Two companies with Marcellus Shale assets, Consol Energy and Noble Energy, announced plans earlier this month to form a master limited partnership to handle pipeline and processing demands in the shale play.
They are among the most recent in a long line of companies to use a master limited partnership (MLP), a tax vehicle developed in the 1980s that gives companies incentives to invest in energy infrastructure.
And they likely won’t be the last.
Master limited partnerships are publicly traded entities that pass on earnings directly to their shareholders who then pay taxes on that income. The first one was formed by Apache Petroleum Co in 1981. Later, the Tax Reform Act of 1986 under the Reagan administration accelerated their use as a way to invest in domestic energy infrastructure.
The MLP structure is different than that of a traditional energy company. And pipeline companies, in particular, are well suited for the model, said Andrew Brooks, vice president for Moody’s Investors Service.
For example, MLPs are required to distribute their cash flow to their limited partners. “So they need sources of cash flow that are stable, that don’t take commodity price risk or volume risk,” Mr. Brooks said.
Interstate pipelines — those regulated by the Federal Energy Regulatory Commission — tend to be backed by long-term, fee-based contracts, he noted.
“That's a stable, highly certain cash flow stream, which is paid out to limited partners,” Mr. Brooks said. “The companies then go to external markets to finance their projects.”
The use of such partnerships pre-dates the shale revolution, but demand for more pipelines to ship growing oil and natural gas production has bolstered their popularity.
The National Association of Publicly Traded Partnerships counts 139 MLPs currently in existence. The lion’s share — about 83 percent — are energy companies, representing about $510 billion in market capital, said Mary Lyman, executive director of the Arlington, Va., trade group.
“Midstream companies are the majority of the MLPs,” Ms. Lyman said.
Canonsburg coal and natural gas producer Consol is partnering with Houston-based Noble Energy to form an MLP called Cone Gathering LLC to provide midstream infrastructure for their jointly-owned acreage in the Marcellus.
An initial public offering for the partnership is planned for later this year. No further details have been disclosed, as the companies filed a confidential draft registration statement with the U.S. Securities and Exchange Commission.
“Because investors in the MLP are taxed — not the business entity itself — it’s a pass-through entity,” said Michael Grande, director of utilities and infrastructure practice for Standard & Poor. “It promotes the use of this vehicle to build the infrastructure because it’s more cost efficient and has a lower cost of capital.”
Master limited partnerships must generate most of their income from natural resources, real estate or commodities.
In the Appalachian Basin, the geological formation that includes the Marcellus and Utica shales, soaring production has gotten ahead of pipeline development, creating a backlog of wells looking for pipe. That demand isn’t expected to wane anytime soon.
Mr. Grande noted that the Marcellus has a low cost to drill, even when natural gas prices are low.
“This is a very robust and desirable area for MLPs,” Mr. Grande said.
On June 20, Alerian added EQT Midstream Partners to its Alerian MLP Infrastructure Index, a composite of 25 energy infrastructure companies. The investment firm has several indices that serve as benchmarks for master limited partnership assets.
EQT Midstream believes the “region’s shale is well-positioned for continued growth, due to low production costs and access to multiple existing and new markets,” said Randall Crawford, executive vice president and chief operating officer.
EQT chose to spin off its midstream infrastructure in 2012 as it “became clear to us that we needed a funding source to capture the significant midstream opportunity we had in the Marcellus,” Mr. Crawford said.
“The MLP space is a deep market that provides a repeatable and low-cost (relative to the alternatives) capital source,” Mr. Crawford said. “The MLP, in our judgment, is the best way for growth oriented midstream companies, such as EQT, to fully leverage their assets.”
One factor playing into midstream investment is that shale drilling is taking place in areas that don’t have a recent history of oil and gas development. Pennsylvania hasn’t seen large-scale drilling in about a century, noted Ms. Lyman of the National Association of Publicly Traded Partnerships.
“The infrastructure to deal with what’s coming out of the ground was scanty or non-existent,” Ms. Lyman said. “There’s a need for pipelines. MLPs have stepped in to do that.”
Andrew Brooks, vice president for Moody’s Investors Service, notes the Marcellus is producing about 14 billion cubic feet per day of natural gas, and is expected to reach 20 Bcf/d in the next few years.
“To put that in perspective, the U.S. in total currently produces about 70 Bcf/d of natural gas,” Mr. Brooks said. “If you’re producing at this magnitude, you have to have the infrastructure to get the production to market.”
Stephanie Ritenbaugh: firstname.lastname@example.org or 412-263-4910