The Marcellus shale-gas play has awakened the once-sleepy Appalachian Basin, and now a party is in full swing. As the lively crowds at Hart Energy Publishing's recent Marcellus Midstream Conference and Exhibition in Pittsburgh can attest, these days, financial deals are popping in this region's midstream sector nearly as often as in the upstream.

From internal programs to joint ventures, mergers and acquisitions, operators have plentiful rigs at work throughout the vibrant play, and these rigs are delivering gas to the growing midstream industry. In fact, much of the buzz has been about the infrastructure urgently needed to continue taking gas out of the basin and sending it to energy-hungry markets. According to recent reports, the price tag to adequately build out new take-away facilities could approach $10 billion during the coming years.

Such midstream growth increasingly drives new financial deals between producers and pipeline operators, pipeline operators and gas processors, and processors and storage facilities.

Ben Davis, a partner at Dallas-based Energy Spectrum Capital, offered a rundown of the busiest Marcellus operators, ranked by drilling permits, to illustrate the "tsunami of gas" from shale that must be moved to markets.

The private-equity firm's management closely follows the link between upstream and midstream activities and has become a top provider of capital to midstreamers. To date, Energy Spectrum has raised nearly $2.1 billion by establishing six midstream-targeted funds—and each fund raised significantly more than the last. Energy Spectrum's first fund totaled $140 million, while the latest, formed in 2010, raised $750 million from investors seeking low-risk investments with index-outperforming returns.

New Trend

A new trend, particular to the Marcellus, is driving these deals. Although most large-scale processing, storage and transmission facilities are owned and operated by midstream companies whose customers are independent producers, some gas gathering is built and operated in-house by the producers themselves. The large production rates of most Marcellus wells give producers an incentive to determine ways to get their gas to major pipelines even at the early stage of field development. As a result, many are financing the buildout of their own gathering facilities, and monetizing them at a later date. They then use the proceeds to fund new exploration and production activities that generate higher returns.

Gas-processing joint ventures are appearing in the wet-gas portion of the Marcellus shale that comprises some 10% to 15% of the play on its western side, Davis said. The processing and pipeline expansions range from brand-new projects to realignment of existing infrastructure.

The new midstream deals fall into three general categories, said Mark Huhndorff, a managing director for securities firm Raymond James & Associates. First, private equity is backing start-ups tackling greenfield projects. Second, established companies are forming joint ventures. And third, large, integrated companies are taking on organic-growth projects.

"We are seeing big expansions around the Marcellus in pipelines, processing and storage," he said. "Capital is coming from credit, company cash flow, private equity and public markets. Marcellus players are strongly committed to developing the midstream infrastructure, but large amounts of capital will be needed."

Key players in new deals will be Chesapeake Energy, Range Resources, East Resources, Seneca Resources, Talisman Energy, Consol Energy, Statoil and Atlas Energy, because they hold an aggregated 50% of the Marcellus acreage, he explained.

Meanwhile, five major trunklines currently provide Marcellus production take-away—Texas Eastern Transmission, Columbia Gas/Columbia Gulf, Tennessee Gas Pipeline, Transcontinental Gas Pipeline and Dominion Transmission.

Producers and midstreamers alike have taken to forming joint ventures to fund increased midstream infrastructure in the play, said Huhndorff. For example, Williams and Dominion joined to fund the Keystone Connector pipeline; Rex Energy and Stonehenge formed Keystone Midstream; Williams and Atlas produced Laurel Mountain Midstream; MarkWest and NGP Midstream & Resources gave birth to M&R MWE Liberty LLC; and Penn Virginia and Range Resources agreed to jointly construct and operate gathering lines and compression facilities to serve gas production in Lycoming, Tioga and Bradford counties in Pennsylvania.

Key Role

Certainly, private equity is making a splash in the Marcellus, said Scott Soler, managing director for Quantum Energy Partners. Private equity can play a key role in developing the enormous opportunities there, which will require $10 billion in midstream investment by 2020.

"An amazing amount of infrastructure needs to be built," he said. Quantum plans to help that effort along, as it has $1 billion earmarked for midstream investments out of $3.5 billion in available capital. From a private-equity perspective, to deliver the desired returns a project must be of sufficient size to handle both anchor and third-party gas.

Soler based his evaluation on supply-demand economics. A recent study suggests that the shale play contains some 500 trillion cubic feet of gas, but it could be higher. Additional formations, such as the Purcell Limestone and Upper Marcellus, have yet to be developed.

The burgeoning supply is driven by the horizontal rig count, which has increased from five rigs in fourth-quarter 2007 to 120 rigs in first-quarter 2010, he said.

Meanwhile, current gas consumption in the Northeast and Mid-Atlantic market has reached some 12 billion cubic feet per day. That represents about 20% of the nation's total market, and it is higher during the winter.

"The systems need to be scaled up," said Soler. Monetization is another requirement. Midstream development returns 12% to 18% on equity at its core, but developers having a differentiated strategy and scale could generate 30%-plus returns, he said. Typically, private-equity funds have 10-year terms, after which a sale or conversion to a master limited partnership can occur.

Meanwhile, unlike shale plays like the Barnett or Haynesville, the geographical challenges inherent in the Marcellus will increase development costs. Wet-gas areas will need additional fractionation capacity. And the lack of an ethane market will require expanded take-away capacity or a new market in the Northeast for the valuable liquids.

Also, the region's topography includes mountains, national forests and more water-crossings than other areas. Eventually, all challenges can be overcome; they just require major investment, he said.

"Critical factors we look at in any investment we make are strong governance, financial alignment of the team doing the work, and a good measure of control over the exit," he said.

Going forward, a whole new round of infrastructure development is anticipated for the Marcellus. The complexity of the midstream needs in Appalachia, with many different pressures, plays, volumes and timings, means that opportunities for experienced midstream providers will only increase during the next few years. Actually, the party is just getting started.