The numbers are in. Global upstream mergers and acquisitions values topped $211 billion in 2010, a 42% increase over 2009. The transaction frenzy was driven by a rush to oil and natural gas liquids plays, fueled by high crude oil prices and the continuing gas-supply glut.

Midstream-asset trading was not far behind. In 2010, worldwide midstream M&A transactions returned to their 2006 all-time high of $49 billion in value, according to the recently released IHS Herold 2011 Global Midstream M&A Review. The IHS study includes pipelines, gathering and processing facilities, tankers and diversified midstream holdings.

The $49-billion tag represents a 400% increase over 2009’s $12.6 billion in total asset-deal value. According to the report, about 94% of midstream M&A activity in 2010 was driven by spending on gas pipelines, gathering and processing facilities in the U.S. A significant number of the deals represent corporate restructuring and companies trading fixed-asset properties to fine-tune operations.

Several of the largest transactions involved master limited partnership (MLP) restructurings by companies operating in U.S. unconventional gas plays. Total transaction value for shale-gas assets increased 255% year-on-year, reaching an all-time high of more than $5 billion. Transactions involving gas-gathering and processing facilities led the deal count with 24 deals in 2010, followed by 10 involving liquids pipelines and eight involving gas pipelines.

This pipeline alignment sheet depicts a West Texas crude line built in the 1920s.

The wealth of midstream assets trading hands clearly reflects rapidly increasing natural gas production combined with unfavorable gas prices, says Cynthia Pross, senior analyst for M&A research at IHS.

“I think many of these deals indicate a desire by companies to cut costs by streamlining operations through restructuring, to improve balance sheets and to gain increased access to capital through larger, consolidated operations. Ultimately, they want to optimize their profitability, since natural gas margins are so thin,” she says.

MLPs are streamlining operations through acquisition of their general partners, eliminating general partner distribution requirements and using funds for capital expenditures or to maintain distributions to MLP unit-holders.

“Aside from cost control through consolidation and a need to enhance balance sheets, many of these companies find the M&A market a way to quickly and economically expand geographically, versus taking on extensive new construction,” says Pross.

“In particular, we have seen this in U.S. shale plays, where we witnessed a higher deal count than those for conventional gas plays in 2010. Most of these transactions were asset-level deals that ranged from $100 million to $1 billion in total transaction value.”

Also adding to the boom are upstream oil and gas operators selling midstream assets to midstream-focused companies, allowing the seller to invest the proceeds into upstream activities while locking in long-term midstream capacity agreements with the buyer as part of the deal.

But not all midstream companies are buying or selling assets to tweak portfolios. Some are renting. On January 11, 2011, Corridor Energy LLC announced its formation as an asset-management company focused on buying and then leasing out energy-infrastructure assets.

REITS to riches

Corridor Energy, based in Leawood, Kansas, plans to provide growth capital to finance energy infrastructure assets such as natural gas and liquid transportation, storage facilities and electric power transmission and distribution.

The company will own and lease energy infrastructure assets and act as a financing partner, operating businesses. The assets are critical conduits for energy delivery, relying on real estate corridors for right-of-way. As such, the real assets targeted by Corridor Energy will become real estate investment trust (REIT) qualified.

Corridor Energy was formed by principals of the Calvin Group and Tortoise Capital Advisors LLC, as well as by Tortoise’s majority owner, Montage Asset Management LLC. Rick Green, former chief executive of Aquila Inc. and Utilicorp United and a founder of the Calvin Group, is the managing director of Corridor Energy and leads its management team. Altogether, the executives at Corridor Energy have 70 years of combined energy industry experience and have originated more than 40 transactions totaling over $10 billion.

“The energy industry has a tremendous growth curve for the next few decades,” says Green. “A lot of investment will be needed in infrastructure. This asset management and financial structure is a new application that will bring additional capital that hasn’t been there before into the industry.”

Green, a 30-year veteran of the traditional and alternative energy industry, sees his position with Corridor Energy as an opportunity to partner with Dave Schulte, a founder of Tortoise Capital and Corridor, and whom he has known for more than 15 years.

