into oil production which, Hopper says, is a byproduct of being in the gas-reservoir storage business, as opposed to the salt-cavern storage business.





"We like that aspect. You make good money in the gas-storage business, but you make even more when you produce oil and Btu-rich gas that you can process and extract liquids from. And, of course, the crude oil and natural gas liquids markets are very strong right now. We're seeing record prices there as well. That's all very favorable for our business model."

Nonetheless, gas storage is core. Falcon is looking into future storage strategies in a major way, with the expected increase of U.S. LNG imports a major factor that has Falcon gearing up to be ready.

Rightly so, as the EIA forecasts increased LNG imports for the next few years based on current global supply and imports from new sources such as Equatorial Guinea, Norway and Yemen. "LNG imports create a need for more storage capacity," says Hopper. "Because U.S. demand is off, those shipments are going into storage."

Falcon plans to expand during the next five to six years when new LNG import capacity comes online. Its MoBay facility in Mobile, Alabama, will have 50 Bcf of storage downstream of pipeline bottlenecks, with an in-service date of 2008. MoBay will store imported LNG to serve Florida and the U.S. Northeast.

Falcon is also developing a new project in a depleted reservoir, the Desert Southwest facility in New Mexico, that is similar to ones already operating in North Texas. Located on Navajo land, it would store LNG that comes into Mexico or California and have capacity of 20 Bcf upon completion in 2009.



Katy Hub

The ability to cycle gas inventory quickly on demand is part of the business model of Enstor Inc., third-largest independent storage operator in North America. It's owned by PPM Energy Inc. of Portland, Oregon, and is part of Spain's Iberdrola group of companies.

That business model drives operations at Enstor's Katy Hub, a storage facility atypical of other reservoir storage caverns due to its unusual geology. Located approximately 20 miles west of Houston, Katy has the capacity to store 21 Bcf of gas.

"A typical reservoir is composed of porous rock and it takes a lot of pressure to move the gas through that," says Patrick De Ville, Enstor vice president of marketing. "Katy is different in that it's a highly permeable sandstone reservoir, so we are able to put gas in quicker and withdraw it much more quickly. It's the best of both worlds."

The Katy Hub has a dual-header configuration, allowing receipts and withdrawals to be made against whatever pressure may exist in any of the 14 interconnected pipelines, and giving customers easy access to those pipelines. Indeed, Katy Hub is connected to more gas pipelines than any other storage facility in the country, including Henry Hub in Louisiana.

With 25,000 horsepower of compression and 10 storage wells, the Katy facility has 600,000 million Btu per day of peak withdrawal capacity and 700,000 of peak injection capacity, and it has the ability to turn quickly even if it is completely filled, says De Ville. Katy can cycle four times a year, whereas a rock reservoir can only cycle about 1.5 times per year.

"A lot of the fundamentals have changed drastically on the supply side. In addition to that, LNG is becoming a bigger portion of our supply mix. When an LNG cargo comes in, the amount of gas they bring onshore at any given time is much more than the market can absorb in a short period of time."

For Enstor, gas storage has become the balancing mechanism for gas delivery. In the past, local gas distribution companies (LDCs) would contract for a specific amount of gas to be delivered in 30-day increments. But now, power generators are contracting gas deliveries from Enstor for eight hours during the day and not taking deliveries during the other 16.

In addition to changes in the configuration of gas demand, De Ville says gas prices will increase as gas continues to be an alternative to residual fuel for power plants.

"Gas becomes a more global commodity when affected by prices overseas. We see more shipments of LNG coming to the U.S. LNG will be looking for the highest-price market, just like crude oil, gasoline and heating oil do. I think, with all of that, we'll certainly see, over the long term, an uptick in price."

To be ready, Enstor plans to build a greenfield salt-dome storage facility, the Houston Hub, about 30 miles northeast of Houston. When operational in 2010, the first phase will have an initial working capacity of 16 Bcf. The facility will be able to handle 600,000 million Btu per day of peak injection (designed for LNG receipts) and 1,000,000 million Btu of withdrawal deliverability (designed for power-plant demand). Enstor plans to further expand Houston Hub's storage capacity by an additional 14 Bcf.

Enstor is also building a 10-Bcf salt-cavern storage facility, the Waha Storage Hub, near the Waha trading center in West Texas. Waha should be operational in early 2009. Enstor also currently owns the 6-Bcf Gamma Ridge storage facility in Lea County, New Mexico, and has 57% ownership of the 40-Bcf Alberta Hub, 80 miles west of Edmonton, Alberta.

Enstor's financing model is unlike that of other owners and operators. "Most storage owners finance their projects with a bank or investors. We are internally financed and are willing to take more risk to get what we know are much higher returns," says De Ville, "by funding our development and by selling parks, loans and hub services."



MLP IPO

Joining the current wave of new master limited partnerships (MLPs), Spectra Energy Partners LP began publicly trading this summer when parent Spectra Energy Corp., Houston, made an initial public offering of 10 million common units of limited-partner interests in Spectra Energy Partners LP. The IPO raised $237 million.

Assets of the new MLP include 50% ownership of Market Hub Partners, which owns salt-cavern storage assets on the Gulf Coast capable of storing 35 Bcf of gas; East Tennessee Natural Gas, a 1,400-mile pipeline; and 24.5% ownership of Gulfstream Natural Gas System LLC, a 690-mile offshore pipeline that connects Mobile Bay, Alabama, to central Florida.

