The shale plays offer undeniable incentive to the prospector. For processing companies in particular, they are providing a large percentage of value to the margins. Companies like DCP Midstream LLC and Crosstex Energy LP have been fortunate to be part of the natural gas liquids (NGLs) movement by being nimble enough to be in the right play at the right time.

The current focus by producers on liquids-rich plays is driving the demand for additional processing capacity. Indicators in the market point to the fact that liquids-rich drilling is too compelling and too profitable for producers to ignore. The result, in short, is that more processing, fractionation and NGL delivery systems need to be built.

Liquids-rich or bust

Before jumping on the opportunity to build more capacity, one must ask if this producer shift will be a long-term move. The prospect seems likely that this is no flash-in-the-pan trend in production.

"We believe the market for NGLs will be strong relative to the gas market for the foreseeable future. Strong supply growth from the shale plays has resulted in lower natural gas prices relative to liquids and crude oil prices. In response, producers have focused their capital on plays where they benefit from gas production as well as liquids and crude production," says Barry E. Davis, chief executive of Crosstex Energy Inc., Dallas.

Thomas O'Connor, chief executive of DCP Midstream Partners LP, agrees. "I think this shift is going to be around for a while. It is consistent with the value. There is a very wide gas-to-crude spread and the liquids that are derived from this drilling realization provide significant value uplift for the producers. So it's easily understandable why they are moving that way."

?“Currently, the market is relatively well-balanced and NGL potential demand appears sufficient to absorb additional production in the near term.” Barry E. Davis, chief executive, CrossTex Energy

While it may be true that gas prices are currently depressed, even if commodity prices increase, the incentive is still present to reap the compelling liquids-rich rewards. "I expect over the next couple of years you are going to continue to see E&P companies consistently focus on liquids-rich areas, as long as crude prices stay healthy and liquids prices stay healthy," says O'Connor.

Processing companies are benefiting from the shift. In fact, about 80% of DCP Midstream's 2011 gathering and processing margins come from liquids-rich production.

Admits O'Connor, "For DCP, liquids-rich production is a very significant part of our business. The producers are making more money by drilling liquids-rich production, and DCP Midstream realizes some of its best margins; a very significant part of our overall earnings come from these areas."

Processing potential

"What's really exciting to me is that we as an industry have gone from a place where five to seven years ago, we were all looking around saying, 'Well we're probably running out of gas in the country. We're going to need to bring on additional sources of LNG and import natural gas,' to one now where we are saying 'Geez, we have enough natural gas in this country which can supply the next 100 years of demand,'" quips O'Connor.

Couple this growth in supply with a market which is getting comfortable that the supply is reliable and with the fact that product will be priced competitively in the marketplace.

O'Connor points out, "I think you'll see gas starting to make very serious inroads into the power-generation market and eventually displace significant quantities of coal. Gas is now being more recognized as a clean-burning fuel, perhaps even recognized as a significant part of the electric generation of this country.

"Now we've got a very solid supply picture, and we've got growing demand and growing acceptance of the fuel, one that is perhaps CO2 friendly. Also, the policy makers of this country are now willing to embrace this, maybe somewhat cautiously, but embrace this as a cleaner-burning fuel," O'Connor says.

"So you've got a very exciting supply-and-demand dynamic. For those of us in the midstream business, what that means is a growing need for infrastructure to bring that gas from these new supply regions to the market. That's going to mean investment, it's going to mean jobs, it's going to mean a very viable midstream business, and it's a U.S.-based, home-grown fuel which translates to a pretty exciting time in the industry," remarks O'Connor.

Considering the current market, it is probable that some of the volatility which has been experienced over the years will be reduced because of the adequate supply. "The supply and demand for NGLs will be a critical balance to watch. Currently, the market is relatively well-balanced and NGL potential demand appears sufficient to absorb additional production in the near-term," Davis explains.

"As an industry, we have an opportunity to regain NGL demand that was lost during the last several years when we had high gas prices and ethane consumption was driven out of the country," Davis continues. "Additional demand has and will continue to come from restarting facilities that were shut down, and the development of new facilities."

?“There is a very wide gas-to-crude spread, and the liquids that are derived from this drilling realization provide significant value uplift… .” Thomas O’Connor, chief executive, DCP Midstream

Building claims

The current challenge for processors lies in building or restarting infrastructure to create additional capacity. The arrival of hydraulic fracturing kicked off shale-play production. Along with this came the restart and expansion of processing plants and a flurry of construction to create additional capacity.