“As we attended conferences, we heard a drum beat from institutional investors that they were looking for direct investment in infrastructure. This REIT is a new business model for them,” says Green. “REITs have been around for decades but, in the past, they’ve been used for office buildings and commercial retail real estate investments.”

Using the REIT structure in energy is now possible because during the past three years the U.S. Internal Revenue Service has worked to expand the definition of assets that qualify for REITs, explains Green. REITs can encompass energy assets, like transmission pipelines, gas storage and power infrastructure that are conduits for energy, as opposed to assets that bring about the conversion of energy such as gas-processing facilities and power generation.

“As we acquire assets, we are required to hold them for a period of time before we can actually declare them with a REIT status. As a REIT, we intend to pay out more than 90% of the income, so the income is not taxed. It allows a larger cash flow to be distributed to the investors,” says Green.

Energy REITS are different from energy MLPs, such as pipeline companies, in that the owners cannot also be the operators. However, REIT managers do have responsibilities.

“While we don’t operate the assets, we do oversee the operations to the extent that we are charged with making sure that maintenance activities are completed and with preserving the value of the assets.”

Yet, why would operators prefer to lease transportation systems instead of owning them?

REIT advantages

“Energy companies that use this traditional REIT structure in its new application in the energy industry can take advantage of the ability to finance their assets but still keep control of exclusive rights to their assets,” says Green.

It’s also a way for operators to free up capital, he says. An operator can make an existing pipeline a REIT, and use that capital to reinvest in growth either by acquiring additional pipelines or developing new midstream assets.

“It’s important to understand that an operator entering into a transaction with us still gets 100% of the value of their assets,” emphasizes Green. “It’s different from a debt financing where a bank loans a certain percentage of the value of an asset. We finance 100% of the value and the lease payment is a hybrid of debt and equity, which is to say there is a fixed portion and a variable portion that is tied to revenue.”

In effect, it mirrors what the business does. The operator is not tied to a total fixed payment. Given these features, and the fact that it allows a competitive price, the financial structure fits well in an operator’s balance sheet, he says.

Before forming the business, Green and his co-founders spoke with investors to gauge their interest in energy REITs.

“The investors we contacted believe it is very important that there is an operating discipline in the REIT management company,” says Green.

Shulte, Green and the rest of the team bring strengths in different disciplines to Corridor. Shulte, with his development of Tortoise Capital, has $6.3 billion under management and an extensive fund-management and financial background. Green’s 30-plus years in the energy industry have been as an operator. Their experience alone has made investors comfortable with the new entity, says Green.

Buying assets

Corridor Energy is now seeking to acquire intrastate pipelines, gas distribution and storage facilities and electric transmission systems, but at present has no plans to determine investments by asset type.

“It’s too early to get to that kind of detail. Right now, with this being a new application, even though it is a traditional way to finance assets, we just don’t know enough about the kind of deals we’ll be doing to make a point of allocating how much money to invest in each type of asset.”

With regard to oil and gas assets, REIT managers are not biased to conventional or unconventional plays. Green sees a variety of opportunities in shale plays and developed basins and will look at gathering systems and interstate pipelines, among others.

“We also want to have geographical diversity in REITs,” says Green. “We will acquire assets located in different regions of the country. The sweet spot is midstream gas, with intrastate pipelines and gathering systems.”

The most important metric, when deciding which asset to target, is the current management, says Green. “It’s all about the management. It’s really a partnership that we are entering. These are long-lived assets, so as we build our REIT and want that REIT to have credibility, not only in who is managing it, but also in the credit worthiness, investors have to see good, competent management in the commercial business.”

Corridor’s acquisitions will be significant investments, he says. An average transaction is likely to be in the range of $100- to $300 million. To assemble a diversified portfolio, Green and company will build the REIT to oversee about $1 billion in assets, beginning with some $400- to $500 million in 2011.

Pipeline equities gets "at least one call per week from interested parties looking to buy trunk lines, gathering lines and right-of-way easements." David Howell, founder, Pipeline Equities LLC.

Midstream middlemen

Meanwhile, managers with underutilized pipeline assets can find a new home for non-core assets through midstream brokers. Such assets can be of value to other companies—including those outside the oil and gas industry.

