One of the chief restraints on the shale revolution has been the ability to economically move oil, gas and other resources from remote hinterlands to key hubs.

For midstream companies, 2014 was the year midstream tied itself up in well-considered, remarkably expensive knots.

“The midstream was a fairly sleepy part of the industry historically and has grown very quickly in the past few years to kind of meet this need,” John England, Deloitte’s vice chairman, U.S. Oil & Gas, said.

John England, Deloitte vice chairman, U.S. Oil & Gas, said the midstream sector has been abruptly awakened to meet tremendous need in the upstream sector.

Midstream companies found themselves in an ideal climate for making deals, according to Ron Montalbano, senior managing director, Ernst & Young Capital Advisors.

“The first half of 2014 was arguably the best exit environment that a seller could hope for,” Montalbano said.

Some private-equity firms made the perfect bet on midstream MLPs. "They were spot on with their investment thesis that this market was going to be tighter and that midstream assets were going to be a much more important part of the value chain," Ron Montalbano, senior managing director, Ernst & Young Capital Advisors, said.

Deloitte has estimated the need for U.S. midstream investment will reach $200 billion by 2035. Despite 2014 oil prices abruptly dropping into a sinkhole, progress will continue. E&Ps still need more infrastructure to move hydrocarbons to markets.

Over the past five years and more, private-equity groups have backed dozens of management teams and bought companies, adding value to midstream companies through expansions, smaller acquisitions or greenfield projects.

The private-equity groups bet right.

“They were spot on with their investment thesis that this market was going to be tighter and that midstream assets were going to be a much more important part of the value chain,” Montalbano said.

In 2011, for instance, North Dakota’s Bakken Shale players essentially wasted through flaring or couldn’t move out 35% of their natural gas production because of limited infrastructure. Hydrocarbons similarly were trapped in the Eagle Ford and Marcellus shales.

By 2013, when overall energy deal values fell considerably, midstream companies made $46.7 billion worth of transactions. By 2014, midstream deals dominated deal flow, doubling the $60 billion value of all E&P deals in 2013 with $126.6 billion pledged to change hands.

MLPs are strongly interwoven into the midstream sector. The explosion of such partnerships has created more than 160 publicly traded MLPs with more waiting in the wings.

MLPs are incentivized to grow their distributions, making them a much hungrier group of buyers than traditional C-corps. They trade at high multiples, enjoy debt at low interest rates and an overall cost of capital that is low.

The result is a large number of buyers unafraid –and able—to pay up for what they want.

“They have the ability to pay very high valuations and still add shareholder value,” Montalbano said.

The average size and stature of transactions in the midstream sector expanded through 2014. In the first quarter, the top 20 M&A deals in oil and gas included just one midstream transaction. In the second quarter, midstream claimed three of the top 20 spots. By the third quarter, there were nine midstream deals among the top 20, even with oil prices dropping.

“Clearly this is a trend of not only a greater number of midstream transactions, but larger in value as well,” Montalbano said.

From June through October, some giant deals were announced.

In October, Targa Resources Corp. made a takeover bid for Atlas Energy Inc., dangling $7.7 billion at shareholders. In a $6 billion deal, Enterprise Products Partners LP announced plans to acquire Oiltanking Partners LP in a two-step merger process that would give Enterprise access to waterborne markets in the Gulf Coast region.

And this summer, in a deal worth nearly $6 billion, Williams Cos. Inc. acquired Access Midstream Partners LP and proposed merging it with Williams’ own MLP to create one of the largest transporters of fuel in the nation.

Foresight

Williams’ midstream deal with Access was an exercise in patience to advance its overall strategy to become the premier provider of natural gas infrastructure in North America.

“Our goal is to be big No. 1 or No. 2 in our markets—and the acquisition of Access was a major step toward reaching that goal,” Tom Droege, senior communications specialist, Williams, said.

Williams closed the merger with Access in July, but first set its sights on Access in 2012. The MLP had established a strong presence in attractive basins, particularly where Williams did not yet have a foothold. Under long-term, fixed-fee contracts, Access operates in the Barnett, Eagle Ford, Haynesville, Marcellus, Niobrara and Utica shales and Midcontinent region of the U.S.

Access, with a market capitalization of about $13.2 billion, provides oil and gas gathering services to Anadarko Petroleum Corp., Chesapeake Energy Corp. and other heavyweights.

Williams structured its deal to buy Access on the front end. In a two-phase plan, Williams paid $2.25 billion for its initial ownership in December 2012. The second phase was an option to acquire additional interest in the company.

