CHAPTER 13 UPSTREAM & MIDSTREAM SECTOR INTERDEPENDENCE: SHARED RISK IN THE DEVELOPMENT OF MIDSTREAM ASSETS

• Jurisdiction: United States

Midstream Oil & Gas from the Upstream Perspective
(Apr 2018)
CHAPTER 13
UPSTREAM & MIDSTREAM SECTOR INTERDEPENDENCE: SHARED RISK IN THE DEVELOPMENT OF MIDSTREAM ASSETS
Derek J. Anchondo
Shareholder
Greenberg Traurig, LLP
Houston, TX
William S. Garner
Shareholder
Greenberg Traurig, LLP
Houston, TX
Ernesto Danache IV
Law Clerk
Greenberg Traurig, LLP
Houston, TX

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DEREK J. ANCHONDO is a Shareholder with Greenberg Traurig LLP, Houston, TX. Derek focuses his practice on domestic and international oil and gas and energy transactions. Derek's oil and gas practice experience covers both domestic and international transactions, including upstream exploration and production activities, offshore drilling, the purchase or supply of crude oil or natural gas, joint operating agreements, the procurement of equipment or services, and engineering, procurement and construction. His energy law experience covers complex domestic and international transactions, including mergers, acquisitions and divestitures, financing transactions, joint ventures, construction, international law related to maritime/offshore and shipping matters in the energy industry. He advises clients on United States regulatory filings, anti-bribery compliance, environmental regulatory compliance, and corporate compliance. He has experience in shipbuilding contracts, vessel repair and modification agreements, and supply and towing contracts for maritime vessels. He has also supervised and participated in high-level tax litigation in foreign jurisdictions.

WILLIAM GARNER is a Shareholder with Greenberg Traurig LLP, in Houston, TX, and Co-Chair of GT's Energy & Natural Resources Practice Group and Chair of the firm's Renewable Energy Practice Group. He focuses his practice on domestic and international hydrocarbon and inert gas transactions and renewable energy. He has experience working on worldwide natural gas projects, including unconventional gas. He has worked on projects in the United States, Canada, Saudi Arabia, Australia, Poland, Kazakhstan, U.A.E., Algeria, Turkey and Mexico. William has also provided counsel to major energy companies, and served as an investment banker for the world's leading oil and gas investment banking boutique, advising on domestic and international upstream and midstream transactions. Prior to joining the firm, William was senior counsel at a multi-practice global law firm.

Abstract

The development and operation of oil and gas midstream assets can be a complex, expensive, and risky process for the midstream operator. As a result, an increasing amount of companies have come up with a number of distinct frameworks to share the cost and risk associated with these projects. This paper was therefore written to explain, as concisely as possible, the evident correlation between the development of exploration and production projects and the simultaneous or consecutive development of midstream assets. This paper will additionally explore the legal frameworks employed by these operators to share the risk associated with these midstream projects, and address the advantages and disadvantages of such arrangements.

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I. Introduction

The domestic energy production has changed substantially in the recent years. The United States is now a top producer of oil and natural gas, and with it, U.S. exports have more than doubled since 2010.¹ Nevertheless, despite this increase in domestic production, the development of midstream assets for transportation has not kept-up with the pace.

The rise in production of oil and natural gas in the United States has fueled a demand for pipeline infrastructure. In recent years, this has been primarily spurred by the "shale boom" which has stimulated tremendous production of oil and natural gas. This boom is the product of technological advances in the oil and gas industry; notably, the combination of horizontal drilling and hydraulic fracturing--"The perfect marriage of hydraulic fracturing and horizontal drilling has unlocked previously untapped reserves, pushing domestic production in 2012 to its highest in 16 years."² In areas such as North Dakota's Bakken Shale, for example, producers were forced to flare 35% of natural gas production just in 2011, according to the Energy Information Administration. In other areas, such as in the Eagle Ford Shale in Texas, producers are having to turn to railways to ship out the produced products which have flooded the region's pipeline and storage capacity.

These facts, therefore, suggest some sort interdependence between the midstream and upstream sectors, and suggest that oil and natural gas production and upstream assets must co-exist to satisfy demand and be economically efficient.

II. Transportation Methods: Operational Advantages and Disadvantages

Natural resources, like crude oil and natural gas, are found and produced in different locations that many times are too isolated from processing, distribution and consumption centers. As such, oil and gas needs to travel from the wellhead to their final destination. While there are many forms of transportation utilized to move these products to marketplaces, pipelines remain the most popular transportation method particularly because of their safety and efficiency. This efficiency not only correlates with the economic benefits associated with such method of transportation. Pipelines are considered safe and environmentally friendly by offering low rates of injuries and fatalities and a low carbon footprint.³ In addition, pipelines can transport large quantities of hydrocarbons, both across short and long distances, to satisfy consumer demand. In many instances, such as for offshore exploration and production, pipelines still remain the most viable option.

There are, of course, operational risks associated with pipeline transportation. First, their high volume and constant flow of hydrocarbons could result in more voluminous leaks when compared to trucks, trains or even ships. Considering that pipelines usually run underground or

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on the ocean or sea floor, an additional risk associated with pipeline transportation is that leaks can be hard to spot and at many times hard to clean up.

Rail transportation of hydrocarbons is also a very common method of transporting petroleum products primarily because the rail infrastructure is already in place and spans across the entire United States and into its neighboring countries. In addition, transportation by railway can offer minimal transit time and respond quickly to the market fluctuations, primarily because of the 140,000 miles of railroad available in the United States.⁴ However, the hazard associated with this method of transportation is the risk of oil related disasters. Due to the large quantities of petroleum products being transported through urban and rural territories, this method of transportation can cause large-scale explosions and severe injury in the event of operational negligence or malfunction.

Another popular way of transporting oil or liquefied natural gas is via ship or barge. This is one of the least costly methods of transportation being utilized to move hydrocarbons internationally and through inland and coastal waterways. Although arguably one of the safest methods of transportation with regards to human exposure and property destruction, they have the greatest possible impact on the environment when these oil and gas carriers do actually spill.⁵

Therefore, although this paper recognizes the operational value of railway, ship and truck transportation, for the reasons laid-out above and its increased popularity, this paper will mainly focus on the development of pipeline infrastructure.

III. The Risks Associated with Pipeline Infrastructure

Before addressing the mitigation of risk in the development of midstream assets, it is important to first consider the risks associated with developing transportation infrastructure such as pipelines.

In terms of profitability, the Federal Energy Regulatory Commission (FERC) is in charge of regulating the rates that pipeline operators charge to shippers of hydrocarbons.⁶ These rates are required to be cost-based reflecting the cost of the operator providing the service.⁷ In addition, the rate includes a return on equity to the pipeline company for the capital invested in construction.⁸ As a result, recourse rates of 14% are usually requested by operators and granted

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by FERC.⁹ A 14% profit can be considerable, especially since it is high relative to the returns one could expect to receive from investing elsewhere in the utility business, which averages between 9 and 10%.¹⁰ Despite this, returns for midstream operators are generally lower and arguably risker than the midstream...