Miles of steel: US natural gas pipelines

US Natural Gas production is booming. IFandP investigates how distributors are bringing new reserves to market and are investing in infrastructure.

Before we start to examine the industry in depth, a quick summary of the basics is in order. As can be seen from Figure 1, a pipeline system has five major components, the supply sources, a long-distance trunkline, underground storage, LNG peaking facilities and a local distribution network. The last three of these are situated within the market area.

The importance of underground storage (typically in the form of depleted natural gas or oil fields, aquifers or salt caverns) can’t be emphasised enough. Natural gas production is to a large extent in the US a by-product of oil output, which is not dictated by changes in gas demand. Its role will grow if the US moves towards greater use of LNG. Salt caverns have rapidly gained importance since the 1980s and the majority are located in the Gulf Coast States. At the end of 2006 the Midwest had the largest number of storage sites, at 121, and capacity, followed by the Northeast (108 out of 398). The Central region is unique, in that the majority of its storage facilities are used to store surplus production to reduce variations in flow rates.

The local distribution network is designed to accommodate the peak load on the system, which typically occurs during the heating season, while the main trunklines, tend to run at a more constant load as they often serve many different regions. The seasonality of demand means that during the summer months, the excess capacity is used to refill natural gas inventories so that they are at their height at the start of the heating season (November 1). In some regions, the change in demand is so strong, that transmission companies can sometimes build additional storage facilities as an alternative to increasing pipeline capacity.

Figure 1: Simplified schematic of natural gas pipeline capacity. Source: EIA

Traditionally, natural gas was transported from the Gulf of Mexico to the Northeast and from the Rockies to the West Coast. Although such trade continues, the size of the US pipeline network has grown to the point where the majority of producing regions are capable of serving multiple consuming regions.

2007 in review

The past year saw a boom in American natural gas prices. This has given gas producers the incentive to ramp up production. That, coupled with the fact that many of the new plays are or were poorly served in terms of pipeline infrastructure, has lead to a remarkable surge in pipeline projects. Analysts at Lippman Consulting now expect the majority of additional capacity to come from the mid-continent and Rockies regions, as illustrated by the fact that gas production in Northeast Texas and Wyoming increased by 114 and 86 per cent between 1998-2006, while total US output fell by one per cent over the same period. The firm anticipates total new capacity from the two regions to reach 6bnft³pd by 2012.

The rise in the value of natural gas has meant that it is now economical to extract it from reservoirs which would otherwise be too difficult and expensive to operate. A prime example is the Barnett Shale, located in Texas. It has 2.5trnft³ of proven natural gas reserves and is thought to contain as much as 27-30trnft³ according to an impact study conducted by the Perryman Group (2006 data). However, it is a “tight” reservoir, meaning that the reserves require hydraulic fracturing to be extracted. This is expensive and water-intensive.

Recent advances in horizontal drilling, which enables oil producers to access reserves located under built-up areas have also proven invaluable. The Shale produced over 1trnft³ in 2007, up 29 per cent YoY. The medium-term outlook in terms of natural gas production is quite dramatic. According to data from Wood Mackenzie, Citigroup and FERC, output from the Rockies and the Barnett Shale is expected to grow by 33 and 200 per cent, respectively, between 2007 and 2013. In addition, 8.7bnft³pd of LNG import capacity is currently under construction on the Gulf Coast.

It’s not surprising then, that the largest pipeline project completed in 2007 was in Texas, in the form of Centrepoint Energy company’s Perryville expansion project. This connected Texas’ intrastate pipeline network to Perryville, Louisiana and has a capacity of 1.2bnft³pd, allowing production from the Barnett Shale and Bossier Sands to reach markets in the Northeast and Southeast. It was shortly followed by the Gulf South Pipeline Company’s East Texas to Mississippi expansion, which came online in the first quarter of this year. More are soon to follow. FERC has approved Texas Gas Transmission’s (TGT) plans to up the capacity of its proposed Fayetteville and Greenville laterals by 0.4bnft³pd to 1.2bnft³pd, along with a 1.7bnft³pd interstate pipeline to be developed by Gulf Crossing Pipeline. It will connect the Barnett and Woodford Shales to the Midwest and the Southwest, via intermediaries.

