No solid black line separates upstream from midstream. The exact divide between sectors, and product custody, frequently lies somewhere within a fuzzy, indis­tinct gray zone where one link in the energy chain becomes another. The transfer point may be a wellhead, a tank battery or a meter run down the road.

It depends. One producer does it here; another does it over there.

Wherever the handoff occurs, both sec­tors thrive profitably on—big word here—symbiosis, defined as “a cooperative, mutu­ally beneficial relationship” between people, plants, animals or groups. Upstream can’t make money if midstream isn’t there to pick up the production. Midstream depends on upstream and exists to take production, process it, transport it and store it for end users.

Midstream may have evolved in recent years as a separate sector in its own right, but in many cases, the corporate parent of an exploration and production company is the owner—or at least an important part—of the same organization as the midstream unit that serves it. Go out in the field and look around. The pumper making a run to check wells drives a pickup the same color and model as the switcher monitoring meter runs and compressors.

Or, the same field hand does both and jots down time spent doing each in two columns on one time sheet.

Midstream’s evolution has involved an upstream parent spinning off its midstream component as a stand-alone entity, usually as an MLP, to gain the tax and cash flow advantages such partnerships offer—and greater market exposure. Large producers usually have had an in-house midstream division while smaller oper­ations jobbed the haul-off work to someone else. In either model, what makes the upstream-mid­stream relationship work remains the same: ser­vice, dependability—and symbiosis.

Creating a separate midstream link in the energy value chain makes sense, according to Ben Davis, partner at Energy Spectrum Capital, a Dallas-based upstream and midstream private equity provider and long-term industry partici­pant. The midstream is another—and sometimes very attractive—way for investors to enter the energy business, something upstream producers with midstream assets see clearly when markets cooperate, he said.

“It’s one more way to access the public mar­ket” and create additional value, Davis noted.

“The advantage for the upstream company is they can ‘sell’ their midstream assets to their midstream counterpart, a friendly party, and have security of rates and capacity,” Davis explained. Producers enjoy “a built-in buyer whom they trust.”

During the run-up to the commodity peak in 2014, “they were doing this at that time at some really nice prices. The market multiples that [the deal] conflict committees could justify, based on where the public markets were, were high, 12 times or 14 times cash flow.” In con­trast, upstream assets may have brought seven times or eight times cash flow, he said.

Consider Rice Energy Inc. and its midstream unit, Rice Midstream Partners LP (RMP). The producer holds interests in some 200,000 net acres in core areas of the rapidly growing Marcellus and Utica. It had net production of some 675 million cubic feet equivalent per day (MMcfe/d) in the first quarter, a 50% increase, year-over-year.

“Midstream has been part of our business ever since we developed our first well, so the upstream and midstream for us has always been viewed jointly in our pursuit of long-term value creation,” said Daniel J. Rice IV, CEO of both Rice Energy and RMP. “The rationale for the RMP IPO was similar to the rationale for taking Rice Energy public in January of 2014. We identified significant, future opportunities to grow our midstream business and believed that access to the public markets would provide the capital necessary for us to continue investing in our business.

“RMP has continued to evolve since we went public and now has 114,000 gross dedi­cated acres in the core dry gas Marcellus Shale in Pennsylvania, nearly 20% of which is from high-quality, third-party operators, a successful water services business and a growing backlog of attractive drop-down candidates to perpetuate future growth,” he added.

Captive midstream units can become sizeable operations in their own right.

Third-party customers

Anadarko Petroleum Corp. is the sponsor of Western Gas Partners LP, ranked No. 14 on the 2015 Midstream 50 list of Oil and Gas Investor’s sister publication, Midstream Business, with 2015 revenues of $1.6 billion and EBITDA of $758 million. Anadarko holds an 84% interest in Western Gas Partners’ gen­eral partner, Western Gas Equity Partners LP, as well as an 8% direct interest in Western Gas Partners.

No surprise, then, that Western’s mid­stream assets closely match the major producing regions of Anadarko, such as Col­orado’s Wattenberg Field, where Anadarko holds approximately 350,000 net acres with an estimated 1.5 billion barrels of oil equiva­lent (Bboe) in recoverable reserves. Western overlays the Wattenberg and the surrounding Denver-Julesburg (D-J) Basin with multiple midstream assets, including its Wattenberg gathering system, Fort Lupton gas processing plant and interests in takeaway pipelines.

Having a strong upstream sponsor offers a midstream operator the opportunity to pursue third-party growth, a point emphasized by Don Sinclair, president and CEO of Western Gas Partners, at the recent Master Limited Partner­ship Association (MLPA) investor conference in Orlando, Florida.

