Midstream’s Appalachian Spring

Even as upstream attention shifts west from the Marcellus shale in Pennsylvania and West Virginia to Ohio and the Utica, midstream development in the Marcellus region has stepped to the fore, marking some maturation of the play.

MarkWest Energy Partners LP, based in Denver, was the big, early mover in the Marcellus midstream, and today has the bulk of installed and planned capacity with its Liberty segment. The company is closely allied with most major players upstream and down, and those report a good comfort level despite MarkWest’s dominant share of capacity in the play.

Shell Chemical LP has gotten most of the attention downstream with its steam cracker and polymer units proposed for a site just outside Pittsburgh. While no one doubts that project will proceed, there is a good deal of discussion about how the rest of the value and logistics chain will develop.

MarkWest’s 200 million cubic feet (MMcf) per day Mobley I train in Wetzel County, West Virginia, started up in December. That plant is part of a three-train processing complex that is one of the key components in a sweeping Marcellus midstream investment program that will give the company 3 billion cubic feet (Bcf) per day of throughput by the end of 2014.

The company’s current Marcellus assets comprise 390 MMcf per day gathering capacity; 915 MMcf per day processing capacity; a 60,000 barrels (bbl.) per day, propane- MarkWest’s 3 billion cubic feet per day of new capacity installed and planned is just the opening play of new work in the Marcellus midstream. By Gregory DL Morris 50 January 2013 MidstreamBusiness.com plus fractionator; and 90,000 bbl. of natural gas liquids (NGL) storage.

The multi-year, three-state expansion has 18 individual projects totaling 2 Bcf per day processing capacity, 115,000 bbl. per day of ethane-plus fractionation, and the 50,000 bbl. per day Mariner West pipeline project. There were some construction delays with Mobley I, due primarily to permit complications and severe weather, most notably Hurricane Sandy in late 2012.

Nevertheless, Randy Nickerson, senior vice president and chief commercial officer at MarkWest, tells Midstream Busines Mobley I “will be operating at commercial levels” in early 2013.

“It takes 12 to 18 months for one of these plants to come to full capacity,” he notes, adding that capacity is a bit of a moving target with Mobley because the second train is due to come into service in the first few months of this year.

Despite the size and scope of the Marcellus midstream expansion, Nickerson says his firm has been very prudent in matching processing and logistics capacity to actual liftings.

“To some degree, we work with every single mediumto- large independent or major in the Marcellus,” he says. “We have contracted all or most of their gas. There are some independents in Marshall and parts of Wetzel counties [West Virginia], but those are the only areas where we don’t gather and/or process.”

Stressing that “our efforts are collaborative with our producer partners,” Nickerson explains, “the market is much more of a push than a pull. There is not much speculative construction; most is based on specific requests from customers and partners. The dramatic expansion over the next 18 months in the southwest of Pennsylvania and surrounding areas is in step or just slightly behind our producers.”

Looking ahead, Nickerson says that there will be opportunities to optimize and expand the NGL infrastructure and marketing activities in the Marcellus. He notes in particular the Mariner East project that will export ethane and propane from the former Sunoco refinery in Marcus Hook, Pennsylvania, outside Philadelphia. Range Resources is the producer partner in that project.

Nickerson stresses that there are no immediate plans for new capacity or projects beyond the currently announced slate, but rather emphasizes that as the projects are completed, optimization opportunities will become apparent.

“Over the long term, producers will continue to grow their business, and we expect to be a part of that. If we give them good service now, they will get good results and we will see continued opportunities,” he adds.

The more the merrier

Tom Gellrich, principal of TopLine Analytics, of Valley Forge, Pennsylvania, confirms that MarkWest is the pacesetter in the Marcellus midstream, but adds that he expects producers upstream to encourage other processors to take a larger role. He stresses that MarkWest has done a fine job of working closely with producers and has been especially energetic in working to develop downstream demand.

“The players really look to them as the leader, but even if MarkWest is perfect, the upstream sector is just going to be more comfortable with options,” Gellrich tells Midstream Business. “Producers are going to try to pull in other midstream players just to hedge their risk.”

He did not want to speculate on what other possible midstream operators could become a bigger part of the picture, and also notes that no prudent midstream player would want to build processing or transport capacity on speculation.

“There are no other major midstream processing projects in the Marcellus beyond what MarkWest is doing,” says Gellrich. “There are incremental expansions by many operators, but nothing major. That said, I suspect that we will see others getting in a bigger way.”