The initial stake provided a clear look into Access’ business. Williams found that the company complemented its own commercial, financial and people strategies. The deal was also monumentally lucrative, with Access’ per unit price nearly doubling to $65 in June 2014 from $32 in December 2012.

Eighteen months after its initial investment, Williams exercised its right to acquire the balance of Access from Global Infrastructure Partners II (GIP) for $5.995 billion. Williams intended to own controlling interest in the prized Access assets, and as one analyst noted, the “golden goal” came earlier than expected.

In June, Alan Armstrong, Williams’ CEO, said the deal would amplify the benefits of its relationship with Access and accelerate Williams’ move to a pure-play GP holding company of two leading MLPs.

“The proposed merger of Williams Partners and Access Midstream Partners, if consummated, would create an industry-leading, large-scale MLP with substantial positions across the midstream business—spanning natural gas gathering and processing, natural gas transmission pipelines and NGL and petchem services. Our positions in these businesses provide clearly identified growth for the foreseeable future,” Armstrong said.

“The MLP structure is important to Williams and its MLP Williams Partners’ fulfilling its role as a premier provider of large-scale infrastructure,” Droege said. “Energy infrastructure is largely a fee-based business, which creates stable cash flow to the MLP and, in turn, stable and growing cash distributions to the unitholders of the MLP.”

Cash distributions are tax efficient because no tax is incurred at the partnership level and deductions such as accelerated depreciation are passed on to the unitholders. The low-risk, tax-efficient business model allows Williams to raise capital at a low cost and therefore makes its investment opportunities more attractive.

How does the health of the E&P sector, particularly in shale, impact midstream deals? Obviously, if an open season isn’t successful, a pipeline doesn’t move forward. How far ahead do you have to look to feel comfortable with the economics of a play before doing a deal?

“It’s a fluid process,” Droege said.

Demand for natural gas and the infrastructure to move it is escalating. Large-scale infrastructure projects take time.

“The biggest challenge that is outside of our control is the permitting process, which can require long periods of time in order to certificate new projects,” he said.

The dropping oil price affects some aspects of Williams’ business, such as propane and other NGLs. However, natural gas prices have held strong, and ethylene production is expected to remain near record levels.

“Because our business is more than 80% fee-based, it’s about volumes of natural gas. It’s not about price,” Droege said.

Rise of midstream

In 2014, 17 midstream megadeals of at least $1 billion were announced. The total before taxes and adjustments is $47 billion.

Some of the largest deals were made by E&Ps selling off midstream assets. Occidental Petroleum, Energen, QEP Resources and its affiliates and Hess all made deals ranging from more than $1 billion to $2.5 billion.

“Broadly, we started to see that trend maybe a couple of years ago,” England said.

Upstream companies built gathering systems in the course of ramping up production. While building assets was necessary for fast growth, infrastructure doesn’t enjoy the high returns upstream offers.

“Typically, upstream wanted to either sell assets, joint venture them, drop them into an MLP, something that allows them to monetize that,” he said.

But even as the E&P assets were turning over, Deloitte envisioned what it calls the midstream majors—large-cap midstream companies that cut across multiple geographies and commodities.

Such companies would move gas, oil and NGLs and have a large geographic presence.

“We were already seeing that happen,” he said. “Once some organic growth slowed down, we started to see more M&A activity. M&A activity has started up probably even quicker than we expected. That’s kind of what we’ve seen this year [in 2014 and early 2015].”

Montalbano said that while the drop in oil prices will likely result in a pause in some M&A activity across the oil and gas sector, the ingredients of the MLP buying spree remain intact. The midstream MLP universe still enjoys a lower cost of capital than its competition when pursuing a transaction.

“The need for some upstream companies to raise capital due to the current commodity outlook could result in captive or joint ventured midstream assets hitting the market,” he said.

As for the largest deal of the year, Kinder Morgan recalled its various midstream entities to create a vast company. Three transactions put Kinder Morgan together again for $76 billion.

While the transaction was largely an internal refit, it was still noteworthy for showing the company was ready to abandon the MLP structure.

“It makes sense for Kinder, but it’s interesting because you’ve seen a tremendous wave of companies IPOing to take advantage of the MLP structure while the largest MLP reverts to a traditional C-corp structure,” Montalbano said

Ultimately, the move may have been predicated by benefits on the tax side falling short. Outside of an MLP structure, companies can take advantage of opportunities more quickly and not have a rigid 90% of cash flow distribution.

England said the transaction was effectively an organizational change. “I don’t think it’s foretelling other similar deals, from what I can tell at this point,” he said.

The average size and stature of transactions in the midstream sector expanded through 2014.