According to the EIA in a recent report, 2007 saw “considerable progress in advancing LNG-associated pipelines in several different regions”. It also indicated that the bulk of such construction activity is located in the Gulf of Mexico region and that significant new infrastructure will need to be built to support expanded and new terminals in other areas. It is worth noting that as long as US natural gas prices stay lower than those in Asia and North American and gas production stays at current levels, the role of LNG within the US market will remain somewhat limited.

Pipelines on the horizon

As is to be expected, the administrative hurdles involved in implementing a new pipeline project are considerable. That said, most developments take three years between conception and start-up. Typically, pipeline operators begin by attempting to gauge the market interest. This is usually done by holding an open season for one or two months, in which potential customers can enter into non-binding agreements for the capacity space that will be realised once or if the pipeline is built. If enough customers are interested, then a preliminary project plan is drawn up at the same time and financial commitments are obtained from future customers. This takes another 3-6 months. The project is then filed with regulatory authorities, FERC in the case of interstate pipelines. In this situation, a pre-filing review under the National Environmental Policy Act (NEPA) process is advisable. A full FERC review typically takes 15 months on average while pipeline construction is usually finished within 18 months.

According to FERC data, there is an impressive 33.21bnft³pd of new pipeline capacity (spanning 5473 miles) on the horizon. This breaks down to 3.832bnft³pd in the Northern states, 5.663bnft³pd in the Northeast, 8.57bnft³pd in the Southwest and an impressive 10.54bnft³pd in Central America and the Southeast. In addition, there is the 4.5bnft³pd of capacity represented by the proposed TransAlaskan pipeline. To put this into some perspective, 14.859bnft³pd of new pipeline capacity came online in 2007.

In a report released in July, the EIA indicated that around 200 projects are proposed for development in the 2008-10 period. Of this figure, 41 projects have been approved, with four projects scheduled for 2008 already completed. There are 13 still at the planning stage, while another 46 have been submitted to authorities for review. If all 200 materialise successfully, then they would add an extra 103bnft³pd and 10,100 miles of new pipelines. However, this scenario is unlikely given the fact that many large-scale infrastructure projects often are abandoned when the economics become unfavourable or merely uncertain.

Rising costs

This is understandable as the sums involved are colossal. El Paso Corporation alone is committed to spending US$8bn in expanding its pipeline network, while the proposed Alaskan pipeline is expected to cost at least US$30bn. The latter will have a capacity of 4.5bnft³pd and cover some 700 miles. TransCanada is looking to be the major developer, but it has recently experienced fierce competition from a collaboration from ConocoPhilips, who is seeking to push ahead with a competing pipeline, nicknamed “Denali”. However, it is now looking increasing likely that TransCanada will eventually prevail, as the Alaskan House of Representatives has recently overwhelmingly backed its proposals by granting it a state licence, financial aid and tax benefits.

Despite this development, TransCanada’s rivals are showing no signs of backing down and both projects are currently working hard to attract ExxonMobil to their cause. Exxon’s support matters a great deal in this contest, because it controls the lion’s share of natural gas leases on Alaska’s North Slope. Currently, the oil major has voiced its informal support for a joint project. This is probably the best course of action for all concerned, given that the three participants have previously cooperated on other projects and TransCanada can’t build a pipeline without gas to sell.

The amount of natural gas under Alaskan soil is impressive, more than justifying the massive investment required to bring it to market. The North Slope is known to hold some 35trnft³ of gas reserves, and state authorities have estimated that further exploration could boost this to 250trnft³.

