S&P discusses challenges looming for natural gas industry

Pipeline & Gas Journal, April, 2005 by Royal F. Shepard, Yogeesh Wagle

We expect that the U.S.'s increasing reliance on natural gas, including LNG, will require continuing investments in our transportation infrastructure, including interstate pipelines and related underground storage. Control of the transportation network has evolved since the FERC ordered the unbundling of pipeline services in 1992. As a result of this action, pipelines could no longer market natural gas directly' to LDCs and other consumers. At the same time, large integrated energy companies, traditionally the principal owner/operator of midstream assets, began to evaluate their return on investment.

Many couldn't justify owning and operating pipelines, storage facilities, or processing plants on a standalone basis. And, as a result, some assets were divested to allow a focus on core exploration and production activities. The emerging class of merchant companies, such as Enron, El Paso and Williams, consolidated many of these assets in the 1990s. And El Paso remains one of the largest owners of interstate pipelines in the U.S. The well-published problems facing many merchants in recent years, however, has largely put an end to this trend.

Overall, additions to the natural gas pipeline network slowed considerably from 2002-2004. based on numbers published by the EIA (5). No doubt the financial difficulties of several energy industry participants played a role. We also have seen reduced demand for links directly to new natural gas-fired power plants. In our view, though, changing organizational structures will help provide a better means to finance future expansion and industry consolidation. Partnerships are increasingly used to take legal ownership of midstream assets.

Role Of MLPs

Master Limited Partnerships (MLPs), created by Congress in 1986, offer an opportunity to minimize tax liability. In addition, they offer the previous owners a means to monetize their investment. Ready access to capital markets can be provided, as units are often publicly tradable on stock exchanges. According to the Coalition of Publicly Traded Partnerships, at least 31 oil- and gas-related partnerships are currently traded (6).

Examples include one of the key Canadian links, Northern Borders Pipeline (Northern Borders Partners LP), and Enterprise Products Partners L.P., which recently merged with GulfTerra Energy Partners, a holder of substantial natural gas midstream assets previously controlled by El Paso Corp. Duke Energy Field Services, one of North America's largest midstream energy companies, also recently said that its is considering the formation of a new MLP through a joint-venture with ConocoPhillips.

Private equity investors have also become active in adding MLPs to their portfolios. And recent federal legislation allowing mutual funds to invest in MLPs should expand the potential pool of equity capital, in our view. We believe this should also continue to drive these entities to increase distributable cash flow through both acquisitions and investments in expanding capacity. Standard & Poor's expects MLPs to remain a preferred vehicle in financing the natural gas transportation network in coming years.