CHAPTER 1 SETTING THE STAGE - AN OVERVIEW OF THE INTERRELATIONSHIP BETWEEN THE MIDSTREAM AND UPSTREAM SECTORS: THE ONCE AND FUTURE MIDSTREAM SECTOR
| Jurisdiction | United States |
(Apr 2018)
SETTING THE STAGE - AN OVERVIEW OF THE INTERRELATIONSHIP BETWEEN THE MIDSTREAM AND UPSTREAM SECTORS: THE ONCE AND FUTURE MIDSTREAM SECTOR
Partner
Hogan Lovells US LLP
Denver, CO
Allison Hellreich
Senior Associate
Hogan Lovells US LLP
Washington, DC
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SCOT W. ANDERSON is a partner in Hogan Lovells US LLP's Denver office and Global Head of the Energy & Natural Resources Group. Scot's practice focuses on commercial transactions, regulatory advice, and project development involving the mining, oil and gas, and energy industries. He has represented a number of clients with projects on Indian lands and internationally. Scot advises on the full sweep of issues affecting the oil and gas, hardrock mining, and coal industries. He has worked on complex transactions for natural resources clients, including the formation of new joint ventures, the divestiture of natural resources projects, and the acquisition of leases and reserves for mining and oil and gas clients. He has represented clients in administrative proceedings and in federal and state courts. He has extensive experience addressing issues related to mineral development of federal public lands and Indian lands. Scot's practice includes international project development and transactions. He has worked on matters throughout North and South America, and in Europe, Australia, Africa, and Asia.
ALLISON HELLREICH is a Senior Associate with Hogan Lovells US LLP, in Washington, DC. Allison has represented natural gas pipeline companies, electric generators and marketers, nuclear actors, and other energy industry participants in both regulatory and transactional matters. Prior to joining Hogan Lovells, Allison represented both a natural gas company and an electric marketing company in litigated proceedings before the Federal Energy Regulatory Commission. She also helped bring appeals of Federal Energy Regulatory Commission decisions on behalf of energy industry clients in a U.S. Circuit Court. Allison served as the Senior Projects Editor of the George Washington Journal of Energy and Environmental Law and as a legal intern in the Immediate Office of the General Counsel at the U.S. Department of Energy while attending The George Washington University Law School.
I. Introduction
There comes a time when an upstream operator must place its hard-earned production into the hands of a gatherer or transporter. When we talk of "Midstream from an Upstream Perspective," we recognize that the lines between the upstream business model and the midstream business model have been crossed. Perhaps better stated, those lines have been blurred. As we work through our overview of the midstream business, we have two goals. First, we want to provide a description of how the business of midstream asset development works. A review of the economic drivers and regulatory environment will help upstream producers understand that business model, and the rationale and import of the contractual arrangements between the midstream and upstream sectors. Second, it is likely that an E&P company will find itself in that fuzzy area between the standard divisions. When an E&P company engages in commercial activities off its leasehold, it can become subject to new and unfamiliar regulations, and novel commercial and economic structures. We will try to provide some guideposts as an E&P company moves outside of its usual regulatory and commercial framework. This paper provides a high level introduction to these issues, and our colleagues throughout the remainder of this Special Institute will provide a more detailed analysis of the intersection between the midstream and downstream industries.