That said, the sheer scale of the price tag associated with the project is enough to make anyone wince and that’s before today’s inflationary environment is factored in. Drue Pearce, the top US official in charge of coordinating the permitting of the project said that its cost is the single biggest obstacle to the project being realised and suggested that there is a danger of construction being delayed past 2018 in the form of setbacks from labour or permitting issues. “Those delays could be very, very costly if they happen,” she said in a interview with Platts.

Other projects are already suffering. Kinder Morgan Energy Partners’ (KMEP) Rockies Express Pipeline, which is one of the largest pipelines ever built in the US and once completed will be 1678 miles long, has seen the cost of its Eastern leg increase by 11 per cent due to difficulties in finding qualified workers. In addition, back when the project as a whole was in the planning stage, Kinder was able to lock in or hedge labour and steel costs. Given that piping was being sold up front at around US$1200/t and now sells for US$2500/t, the savings were immense. Now, according to Sempara Energy’s CEO, Donald Felsinger, whose company is working alongside KMEP, “that type of hedging is no longer available in today’s cost environment,” (Natural Gas Intelligence). Another example of a project experiencing cost inflation is Boardwalk’s Gulf Crossing pipeline which has seen estimated costs increase by US$300m to US$3.7bn, on account of the need for additional facilities and construction delays.

A key factor is the sheer number and size of projects being pursued across the country simultaneously, which naturally heightens the effect of any labour shortfalls. The rising cost of steel owes much to the soaring cost of coking coal and increased demand for steel in developing countries such as China.

Interestingly, the Alaskan project has become a political football of sorts, with Sarah Palin, John McCain’s new running partner, taking credit for brokering the deal that rebuilt the project’s momentum after several delays. Unfortunately, as the pipeline is yet to be built, there is still the potential for the state to lose US$500m in spent subsidies if the project falls through. However, as TransCanada has already committed US$600m in order to procure customers for the pipeline and its rivals have earmarked the same amount to be spent on preliminary engineering work, there currently seems to be no shortage of funding or passion for the project.

The rising cost of construction is inevitably going to be passed down the value chain. Indeed KMEP’s CEO Rich Kinder recently went on record as saying that “Tariffs in general will be higher than they have been on prior projects. If you had to replicate REX today at today’s steel prices, today’s compression prices, there’s no telling what the tariff would be. But it would sure be a lot higher than the roughly US$1.10 across the whole system that is our present tariff. So, yes, tariffs are going to get higher, in general, to reflect the higher-cost construction.” (Natural Gas Intelligence).

Mergers and acquisitions

Recent activity in the pipeline sector include TransCanada’s acquisition of the Bison pipeline project from North Border Pipeline. The proposed development is expected to transport 400mft³pd of gas from Wyoming’s Powder River basin to a connection with the Northern Border system, located in North Dakota, 289 miles away, for delivery to the Chicago area. Russ Girling, president of TransCanada’s pipeline division had explained that the deal was made in order to strengthen his company’s Pathfinder project which was expected to run from Meeker County, Colorado, to Morton County (a distance of 625 miles) with an initial capacity of around 1.2bnft³pd, to be later increased to 2bnft³pd. The company is now looking at potential synergies between the two projects and will probably go ahead with Bison as a stand alone, if Pathfinder stalls for any reason.

There is also Sempra Energy’s purchase of Energy South, for US$510m in cash. The main attraction for Sempra is believed to be EnergySouth’s Midstream subsidiary which holds a majority ownership in two large underground natural gas storage facilities, which together can hold up to 57bnft³ for delivery to some of America’s fastest growing gas markets. It is worth pointing out that Sempra will also gain Mobile Gas Service Corp from the transaction, which is a distribution utility serving around 93,000 customers in southwest Alabama, a market poised for rapid growth.

