Parnon Potential

Tulsa, Oklahoma-based Parnon Gathering Inc. is not a typical midstream company. Rather than competing with heavy hitters, Parnon's business model has taken on a creative bent to allow it to serve niche markets and thrive through its unique structure and business strategy.

Parnon is unique in that it combines both pipelines and trucks into one crude-oil logistic company. The company exclusively transports crude oil, via pipeline and trucking services, and owns major storage facilities at Cushing, Oklahoma.

Parnon is a U.S. subsidiary of Arcadia Energy Trading Group, which is owned by Farahead Holdings Ltd. Arcadia Energy has roots in Europe and Africa, but wanted a U.S. trading presence, and thus established Parnon Gathering.

The decision to have a U.S. trading presence, according to Paul Adams, chief executive of Parnon Gathering, was driven by a number of factors. "They decided that they needed to have global coverage if they were going to be a successful oil trader. So about three years ago they moved forward with the decision to expand into North America by recruiting a couple people to start trading crude oil. At that time, they also made a commitment to build tanks at Cushing."

Today, Parnon owns three million barrels of storage tankage at Cushing. Recently the company made two small acquisitions, including a 6-inch diameter pipeline in southern Oklahoma, which it bought from Copano Energy LLC in 2009, and a trucking business in Kansas, which it bought in 2010. Those two businesses now move about 10,000 barrel (bbl.) per day collectively.

Recent repairs have been completed along the full length of the existing pipeline, which will enter into service in May 2012

"When I joined and agreed to manage the U.S. business, our objective was to build out more of the U.S. midstream assets," says Adams. "That is exactly what we have done over the last two years. We've built out the gathering and pipeline business that will hopefully, in due course, compliment the Cushing assets and the domestic crude oil trading that will continue."

Also, although future acquisitions are on the company's radar, no deals are planned in the short term. "The company would definitely not rule out an acquisition. The businesses that we've looked at thus far, however, have not looked attractive and so we've focused on organic expansion. We have bought 20 new trucks and trailers in the past year, and added two further locations to the 18 we already own," he says.

Although the company is primarily focused on crude oil, that isn't to say that it hasn't looked at some projects that have condensate and gas components to them. However, according to Adams, "We just aren't deliberately seeking to expand into those areas. Most of the projects we are evaluating are crude-oil focused."

The benefits of this strategy are quite simple, Adams says. "We really focus on what we know."

Growth opportunities

Since its beginning, Parnon has worked to serve operators by offering tailored and flexible transportation options for crude oil. A major step toward this strategy is the recent decision to build a new 114-mile, 8-inch pipeline running from Cherokee, Oklahoma, to move crude to Cushing, Oklahoma.

"We have existing volumes that we purchase in Kansas, and we currently have to ship all of those volumes on third-party pipelines to get to Cushing. The Kansas market is very constrained. It is a circuitous route to get to Cushing and it's costly, with multiple carriers involved. So we've been constrained on growing our volumes because third-party routes are mostly at capacity," Adams says.

The company just announced the construction of a pipeline that will bring oil from northern Oklahoma and up in Kansas, down to Cushing, Oklahoma. Parnon initially designed it to move existing crude oil more effectively, but looked for a route that would originate in areas of significant new drilling activity and available third-party volumes looking for a route to Cushing.

"We've deliberately routed it up through that northern central Oklahoma area, starting at a small town called Cherokee," he says. "There is a lot of drilling activity in that area, straddling the Kansas and Oklahoma border. So in addition to the volumes we already buy and the volumes we believe we can acquire in Kansas, there will be more drilling there that will definitely want a route to market, and does not currently have one."

Parnon-owned trucks await new delivery orders as producers ramp up production.

The new line, called Great Salt Plains Pipeline, will include 114 miles of 8-inch pipeline, and will move from Cherokee, Oklahoma, down to Cushing, Oklahoma. It is scheduled to be commissioned in May 2012, and will move 18,000 bbl. per day of crude oil, with an option to uprate to 35,000 bbl. per day. Also, the Great Salt Plains Pipeline will transport production from Central and West Oklahoma and interconnect with Parnon's crude oil tanks at Cushing. In addition, the origin terminal at Cherokee will have storage for 70,000 bbls.

