With U.S. natural gas prices sputtering along at a level that most analysts believe is generally below full cycle costs and causing financial indigestion for many producers, what do these low prices mean for the midstream segment of the industry—and in particular for the dominant part of the midstream segment, the master limited partnerships (MLPs)?

Like all hard questions in life, the answer is, it depends. To begin with, MLPs are created as a source of stable cash flows, and thus we need to understand how low prices are affecting these flows. Clearly, in the case of the upstream MLPs, for those with a high exposure to natural gas development, the impact on cash flows can be severe. But upstream MLPs with a high liquids exposure could conversely be doing very well. For the midstream MLPs, the impacts will depend on the MLP's asset focus (such as gathering, processing, pipelines, and storage), geographic exposure (to dry gas, wet gas, and liquids reserves) and its contract mix.

Gathering and processing

In the case of gathering and processing MLPs, cash flows attributable to gathering activities could be adversely affected if producers curtailed dry gas production or shifted production to other more liquids-rich gas plays. In terms of processing activities, in addition to possible reductions in volumes processed, the impacts will depend on the contract mix, such as straight-fee, percentage-of-proceeds, percentage-of-liquids, and keep-whole. (Note that the exposure to strong liquids prices and thus the possible impact on cash flows increases with different types of contracts, with straight-fee contracts least exposed and keep-whole contracts most exposed.)

That the U.S. resource mix has an obvious geographic angle is also important for MLPs. As relative price differences between oil and natural gas have shifted, development and production activity has shifted away from drier gas plays to wetter, more liquids-rich gas plays, and to predominantly oil plays.

While we have seen activity slow somewhat in the mature and traditionally drier shale gas plays (such as the Haynesville, Fayetteville and most of the Barnett), activity in the generally wetter shale gas plays, like the Permian, Granite Wash, some of the Marcellus, and in particular, the Eagle Ford, has grown substantially.

Similarly, the rapid increase in shale oil development in the Williston-Bakken and Niobrara shales has underpinned the success of MLPs with assets in those regions.

Pipelines

Pipelines, both those in and out of MLPs, typically have minimal direct exposure to commodity prices, as they generally don't take ownership of the commodity. Revenues and earnings are largely driven by demand charges similar to rent or toll-road collections. These structures are underpinned by take-or-pay clauses, typically out a number of years.

However, the contract dating mix of pipelines does provide some risk, as contracts roll-off and volumes decline in regions with less-economic gas.

In addition, to the extent a pipeline system is not fully subscribed, a shift in the supply patterns, including supply basins, from dry gas to wet gas, might decrease the volumes available for transmission or storage, under excess capacity arrangements, and put downward pressures on cash flows.

Storage

Storage-focused MLPs have been impacted less by the absolute level of prices than by the changing price differentials, first as infrastructure expansion has reduced inter-hub differentials, and then as reduced volatility, along with generally flatter forward curves, has reduced some of the returns to storage.

During the coming 25 years, the midstream oil and gas business in general, and the midstream MLPs in particular, will be driven by the expected huge infrastructure growth. Last year's study for the Interstate Natural Gas Association of America pegged U.S. midstream infrastructure requirements to 2035 at more than $200 billion, or more than $8 billion per year.

Despite the current weak prices for natural gas, the opportunities for infrastructure-driven organic growth for the midstream and MLPs will be substantial, particularly in the newest growth areas where traditional infrastructure was particularly thin (such as the Marcellus, Eagle Ford and Bakken shales). If natural gas is the bridge fuel to our energy future, then the midstream is the bridge to natural gas's future. n

Marcela Donadio is the Southwest Sub-area energy industry leader for Ernst & Young LLP, a member firm of Ernst & Young Global Ltd. serving clients in the U.S. and Americas oil and gas sector leader for the global Ernst & Young organization. The member firms of Ernst & Young Global Ltd. provide auditing, accounting, tax and transactions services to their clients in 140 countries worldwide. Donadio has more than 35 years of domestic and international audit and accounting experience. The views expressed herein are those of the author and not necessarily those of Ernst & Young LLP.