The big players

El Paso Corporation
El Paso (EP) is the largest pipeline owner in the US, holding 43,000 miles of pipeline through its subsidiaries, which include Tennessee Gas Pipeline, Colorado Interstate Gas, Wyoming Interstate Gas, and El Paso Natural Gas. It holds 19 per cent of total US interstate pipeline mileage, 24bnft³pd of capacity and it handles 28 per cent of all gas delivered to US consumers. It is also aggressively expanding, having committed US$8bn to its backlog of projects. One of the most important is the Ruby Pipeline, which will connect Malin on the California/Oregon border to the Opal Hub in Wyoming. It will be 670 miles long, with a capacity of 1.3-1.5bnft³pd, is expected to come into service in 2011 and is forecast to cost US$3bn.

There is also Florida Gas Transmission company’s phase VIII expansion, which is due to add 500 miles of 800mft³pd capacity at a cost of US$2.4bn. The project is a 50/50 joint venture, in partnership with Southern Union company and completion is due in 2011.

El Paso is also a significant natural gas producer in its own right. It boasts a 97 per cent drilling success rate and a growing unconventional inventory. It is primarily focused on developing coal seam and tight gas deposits, domestically and is looking abroad to Brazil and Egypt. It has 2.8tnft³ of proven reserves (86 per cent of which is located within the US and onshore).

As for the future, the company predicts its EBIT will increase at a rate of 10 per cent between 2008 and 2013 and it’s E&P activities will see 8-12 per cent growth between 2008 and 2010.

Kinder Morgan Energy Partners
Although firmly focused on pipeline transportation, Kinder Morgan Energy Partners (KMEP) is more diversified than El Paso. In addition to being the second-biggest transporter of natural gas in the US, with around 22,000 miles of pipelines, it is also the largest independent transporter of petroleum products with the country, capable of transporting over 2mbpd. Moreover, it is the no. 2 oil producer in Texas (with a daily output of some 55,000bbl). It is participating in the Rockies Express interstate pipeline as a developer and furthermore, it is the largest independent terminal operator in the US, with the capacity to handle 103mbbl of liquids and 87Mst of dry bulk products. It is also the most significant transporter of CO₂ in the country (1bnft³pd of capacity).

KMEP’s diversification is reflected in that natural gas pipelines are only 27 per cent of its asset base. Its many activities haven’t prevented it from losing sight of the changes occurring within the natural gas industry. It is responding to the shift in US natural gas supply sources, with the Rockies Express Pipeline and the Midcontinent Express pipeline to serve the Barnett Shale. KMEP will have a 50 per cent share in the Rockies Express Pipeline (with SRE and COP each taking a 25 per cent stake), which is due to come into service in 2007-09. The Midcontinent Express Pipeline is a 50/50 joint venture with Energy Transfer Partners (ETP), and will transport natural gas from producing regions in Louisiana and the Midcontinent to the Eastern US, it is expected to come into service in 2009. There is also Kinder Morgan’s Louisiana pipeline, which is also scheduled for completion in 2009. The combined financial commitment made by KMEP for all three projects is US$4.215bn and together, they represent 5.7bnft³pd of natural gas transportation capacity.

Given that KMEP reported 17.6 and 16.7 per cent returns on the capital invested in its natural gas pipeline network in 2007 and 2006, it clearly has been successful in extracting value from its investments in this sector, especially as these figures out-perform those for its other assets, with the exception of CO₂ pipelines.

Williams
Marketed as a “pure-play” natural gas company, Williams is both a key player in the US natural gas pipeline market and a producer. As far as its E&P operations are concerned, 2007 results boasted extremely low operating costs compared to its competitors (just over US$1/mft³ equivalent, compared to the group average of US$1.59) and is in the top quartile for finding and development costs. It is also looking to take advantage of the boom in Canadian natural gas demand, triggered by growth of the Albertan oil sands.