"Crosstex's 2005 acquisition of El Paso's processing and NGL infrastructure on Louisiana's Gulf Coast helped position us as a player in this business. In Louisiana, we have six processing plants handling about 1.2 billion cubic feet per day. In the Barnett shale, we expect to be at full utilization of our three recently constructed processing facilities totaling almost 300 million cubic feet per day," says Davis.

Meeting producers' time-line for infrastructure is a challenge. "Timing is always the challenge. We were one of the first movers in the Barnett shale and now transport about 20% of the production out of the play. About 25% of this gas is liquids-rich and requires processing," Davis remarks.

Crosstex is also well positioned in the Haynesville shale. The majority of facilities there are adjacent to its LIG system, which is the largest intrastate pipeline in Louisiana. The company was able to move quickly and develop what has become almost 500 million cubic feet per day of capacity.

Today the market's major bottleneck remains NGL fractionation and delivery systems, according to Davis. "Crosstex provides producers with a solution to this challenge. We have about 50,000 barrels of excess capacity in South Louisiana that can be connected to any of the emerging shale plays via pipeline, rail, barge and truck delivery systems," he says.

"In South Louisiana, we will soon start our Eunice fractionator, a 35,000-barrel-a-day facility that has been shut down for about four years."

Old stakes, new prospects

Beyond the challenges of getting capacity built, and the time it takes to permit, site and construct facilities, there are other factors to consider.

"The other challenge is matching up the development of midstream facilities with producer developments. In many of these new plays, we don't have a lot of information around gas quality, or around the speed at which the gas can be brought to the midstream facilities," says O'Connor.

However, much of the liquids-focused drilling lies in places like the D-J Basin, the Permian, and the Eagle Ford that are within or adjacent to DCP Midstream's existing footprint.

The D-J Basin is a legacy area that Noble Energy Inc., Anadarko Petroleum and others have been drilling vertically for years. Now, producers are starting to drill horizontals into the Niobrara and they are getting initial production rates at multiples of what they gained from the verticals.

"This re-invention of the D-J Basin, it's been a very good area for us. It could move us to another level. So we're bringing on a new plant there and then we're moving forward with an additional large-scale processing facility," says O'Connor.

Additionally, there has been an upswing of activity in the Eagle Ford. DCP Midstream has about 800 million per day of processing capacity in this burgeoning region. About 250 million of that is open capacity, which is being made available for Eagle Ford production.

This won't remain the case for long, says O'Connor. "What we're proposing to do is to connect up with the producers and bring their initial production to fill up that 250 million per day of open capacity. We've announced in the last couple of weeks that we have signed agreements with producers to bring production from 450,000 acres to our facilities."

Among that producer group are ConocoPhillips and a Pioneer Natural Resources Co. joint venture. "With those agreements in hand, we think we'll be able to fill that existing 250 by the end of 2012. So we announced that we are also going to move forward with the construction of an additional 200 million per day of new processing capacity at what we called our Eagle site, a new plant. We've probably got one of the best positions in the Eagle Ford, and we're looking forward to some very good things there," says O'Connor.

DCP Midstream's recurring motto of construction is to build off the existing footprint, match what the producers are doing in production, and when that potentially has been filled up, the company starts building new capacity to match up with the producer's production profile.

"The last area I mentioned is out in the Permian, which is very similar to the Eagle Ford. The producers out there are drilling up two formations called the Wolfberry and the Avalon shale," says O'Connor.

"In the Wolfberry, we started up the existing Robert's Ranch plant that had been shut down five years ago. We restarted it, put some more money into it, brought it up to current standards, and it's providing an incremental 40 million per day."

DCP Midstream's activity in the Avalon shale is a bit of a different story. It is a relatively new formation, located in Texas and Southeast New Mexico.

"The Avalon shale is in the exploratory stages, but we've been able to provide gathering and processing capacity to producers out in that area, as they begin to explore and develop the Avalon. And we've been able to provide up to 100 million per day of new incremental capacity by levering off the existing footprint, and using some under-utilized capacity that existed in Southeast New Mexico," says O'Connor.

"Once that is filled up," he continues, "and if we get a very good view (which we are starting to get) that the formation is working out, the producer interest is remaining strong and the development is accelerating, we'll move forward with the construction of a new 200- to 250 million-per-day processing facility for the Avalon shale."

Producers' shift in focus to liquids-rich production has provided processors with ample amounts of both challenge and opportunity. It remains to be seen how long this run of prosperity in the shales will last.

?Crosstex Energy’s newly reopened Eunice processing plant in South Louisiana is equipped to handle the influx of liquids-rich production.