Third-party business could be a substantial chunk of Western’s business in the rapidly developing Delaware Basin. Sinclair called the D-J “a template for the Delaware Basin” and described Western Gas’ growth plans to serve, first things first, its sponsor in the West Texas unconventional basin. But in addition to Anadarko, “we have blue-chip customers in our Delaware Basin service area,” he noted. That includes current and future customers such as Cimarex Energy Co., ConocoPhillips, Carrizo Oil & Gas Inc. and Apache Corp. Third-party business “helps us diversify the risk,” Sinclair added.

Those third-party volumes would be in addition to handling the impressive, 2 Bboe of recoverable resources in com­ing years that Anadarko has identified on its Delaware acreage.

As the sponsor grows, so grows the mid­stream MLP. Overall, Sinclair noted, Anadar­ko’s top-tier Delaware acreage under lease is more than three times the size of what it holds in the D-J.

In Appalachia, “we’re already providing midstream services to third-party customers in standalone areas outside of Rice’s producing properties,” Rice said. “In Pennsylvania, RMP is active in Washington County, east of Rice’s activity, and in Ohio, we’ve stepped out to eastern Belmont and Monroe counties to pro­vide midstream services for Gulfport [Energy Corp.] and Consol Energy. In both instances, we’ve established a midstream presence in areas that we have a deep upstream expertise in and are geologically similar to Rice’s core operating areas.

“Our high-quality, third-party business both in Pennsylvania and Ohio has grown substan­tially over the last few years through a couple of different ways,” the CEO added. “Shortly after Rice Energy’s 2014 IPO, we acquired a gas gathering system that included third-party acreage dedications as part of the transaction. Since that time, we’ve extended our contracts with our third-party customers because of the quality service we provide to our customers and like-mindedness we share as E&P operators,” Rice said.

“We’ve also been able to source new third-party opportunities through our own corporate development efforts with top-tier operators like Gulfport Energy. Our third-party business is a significant and growing portion of total through­put, and we’re delighted to provide these mid­stream services and expand this piece of the business,” he added.

Permian perspectives

Devon Energy Corp. combined its mid­stream assets with Crosstex Energy Inc. in early 2014—at the time a major midstream service provider to Devon—to form EnLink Midstream Partners LP. The two maintain a strategic partnership. Devon holds a 64% inter­est in EnLink’s general partner, a 25% interest in EnLink’s limited partner and a majority of seats on the EnLink boards. EnLink handles a portion of Devon production in the Permian, Stack, Barnett and other plays while handling a significant volume of third-party business.

Andrew Deck, senior vice president, Permian Basin, for EnLink, highlighted the importance of tight upstream-midstream partnerships in a pre­sentation at Hart Energy’s recent DUG Permian conference in Fort Worth, Texas. “Neither the producing company nor the midstream company can be successful without the other,” he said.

A good partnership is particularly important in a bustling region like the Permian, he noted. One of EnLink’s strategic goals for 2016 is to deepen relationships with its customers.

“Planning and partnering are going to be essential for us to be successful,” Deck said. Takeaway capacity is not a major concern right now, he added, but that is not the case with gathering infrastructure—primarily low-pres­sure piping and compression used to aggregate volumes for processing.

“Over the last 18 to 24 months, producers drilled wells twice as fast, they drilled wells at half the cost, and wells generally have about twice the reserves as they used to have,” he said of the big play. He noted that’s about four times the reserves for the same capital investment for a producer. Those kinds of numbers have an impact on the midstream sector, too.

He noted EnLink has invested more than $1.1 billion in the Permian over the last 18 months, including acquiring midstream assets from pro­ducers, such as the 2015 purchase of Matador Resources Co.’s gathering and processing oper­ations in the Delaware Basin. Devon counts the Delaware as a core area for future growth.

“As challenging conditions in the oil and gas market are showing signs of improvement, I’m confident we—midstream and producers—will emerge smarter and stronger,” Deck said. “Infrastructure requirements are going to grow significantly, and this growth is best accom­plished through mutually beneficial, partnering relationships between midstream and produc­ing companies.

“Timing will be essential going forward,” Deck added.

Having an in-house midstream operation offers a producer advantages, both operationally and financially, according to Rice.

“One distinct advantage we have over many of our peers is that we own and operate our own midstream systems, which provides many oper­ational and economic benefits,” he said. “The highly interdependent nature of the upstream and midstream businesses affords seamless, vertical integration for Rice that produces many competitive advantages.”