Adams is bullish on shale drilling and sees many avenues for continued growth. "There has been a lot of domestic drilling in very mature provinces," he says. "There are a lot of mature provinces that have been benefiting from the improved technology. The Great Salt Plains Pipeline is tapping into the Mississippi lime formation, and potentially west into the Granite Wash, and we think that's a good move. There is no evidence that, with current prices, drilling isn't going to continue at the high rates we've seen for quite some time. Obviously, with gas prices as depressed as they are, oil is a much more attractive drilling proposition for E&P and midstream companies looking to build infrastructure."

According to Adams, the infrastructure in place is not only insufficient, but it's also aged and needs to be replaced. Thus, he says, it is somewhat of a golden age for midstream infrastructure.

"Much of the infrastructure, the pipelines and the tankage facilities in North America are very old. They were laid out in many cases 50 or more years ago, so that existing infrastructure is either inadequate or misplaced, for the majority of new production."

He notes that some conventional areas, like Kansas or Oklahoma, aren't well served in getting new production to market, and sees opportunities for new infrastructure. Yet, there are challenges that must be overcome.

"Unfortunately, this is coupled with considerable uncertainty because of an unusual situation. Gulf Coast prices are dramatically higher than Cushing prices. And some projections show that differential is probably going to be maintained for a couple of years until some of these major new pipelines that bring Canadian crude down to Cushing are extended all the way to the Gulf Coast."

In short, the market economics are skewed. This, according to Adams, represents a good opportunity and incentive for anyone looking to get oil all the way to the Gulf Coast.

"That's why you see Bakken crude being railed all the way to the Gulf Coast. And why people are either railing or trying to reverse other pipelines further south to get to the Gulf Coast. I don't think that's a long-term phenomenon. I think once there are major pipeline routes from the Midcontinent to the Gulf Coast, we will see those differentials contract. However, given the lead times to put a lot of this infrastructure in the ground, it's unlikely that two or three years from now we'll see that same incentive," he cautions.

According to Adams, these economics and market drivers will encourage Canadian producers to build major lines. In fact, just recently, Enterprise Products Partners LP and Enbridge Inc. announced plans for a new pipeline to transport crude oil from the oft-discussed oversupplied hub at Cushing to the Texas Gulf Coast refining complex. The Wrangler Pipeline, as it will be called, will have the capacity to transport up to 800,000 bbl. per day of crude oil and accommodate the constrained medium-to-light crude oil currently stranded at Cushing and priced at a substantial discount to the oil imports that account for most of the supply for Gulf Coast refiners.

A Parnon trucking station in Oklahoma is building up activity.

For now, Parnon's focus is to build its Great Salt Plains line, on budget and on time. After that, the company will turn to other projects, such as extending that line farther south and west into western Oklahoma.

Being a smaller midstream company, Parnon has to be quick on its feet to stay ahead of the game, and has no plans to become a master limited partnership (MLP).

"From a financial perspective, larger MLPs have a very attractive capital cost, and when large assets come on the market, it's no coincidence that they almost invariably get bought by existing MLPs. We don't see attractive returns in the prices paid for the multi-million dollar assets when they come on the market, when someone like BP Plc sells a package of pipelines. We've bid on those, but without the benefit of the MLP structure we certainly can't see those returns being an attractive option for us."

In addition, Adams says that the big companies also have a lot of economies of scale to help them. "So I think that if you are a smaller company, you've got to figure out what your niche is, rather than trying to go head to head with these larger players. We also believe that producers value the quality of operational and financial service. At the end of the day, it's still their primary concern that their oil is always reliably and safely taken to market, and they are certainly prepared to put a premium price on quality of service," he says.

It doesn't hurt that although Parnon is a small company, it has deep-pocketed owners in Farahead Holdings. "So we also enjoy the benefits of credit lines. We're fortunate in that regard for the capital projects and financing of our business. Generally, we've got ready access to that capital, without which could be a handicap to a lot of other smaller companies in this sector," Adams says.

The company is also flexible with its ability to lift split loads, otherwise known as small parcels, from the smaller producing wells. In addition, Parnon has recently installed a processing plant down in southern Oklahoma to handle wet barrels that the bigger midstream companies typically would reject.

"We believe that we thrive by offering niche services, and service quality which enables a small company like ourselves to compete," says Adams.