As far as pipelines are concerned, Williams operates three major interstate pipelines at opposite ends of the country: the Northwest pipeline – Transco, which connects the Gulf of Mexico to the Northeast and the Gulfstream (50 per cent owned), which connects with Transco and links it to markets in Florida. These three represent over 15,000 miles of interstate pipelines and account for roughly 12 per cent of US natural gas consumption, possessing a designed capacity of over 12bnft³pd, enough to supply 30m homes. The company has 14 expansion projects either planned or in progress. Projects in guidance amount to around US$750m, while the total for all proposed projects is closer to US$3.3bn.

Energy Transfer Partners
ETP holds around 16,850 miles of natural gas pipelines, with another 350 miles of intrastate pipeline under construction. It also owns three natural gas storage facilities with 74.4bnft³ of working capacity and a retail propane business, which serves over a million customers. Its network handles roughly 19 per cent of the US daily natural gas consumption, transporting over 12.1bnft³pd. The majority of ETP’s network is concentrated on the Gulf coast and provides access to major market hubs, with over 35 interstate pipeline connections. It also owns the largest intrastate pipeline system in the US, in the state of Texas, which accesses five major producing basins including the Barnett Shale. ETP has six expansion projects in the state which have either been recently completed, under construction or announced.

ETP has two main interstate pipelines: The Transwestern Pipeline, which connects the producing regions in Texas, New Mexico, Colorado, and Oklahoma to demand areas in the western US, and the Midcontinent Express Pipeline (as a 50/50 joint venture with Kinder Morgan). The Transwestern Pipeline is currently undergoing two expansions, while the Midcontinent Express is due to come online by 2Q09 with 1.5bnft³pd of mainline capacity, aiming to reach 1.8bnft³pd via additional compression.

The company has seen strong growth recently, with its 2Q08 EBITDA up by 19 per cent to US$292m. It expects EBITDA to continue to increase – 16 and 30 per cent YoY in 2008 and 2009, respectively. The rate at which the company has grown in recent years, is impressive, with natural gas transmission volumes increasing by a CAGR of 87 per cent since August 2004.

Natural gas imports and exports

According to the EIA, the US has 55 locations where natural gas can move across country borders, six of which are LNG facilities. In 2006, Canada was responsible for 99.8 per cent of natural gas entering via pipeline with Mexico making up the remainder. Canada also takes the majority of US natural gas exports at 60 per cent.

In 2007, the US was a net importer of natural gas to the tune of 3.785trnft³, with 83.27 per cent of all imports being delivered via pipeline. As far as its two major suppliers are concerned, Mexico looks like it is seeing a bumper year, with production hitting a quarterly record in 1Q08, up 13.29 per cent YoY, despite falling oil output. The country has good-sized reserves but innovative new technology is required to exploit its deepwater fields in a commercially-viable manner. In contrast, Canadian natural gas production fell two per cent in 2007, to 16.8bnft³pd, possibly due to reduced drilling in the second half of the year. Despite this, exports were up by 4.4 per cent.

Worryingly, data from the Canadian Association of Petroleum Producers indicates that as far as natural gas is concerned, the country’s reserves-to production-ratio has been falling since 1986, but as reserves have increased in both 2005 and 2006, it doesn’t seem as though the country will suffer from major declines in production in the near future. All things considered, it looks as though pipelines will continue to be the most important means of delivering natural gas to the US for quite some time to come.

Figure 2: The changing face of US natural gas supply. Source: KMEP presentation, September 2008

Natural gas production in the US has risen by eight per cent so far this year (EIA data), and so the general prospects in terms of supply are, if anything, too rosy from the perspective of the industry, given that this additional production has created fears of a supply glut which could weigh heavily on the price of natural gas. However, a great deal of the new output is coming from fields like the Barnett Shale (see Figure 2) as a result of technology advances, and modern extraction techniques mean that peak production is reached quite quickly. Therefore, for production to continue to grow, great efforts will be needed to access new reserves.

For more information on this subject, consider visiting the following websites:
www.kindermorgan.com/
www.energytransfer.com/
www.elpaso.com
www.williams.com