He suggests that Williams Partners LP already has an extensive operation in the Gulf Coast that could provide a model for Northeastern U.S. development, and also that Kinder Morgan Energy Partners LP has the size and wherewithal to be a competitor wherever it chooses.

“All of the midstream operators were a little surprised at how rapidly the upstream action shifted in the Marcellus from dry to wet and then overall from the Marcellus to the Utica,” says Gellrich. He sees two midstream keys for the Marcellus: the Shell cracker and other NGL developments such as propane dehydrogenation. “I think that in the midstream sector, someone will jump in once Shell confirms that their project is on track. That is a huge ethane market.”

Just as important, he explains that among downstream customers who buy polymers and make consumer goods or components, there is a reluctance to rely just on one ethylene-polyethylene complex, no matter how big or well run.

“You really need at least two Marcellus crackers for the sake of downstream viability,” says Gellrich. “Everyone wants to minimize risk, so there is a double lag in any development away from areas of existing infrastructure.” Midstream processors need to be assured by producers that they have molecules behind pipe, and fabricators need to be assured by processors and petrochemical companies that there will be security of supply as well.

“Marcellus gas has not been going to market because the pipelines and infrastructure have not been there,” says Gellrich. “That explains the differential of as much as $1.50 per thousand cubic feet between the Marcellus gates and the Henry Hub price.” But he is sanguine that it will all fall into place, and notes that on the Marcellus natural gas scoreboard there are 20 projects with a total of 8 Bcf of capacity due in the next 18 months.

Gellrich also notes one other risk-management strategy: “MarkWest is shifting to fee-based contracts,” he says. “From 2009 through 2011, their feebased business was flat at 40% of total net operating margin. But then in 2012 that is projected to rise to about 46%, then forecast at around 61% in 2013 and up close to 70% in 2014.” Company data confirm Gellrich’s observations.

Gathering is strategic

MarkWest Energy Partners has an ambitious expansion program in the Marcellus as it—and other midstream players—adds infrastructure to bring the play’s hydrocarbons to market.

Given that most of the prime acreage in the Marcellus region is under lease, further expansion by any upstream or midstream company is likely to take place through mergers and acquisitions.

Cynthia Pross is senior analyst for midstream mergers and acquisitions (M&A) research at IHS, and based in Norwalk, Connecticut. “We really saw deals in the Marcellus get going in the beginning of 2011, but since the third quarter of last year activity has slowed quite a bit,” she tells Midstream Business.

But she expects to see some revival soon. Given the head start that some companies have, she notes, “it is now much faster to acquire than to try to start from the ground up.”

The first indication could have already come, she suggests, in the November 2012 deal by Crestwood Midstream Partners to acquire compression and dehydration assets in West Virginia from Enerven for $95 million. Not a blockbuster deal, but a significant one.

“Since 2010, there have been about 28 or 30 deals in the Marcellus midstream worth about $27 billion,” Pross says. The values of deals have fluctuated widely, and some have not been disclosed, but the rough average of about $1 billion each is fair, she says. The more important number, she adds, is that master limited partnerships (MLPs) have accounted for $23 billion of the deals, or more than 82%.

“The cost of capital is just lower for the MLPs, and the slow, steady growth lends itself to the MLP model,” Pross says. “The Crestwood deal is a good, safe type of move, just a bolt-on for them.” She notes that the most active company in the segment has been Williams, doing about $15 billion in deals. “Second has been Global Infrastructure Partners. After that it falls away fast.”

Pross does not find it unusual that Williams and some of the other acquirers in the market have done deals but not yet announced expansion plans in processing.

“Gathering is the strategic reason for M&A in this play,” she says. “On a business case, that provides the solid, long-term contract with good clients. Then companies can build out processing based on the gathering assets as necessary.”

She reflects that the recently ended flurry of activity may have been a reflection of the scramble to move from dry-gas to wet-gas assets.

“Also it is a function of the market just settling down. A lot of the attention is moving to the Utica. That does not mean that people are moving out of the Marcellus, just that people are assessing their situations,” she adds.

That contemplative pause is also allowing time for new processing ideas to come to the fore. One is a “regional- scale” ethylene-and-polyethylene project planned for West Virginia by Appalachian Resins. The venture is led by James Cutler, who was principal at Petral Worldwide in Houston for many years. “If you look at the Shell plans, they have the capital, and they have the technical knowledge,” Cutler tells Midstream Business. “You have to wonder why they are still talking about this as a planned project.”