"These assets have revenues that come from contracted capacity fees with no commodity exposure. They are located in fast-growing markets, including Florida, which is growing over 4% per year," says Martha Wyrsch, president and chief executive of Spectra Energy Transmission, and chairman of the new MLP. "The market has been very receptive to this solid offering."

The storage customers are LDCs and gas-fired electricity-generation facilities, as well as marketing and trading companies that want to have the ability to do some arbitrage on price. "Both of our caverns are fully subscribed and we're in the expansion mode for both," says Wyrsch.

Spectra Energy Partners is expanding its 20-Bcf Egan storage cavern in Acadia Parish, Louisiana, by an additional 4 Bcf, and may add 8 Bcf in the future. Spectra Energy also plans to expand its 15-Bcf Moss Bluff facility in Liberty County, Texas, by an additional 8 Bcf.

"Spectra Energy Partners will have a very small, lean staff because we don't want to burden this business with a lot of overhead when we've got a lot of expertise already at Spectra Energy," says Wyrsch.

Mark Fiedorek, Spectra Energy Transmission group vice president, southeast transmission and storage, says, "We like to build and we like to buy storage. We have doubled and are on the way to tripling the capacity of our two storage facilities. We buy storage opportunistically where we see value in development. So it's about buying small to make it bigger."

During the next three years, Spectra Energy Corp. plans to invest more than $500 million to develop storage at various sites, including on the Gulf Coast and in the Northeast. The strategy includes teaming with E&P companies that have depleted reservoirs and converting them into active-cycle storage facilities. Spectra has done that in southern Pennsylvania at its 12-Bcf Steckman Ridge facility.

"We purchased that in April. We're under way to spend about $200 million with our partner, New Jersey Resources (an LDC and energy marketer in the New Jersey region), to develop that site. It's a 50/50 partnership," says Fiedorek. "That's the kind of thing we look for."



Private equity

For the most part, new storage builders and operators who plan to expand their existing locations turn to the private equity and lending communities for support. One of the major players is HM Capital Partners LLC, a Dallas-based private-equity firm that creates investment pools from pension funds, financial institutions and private investors in the form of limited partnerships. From its current fund, HM Capital has executed some 19 transactions in the energy sector, representing more than $3 billion.

"From our perspective, the U.S. gas infrastructure has been underserved over the past 40 years," says Joe Colonnetta, partner at HM Capital.

"Given the amount of capital that has been poured into new drilling programs over the last five years, we find ourselves in a situation where there's a lot of new gas being developed without nearby infrastructure to gather, treat, store and transport it to markets where there is a demand."

HM Capital specializes in South and East Texas and in Louisiana, and has heavily invested in the Midcontinent and West Texas. In 2004 and 2005, it saw major drilling investment in North Louisiana and picked that spot to own infrastructure assets and take advantage of its relationship with E&Ps.

"Resource developers found themselves with significant wells coming online but they had to shut them in to wait to be hooked up to pipelines and storage," Colonnetta says.

"We brought a turnkey program to producers and asked for a long-term commitment in return. As investors, we look at the economics of build-versus-buy based on getting commitments up front. It's a matter of risk. We don't go out and build a greenfield storage facility without underlying commitments.

"On the other hand, if there is an existing storage facility that has some commitments, and the valuations make sense, we would consider buying an existing facility with underutilized capacity."

HM Capital's interests encompass upstream, midstream and downstream segments. Its strategy is to exploit the area of disintermediation that occurs between one segment and another.

"Storage owners and operators capitalize on the inefficient pricing and deliveries in the gas market. This country is still midstream-infrastructure-challenged, despite all of the new production that is coming online and all the capital being invested into the midstream segment. Storage is a short-term fix to that challenge."







GLOBAL STORAGE HUB

Larry Bickle, chief executive of The Bickle Group, a new midstream advisory and investment firm created in Houston this past May, sees U.S. gas storage playing a major role in worldwide gas markets. "In the future, I think we will see the U.S. becoming the worldwide regasified LNG storage hub," he says.

There is a lack of adequate gas-storage capacity in Europe and elsewhere, so gas from liquefied natural gas (LNG) shipments will be parked in the U.S. and niche markets will be born to serve that sector, he says.

"I think you're going to see some very large, converted reservoirs with very slow turns. We're going to be looking at 100- to 200-billion-cubic-foot reservoirs that only turn 1.5 or two times per year, but their purpose will be that semi-annual buffering of LNG imports."

The best types of storage facilities for these markets? Depleted-reservoir conversions with access to three or more major pipelines, Bickle says.

The reservoirs should have a depth of 2,500 to 4,000 feet for pressure optimization and should be simple reservoirs without baffles or faults. They should have 20% to 30% porosity and be able to cycle gas inventory one or two times per year. They should be solid structural traps with a permeability of more than 200 milliDarcies. Finally, they should be in an area with amenable community relations, with easily obtainable subsurface storage rights and regulatory support for LNG imports and gas storage.



WORKING GAS



As of August 3, working gas in storage was 2.9 trillion cubic feet, according to Energy Information Administration estimates. Stocks were 117 billion cubic feet (Bcf) higher than a year earlier, and 407 Bcf above the five-year average of 2,475 Bcf. In the East, stocks were 159 Bcf above the five-year average. Stocks in the producing region were 190 Bcf above the five-year average of 742 Bcf. Stocks in the West were 58 Bcf above the five-year average.



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