To date, the market for oil, gas and products pipelines, either in operation or shut down, has no major auctions or central selling-and-buying exchanges. Unlike for oil and gas properties and drilling and production equipment, there just aren’t enough transactions to warrant such markets, according to David Howell, founder of Pipeline Equities LLC, which appraises and brokers used and recovered pipelines.

Instead, the market for buying and selling pipelines has always depended on direct business-to-business transactions. Pipeline operators sell assets to producers or to other pipeline operators in the vicinity. More often than not, a pipeline that is unprofitable, marginal or in an area of declining production is shut down and abandoned. Also, in past years, pipeline buyers primarily sought to acquire pipelines serving conventional-gas plays. Now, shale-gas infrastructure is changing the market.

In fact, midstream assets near promising U.S. shale plays have become sufficiently numerous to warrant interest from potential purchasers. But the lack of a large exchange market is causing a bottleneck for desired transactions. In response, Howell built a “middleman company” to facilitate efforts to buy and sell used and recovered pipelines.

For example, exploration and production companies are flocking to the Eagle Ford shale-gas and liquids-rich formation that originally fed the great East Texas Oil Field. Howell sees a growing trend of midstreamers seeking to buy legacy, abandoned or out-of-use pipelines. Shale plays and other unconventional gas, oil and CO2 activities elsewhere are becoming targets for midstream buyers, including in-ground pipe in the Haynesville, Eagle Ford, Marcellus, and Barnett plays.

In these areas, Pipeline Equities has acted as a pipeline broker in various pipeline transactions and gets “at least one call per week from interested parties looking to buy trunk lines, gathering lines and right-of-way easements,” says Howell.

Getting started

About 20 years ago, Pipeline Equities received a routine call from a Dun & Bradstreet Corp. agent to update its credit files. In the course of the conversation, the agent asked the usual questions about sales, revenue and employees, and finally asked for the exact nature of the business.

“I replied that we were a pipeline broker,” says Howell. “She was unable to find a standard industrial classification number or code for ‘pipeline broker,’ and she inquired if this category had to do with securities. I replied that it did not, but we bought and salvaged old oil and gas pipelines and then sold them for reuse.”

Unable to place the company in an existing category, the agent created a new category, Pipeline Broker, specifically for Pipeline Equities.

“That’s how Pipeline Equities became the only pipeline broker in the Dun & Bradstreet database. Having such a lofty title in such an organization as Dun & Bradstreet, we needed to live up to that name, and Pipeline Equities became much more involved as a broker of oil and gas pipelines,” he says.

Today, Howell’s company has significant historical data on pipelines, including location and if they are active or inactive, because such metrics have always been essential to pipeline-salvage operations. To get the word out to potential transaction parties, however, Howell found it necessary to update his modus operandi.

“This year, we stopped using direct mail for marketing and switched primarily to e-mail database marketing and various other techniques to draw potential clientele to our website, where they can learn almost anything about our company in the privacy of their office.

“In a break from the past, there’s no question-and-answer session with our agents or myself unless they contact us directly,” he explains. “Yesterday’s handshake is today’s e-mail.”

In the years since the brokerage division was created, the company has acted as agent or broker for numerous parties. The data on outdated and abandoned pipelines it has collected during the past 30 years has become “a treasure trove of information,” he says. And not all pipelines retain their original purpose. The market for used pipeline has evolved to include a surprising array of non-energy-related industries.

“The salvage business offered us the perfect opportunity to find uses for abandoned pipelines and then act as the broker to the next buyer, whoever that might be. For example, abandoned pipelines can be salvaged and reused by changing a gas pipeline over to become a conduit for electric or fiber-optic cable, or other purposes.”

"As we attended conferences, we heard a drum beat from institutional investors that they were looking for direct investment in infrastructure. This REIT is a new business model for them." Rick Green, managing director, Corridor Energy LLC.