That’s particularly important in a region with midstream capacity constraints, such as Appa­lachia, Rice explained. Having a midstream operation helps in “understanding the down­stream markets that are attractive to an upstream company and having the ability to deliver into those markets. Our midstream footprint is ide­ally situated within close proximity of five major interstate pipelines that deliver gas to attractive markets outside of Appalachia for both Rice and our third-party customers. One of the primary benefits is we are able to capture the economic value of the midstream by paying ourselves a midstream fee, which enhances our well eco­nomics and breakeven costs, instead of transfer­ring that economic uplift to a third party.”

He also discussed the financial advantages, echoing the points made by Energy Spec­trum’s Davis.

“The proliferation of MLPs has given upstream companies a vehicle to raise capi­tal by selling midstream assets when the time is right to help fund upstream development activity. This creative financing is an alterna­tive to issuing more C-corp equity or layering on additional debt,” Rice said. “Because Rice owns the general partner of RMP, we are able to maintain operational control of the mid­stream assets even after selling to RMP. This control is important because it allows us to seamlessly integrate our upstream and mid­stream businesses.”

MLP organizational structures vary, but Rice has organized its midstream operations to enhance both operational efficiency and financial returns. Its midstream structure is organized in a manner that would allow it to IPO the general partner (GP) entity, which owns 35% of all outstanding RMP LP units and 100% of the incentive distribution rights, Rice said.

“Through anticipated, future distribution growth, we believe the long-term value of GP holdings could grow in excess of a billion dol­lars. However, it’s still early days, and it will be a while before we start realizing significant GP cash flow, so no definitive plans yet, but we will continue to evaluate in the coming years.”

Managing two businesses that are each competing for capital in growth mode, as were Rice’s upstream and midstream businesses for many years, was another motivation for sepa­ration. “That was certainly one of the reasons for taking RMP public in late 2014: to provide our midstream business with its own source of capital to fund its own opportunities. That competition for capital between the businesses was certainly more difficult pre-IPO than it is today.”

But before going down that path, Rice said, there are certain criteria producers must evalu­ate before deciding whether to form their own midstream business, including “having a scal­able, concentrated acreage position, a lack of infrastructure, a strong sponsor balance sheet and last but not least, the expertise and desire to commit capital to midstream.”

Joined but separate

Even if the upstream producer and the mid­stream operator are separate companies, the joined-at-the-hip nature of their businesses requires close cooperation for mutual success.

More symbiosis: A producer’s contractual commitment of reserves provides the collateral needed for a midstream firm to go to lenders and equity providers for capital needed to start laying pipe or building tanks. In turn, having a dependable midstream link converts proved reserves into the dollars investors seek.

Gary Conway, principal, president and CEO of private Vaquero Midstream LLC, also underscores the dependability topic. A midstream veteran, Conway has overseen the start-up of Vaquero’s new Delaware Basin gathering system and 200 million cubic feet per day (MMcf/d) Caymus processing plant, which links multiple Delaware gas producers directly to the Permian Basin’s key Waha gas pipeline hub.

“I think our advantage is not only our team strength, experienced skill set, philosophy and simple approach, but that we are very willing to demonstrate our performance—not just tell producers about it,” Conway said. “Based on what we have heard from producers to date, they are looking for a midstream company they can count on. I know that sounds really simple, but it can be just that simple.”

So if both sides work together, everyone can make money: Symbiosis.

“We’ve never really bifurcated our deci­sion-making between managing upstream versus midstream,” Rice said. This is largely due to the fact that the Rice family owns approximately 25% of the common stock in Rice Energy, and by virtue of Rice Energy’s 33% ownership of Rice Midstream Partners, there’s significant alignment between man­agement, Rice Energy and Rice Midstream Partners, he said.

“Certainly one of the differences between upstream and midstream is that the upstream investment horizon is much shorter compared to midstream,” the CEO added. “An exam­ple would be a Marcellus or Utica well that recovers the majority of its investment in the first few years, and even then we know within the first six months or so whether the well is going to be great.”

To contrast, Rice is making an infrastructure investment today that requires looking at devel­opment potential that will realize a return over the next 20 to 50 years. “As a result, we have a longer midstream time horizon.”

Rice designs its midstream systems to accommodate not only production from both near-term upstream development and third-party opportunities that could bolt onto the existing system, but to future production over the next 10 to 15 years. “This dynamic causes both entities to look out over the next 10 to 20 years to ensure the investments we’re mak­ing today create value for the long term—at both businesses.”

Part of what makes the RMP story unique is the extensive inventory of dropdown poten­tial including two large-scale, dry gas gath­ering systems in the Ohio Utica to support Rice, Gulfport and Consol’s future develop­ment across 146,000 core dedicated acres, Rice said.

“Our plans include four to five dropdowns over the next four to five years that will con­tinue to drive future midstream growth as well as provide upstream liquidity to continue growth. That in turn fuels midstream growth in a symbiotic manner.”