Wide spots in the pipeline

He suggests that could be because a world-scale steam cracker will make 2 billion pounds (lbs.) per year of ethylene, and require 60,000 bbl. per day of ethane. Half the output will go for 1 million lbs. per year of polyethylene, and the rest go into ethylene glycol and other derivatives. The challenge is not the capital or the technology, Cutler postulates, but the infrastructure— especially storage to take up the slack if feedstock or monomer or any other section of the facility goes off line for any reason.

“There is nothing in the world like what we’ve got in and around Mont Belvieu [Texas],” says Cutler. “But it took us half a century to create that. The entire infrastructure picture is what anyone planning a world-scale cracker in the Marcellus is chewing their fingernails about.”

Not surprisingly, his venture is a quarter the size of the Shell proposal, 500 million lbs. per year of ethylene consuming about 15,000 bbl. per day of ethane. Cutler is also adamant that he does not see the venture as a petrochemical plant, but as “just a wide spot on the pipeline.

What we are going to be doing is monetizing ethane. We just happen to be using a cracker to do it. We are just a processor like the other midstream players.”

Cutler says the financing of the project is in place, most likely as an MLP befitting the midstream market.

“It is just a matter of working the arithmetic around the cost of capital. We are going to be using off-theshelf ethylene and polymer technology, nothing exciting. That 15,000 bbl. per day of ethane would work back to just 350 MMcf per day of gas. The producers can support this.” With a formal announcement of the West Virginia project imminent, Cutler adds that Appalachian Resins has been invited to replicate the project in Ohio.

If the original plan goes ahead, it would not necessarily be the much-discussed second Marcellus cracker. Nova Chemicals, based in Calgary, Alberta has a strong case that its facility at Sarnia, Ontario, is the first Marcellus cracker and that Shell, if built, would be the second.

Nova buttressed that assertion in its Mariner West venture to move Marcellus ethane to Sarnia. The cracker at Sarnia, long heralded as one of the most flexible in North America in terms of feedstocks, is being converted to ethane-only. Westlake is making a similar conversion to its cracker at Calvert City, Kentucky, just announced in October. That unit could also viably claim to be already the first or second regional cracker.

Back to the future

If all of this midstream development in and around the Marcellus sounds familiar, that is because it is.

“At one time there were six crackers in the Kanawha Valley [of West Virginia],”Joe Eddy, chairman of the West Virginia Manufacturing Association, tells Midstream Business. “Today there are none, but we are looking to keep the molecules in the valley as far downstream as possible. That is where the value comes from.”

He explains that the midstream and downstream industries were historic to his state, “but they left because they were following the feedstocks to the Gulf

Coast and overseas. Now the feedstocks are back, and we are working to bring the midstream and downstream industries back.” Eddy made his case in Philadelphia at the Shale Petrochemical Manufacturing Summit in November, held by IQPC and sponsored by PwC.

Garrett Gee, director of chemical advisory services at PwC, concurs, but adds, “the first wave in the Marcellus was the upstream oil and gas boom. The second wave is now the midstream and downstream development. Clearly those industries are being reinvented in the region. But that is just an opportunity, which is not a business case. What technology do you deploy? What is your supply-chain plan? Where can you most effectively deploy capital?”

Just as there are lags from wellhead to midstream and midstream to downstream, there are lags in manufacturing, says John Hotz, vice president of corporate strategy at Nova Chemicals.

“There was a lot of demand destruction as a result of the recession,” tells Midstream Business. “So polymer was exported. Now it is being repatriated as domestic manufacturing grows. That will continue until North American olefin and polymer capacity expands.” Given the huge volumes of ethylene and polymer production planned in the next few years, Hotz suggests that a temporary domestic oversupply could be created, precipitating big exports again, and the cycle will continue.

Returning in some detail to the Marcellus midstream, Hotz details exactly how his firm is a full player.

“We can be called the first mover to create demand for that ethane cut. Supply from Range Resources, Williams, and Statoil will move via the Sunoco Mariner West to our 1.8 billion-lbs. per year Corunna cracker at Sarnia. Right now we are using an ethane/propane mix that we bring up from Conway, Kansas. We are revamping Corunna to run 100% ethane. That will be finished by the middle of 2013, and we will be taking full volumes of Marcellus ethane for that cracker by 2014.”