Texas CEO Magazine March|April 2014 | Page 11

interstate pipelines, for example, have the potential to unlock significant value as the Northeast evolves into an export market for natural gas. Yet, projects of this scale require potentially uneconomic levels of capital investment as route selection and right of way issues in a densely populated region add to bottom-line cost. It is imperative that investors pay careful consideration to the demand profile of the target market prior to deploying capital. Tudor, Pickering, Holt & Co. recently performed extensive analysis on the evolution of natural gas markets in the U.S. Their findings unveiled a number of demand undercurrents that are beginning to drive investment decisions. Natural Gas: The Engine of Economy Low-priced natural gas is bringing manufacturing and other energy-intensive industry back to the U.S. Florida and the Gulf Coast regions are emerging as the most likely markets outside of the Northeast for the huge supply of Northeastern natural gas. Population growth in Florida is taxing existing natural gas supply and driving up prices. Similarly, new capacity in the petrochemical and power generation industries in the Gulf Coast region are seen as having the capability to outstrip existing supply. While pipelines are the logical long-term solution to rebalancing natural gas markets in the U.S., many producers may be hesitant to commit production to new, relatively high-cost routes. Therefore, the challenge for private equity investors is identifying natural gas pipelines and gathering systems with optimal cost structures that will attract producer commitments. Such projects pose high risks in the developmental stage, but provide attractive predictable yields and lucrative exit strategies through sale or conversion to an MLP. The vast new natural gas reserves are also driving a need to develop new processing capacity across the country. Natural gas delivered to end-users must meet certain quality and BTU content specifications that are closely monitored by pipeline operators. Processing facilities extract non-methane compounds from the raw wellhead natural gas to meet pipeline specifications. The liquids removed are the heavier, more valuable hydrocarbons such as propane and butanes, which are often found in raw natural gas. These liquids are more valuable than methane, so are removed and sold at higher market prices. Private equity investors have opportunities in this space by making strategic acquisitions of aging facilities for restructuring and by providing growth capital to independent producers with growing natural gas production. The disruptive nature of the new shale plays is also creating opportunities outside of traditional pipeline projects. Railways have emerged as a short-term solution to delivering crude oil and natural gas liquids. Producers are attracted to rail solutions because volume and duration commitments are significantly lower than most required by pipelines. Railways also offer greater market flexibility than pipelines as the vast rail network in North America allows product flows to be optimally directed amidst changing market conditions. Domestic rail operators have experienced rapid traffic growth over the last few years, constrained primarily by the availability of rail cars and the accessibility of terminals to producers. Private equity funds have the opportunity to benefit from rail constraints by providing growth capital to companies developing terminal infrastructure as well as companies manufacturing rail cars. Midstream private equity investors have seen how these types of investments benefit private equity funds with shorter term investment horizons. The midstream sector of the oil and gas industry is clearly in a state of rapid expansion as the major shale plays across the U.S. continue to outperform expectations. Private equity investors have a critical position in the market forces guiding the developmental decisions that will unlock the value of these relatively new discoveries. Midstream private equity investors are continuing to support the many projects that will help unlock the economic value trapped in the vast North American shale resources. Thomas V. Costantino serves as the Chief Investment Officer of Five States Energy Company, LLC and its affiliate, Five States Energy Capital, LLC. Thomas Edwards supports business development and marketing at Five States. Texas CEO Magazine 11