Alternative markets

Pipeline Equities has brokered a variety of deals for both in-ground and recovered pipe. Recently, it assisted a city government in central Texas in its attempt to convert an abandoned 80-year-old, crude-oil line into a transport system to carry treated wastewater from a treatment plant to parks, golf courses and other irrigation sites along the pipeline corridor. The transaction saved the city millions in taxpayer dollars that would otherwise have been spent on a new system.

Elsewhere, Howell worked to help salvage a jet-fuel-products pipeline that ran 20 miles through a major metropolitan area. The project appeared marginally profitable, but it was in a highly congested area in a major metropolitan area.

“Before demolition, we called a company that provided natural gas to Miami, Florida. It turned out the jet-fuel line ran beside their main line and would work perfectly as a backup manifold to their local distribution system,” says Howell. The gas company saved millions of dollars by acquiring a backup system rather than building a line, and the sellers got rid of a liability.

“And we made a nice fee by finding a buyer for a property that had been considered junk or at the very minimum, a liability,” admits Howell, noting that the pipeline will likely serve Miami for the next 20 to 30 years, while the easement can be used forever.

Each transaction can be challenging, says Howell. He notes that discretion is often a top priority.

“A large, independent pipeline company asked us to broker the purchase of a non-operating pipeline that was well known in the industry. The company did not want to approach the owners themselves and thus reveal their intent,” he says, noting that to do so would have revealed the major midstreamer’s deep pockets. Pipeline Equities, acting as agent for the company, was able to purchase the asset below market price and then resell it to its client. The purchase price was less than the client would have paid the original owners.

Training ground

Almost all pipeline companies have unneeded assets acquired through acquisitions or mergers. These properties range from real-estate parcels to odd-lot pieces of pipelines “that go from point A to nowhere.”

At times, such properties find their way to Pipeline Equities or a client company as worthless inventory or real estate that continues to require tax payments. Recently, Howell discovered another use for them.

He sees the need in the oil and gas pipeline industry for more personnel trained in asset management. Training personnel in how to use old or superfluous assets is increasingly valuable as companies continue to scrutinize their balance sheets. So, why not train them using out-of-operation equipment? Today, Howell supports the reuse of old equipment for asset training for a variety of institutions.

“The International Right of Way Association is one that certifies and educates in this area,” says Howell. “They have extensive certification programs in asset management, acquisition of assets (mostly right-of-way) and negotiation skills.”

Yet, not enough companies understand the value of “silent and underused assets” such as idled pipelines and gathering systems, Howell says. “We are finding more and more uses for them on a regular basis.”

Consolidation

Indeed, even as the global economy recovers and oil trades at higher levels, helping to lift liquids prices, many industries and businesses continue to consolidate assets to optimize cash flow and efficiencies, especially in the midstream space, where assets are being pruned and discarded. These “assets in transition” create additional opportunities for pipeline brokers.

“Often, when an acquiring company obtains another, it is for a particular line of business or a central group of assets that fits well with the purchaser’s current structure. The remaining inventory is left behind and, in many cases, abandoned or turned over to a business-development manager who is busy with other priorities,” observes Howell.

“For those assets, we have been engaged by various engineering companies which, in turn, have been hired to test the integrity of a pipeline that they are considering for purchase. We come in to determine necessary economic evaluations. At the end of these projects, we have an opportunity to purchase the undesired portions of the systems, or act as brokers to dispose of the remaining or less-desired segments of pipeline.”

In other instances, an acquirer seeks an appraisal to identify the equipment in asset packages that best fits its operations. The packages, generally being divested by the majors, contain perhaps one or two good systems as well as a system or two that might be considered substandard or a liability. Often, an outside third party can best evaluate the properties and find a secondary use, such as for fiber-optic cable, electric conduit and water lines. Also, a vintage pipeline that might be considered substandard can be brought up to date using interior-liner techniques.

The business of buying, selling, brokering or acting as middleman for pipelines is useful in a market that is thin or lacking in robust transactions, Howell says. Typically, a brokerage contract begins with a finely detailed appraisal and often ends with an unexpectedly higher-value transaction for the seller or a lower-cost acquisition for the buyer.

Overall, whether assets are managed, bought, sold, leased or built, midstream M&A activities are sure to be numerous in the near term, and managing those assets continues to top the priority lists of midstream managers.