II. Upstream, Midstream, Downstream
It can be hard to define precise limits between upstream, midstream and downstream activities. Companies may take different approaches to how they define "midstream" activities, and some large integrated companies will include midstream activities as part of their downstream division.1 David Pierce has a useful description to help distinguish midstream from downstream activities: "Usually gas leaves the midstream world, and enters the downstream world, when it passes from a facility that is not regulated as a 'public utility' to either an end user or a facility that is regulated as a public utility. The downstream facility may be an intrastate pipeline, interstate pipeline, or a local distribution company."2 This definition limits
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"midstream" primarily to gathering and initial processing of production. Many midstream companies operate FERC regulated pipelines, and so we should cast the definition a bit more broadly. As discussed below, it is not hard to create a pipeline that is subject to FERC jurisdiction. From an upstream perspective, it is important to keep an eye on that jurisdictional line.3
Quite a bit of processing and movement of hydrocarbons occurs on the leasehold, before oil and gas leaves the leasehold and starts its journey to the marketplace. Oil and gas wells may produce a mixture of materials:
o natural gas
o condensate
o oil
o water (usually salty water)
o other gases, such as nitrogen, carbon dioxide CO 2, and sometimes hydrogen sulfide (H 2S)
o solids, including sand, dirt, and scale and corrosion from the tubing. 4
The mixed stream of oil, gas, water, and other materials must find its way from the leasehold through a series of pipelines and facilities to the ultimate end use of those materials as a gas flame, a lubricant, or a Patagonia jacket. The first step in turning the mixed stream into a useable product is to put this mixture through a separator - a pressure vessel that separates the oil, gas and water with gravity.5 The water generated from this process is stored onsite, and then disposed of.6
Oil may be put directly into pipelines, but is more often stored on or near the leasehold in atmospheric tanks. If oil is placed into pipelines, it enters the pipeline under a maximum vapor pressure, to keep the lighter components of the oil stream from converting to a gaseous state, or
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"flashing."7 When oil is placed in tanks at atmospheric pressure, gaseous components will flash from the oil and stabilize the oil at atmospheric pressure.8 The oil may require additional treatment with an emulsion or heater to remove water remaining after the initial pass through the separator.9 At that point, the oil can be sent through a sales meter, and into a pipeline, truck or rail car for transportation.10
Gas leaving the separator also requires additional on-lease treatment and processing before it enters the market. Gas often leaves the wellhead at high temperature and pressure. As pressure is reduced and the gas cools, liquids condense out of the gas stream.11 The condensates or natural gas liquids (NGLs) are captured and processed or sold. Gas may also be run through a dehydrator to remove water within the gas stream. Finally, the gas may go through an amine system or other process to remove CO2 and H2S. Dry gas is often processed to recover liquid hydrocarbons such as ethane, propane, butane and liquefied petroleum gas (LPG).12 NGLs form a major part of the value of a mixed gas stream, and E&P companies often invest drilling capital in areas with wet gas to maximize NGL recovery.
As the oil and gas industry developed, many oil and gas companies were vertically integrated, and gathered and transported their own production to refineries, industrial users, or natural gas distribution systems.13 In fact, Standard Oil started out as a transportation company, and only later began investing in oil and gas production.14 However, changes in the law, in regulation and in the commercial marketplace inspired the development of specialized midstream companies that took over the process of the shipping and storage of oil and gas. Exploration and production (E&P) companies could simply contract with these specialized midstream companies at the wellhead (or close to it) for the gathering and transportation of their production.
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Even as specialized midstream companies evolved, E&P companies continued to build gathering lines and other pipelines, and developed processing facilities. As a result of the shale revolution, production began to outstrip midstream capacity, causing deeper investment by upstream companies in their own gathering and transportation systems. Producers also looked at alternative ways to transport their production. Shipments by rail, for example, increased by over 50 times from 2008 to 2014: from 9500 in 2008 to 493,146 in 2014.15 The drop in oil prices and the development of more pipeline infrastructure reduced the number of rail shipments in 2016 to about half of the 2014 peak, but even that number is well above the 2008 shipment rate.16
The investment by E&P companies in pipeline and processing infrastructure may have arisen from necessity, but it provided benefits to those companies. E&P companies (and other investors) were attracted to the stable revenue streams offered by midstream assets. As a result, upstream companies have been finding ways to monetize those assets. Some midstream companies were able to sell off their midstream assets as a way to generate revenue to survive the impacts of the dramatic drop in the price of oil. Other companies have spun off their midstream assets, often through the use of a master limited partnership (MLP)17 to create an affiliated company with consistent and predictable returns, making those spun off companies attractive investment targets even in a low price environment.18 We will return to the use of MLPs below.
III. Market Forces Affecting Midstream Development
A. Demand, Price and Production
There is of course one major market event that overshadows any other factor in the discussion of investments in the oil and gas industry - the...
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