Romancing The Midstream

?Alinda Capital Partners LLC was attracted to the deal because, “gas will have a big role in the nation’s energy future, and the Haynesville will be a big part of that,” says Chris Beale, managing partner.

Haynesville shale natural gas operators plan to spend about $3.5 billion on drilling prospective acreage in the Haynesville, according to a first-quarter 2009 report by consulting firm Wood Mackenzie. Despite low gas prices, shale players continue to be encouraged by strong well results showing initial production rates as high as 20 million cubic feet per day and making the play economical.

To move that gas to market, new pipeline infrastructure is needed—but financing is scarce. One opportunistic pipeline company saw an opening, however, and made it happen with carefully planned financing and a new joint venture.

In April, Regency Energy Partners LP formed a joint venture with General Electric Capital Corp., which is an affiliate of GE Energy Financial Services (GE), and the independent investment firm, Alinda Capital Partners LLC, to build a major take-away pipeline expansion for Haynesville shale-gas production.

Dallas-based Regency Energy Partners, a midstream gas gathering and processing, contract compression and transportation company, operates in Texas, Louisiana, Kansas, Oklahoma and Arkansas. The company owns 5,950 miles of gathering pipeline, 789,500 third-party, revenue-generating horsepower of compression, and nine processing and treating plants. Regency contributed its Regency Intrastate Gas System, a 320-mile intrastate pipeline in northern Louisiana valued at $400 million, in exchange for a 38% general partnership interest in the JV.

?A welder test-welds pipe for Regency Energy Partners’ Haynesville Expansion Project in north Louisiana.

GE, a global energy investment firm with $22 billion in assets, owns the general partner of Regency and has invested some $965 million since 2007. During the past year, the Stamford, Connecticut-based firm has participated in Regency’s July 2008 equity offerings and dropped down Midcontinent assets into the MLP. GE Energy contributed $126.5 million in exchange for a 12% general partner interest in the JV.

New York-based Alinda Capital was tapped as the third entity due to its association with GE through jointly owned local gas distribution companies and intrastate pipelines. “We have a similar investment approach to GE,” says Alinda’s managing partner, Chris Beale. “We were attracted to this investment because the Regency pipeline system is an essential infrastructure link between the Haynesville shale and the trunklines that serve the major gas markets.” Alinda Capital contributed $526.5 million in exchange for a 50% general partnership interest in the JV.

Alinda was also attracted to the deal because “gas will have a big role in the nation’s energy future, and the Haynesville will be a big part of that,” says Beale.

“Regency has demonstrated its operating and development expertise, and GE is a very knowledgeable and experienced player in the energy field. We saw this as a very good fit for us and we think we can help out not only with the current Haynesville Expansion Project, but also in continued future expansions,” he says.

The joint venture ensures that the enterprise is well funded, with nearly $1.1 billion in equity capital and no debt to date, says Byron Kelley, chairman, president and chief executive for Regency.

The Haynesville Expansion Project consists of 36-inch (Bienville and Elm Grove lines) and 42-inch (Winnsboro line) diameter pipelines, running some 121 miles from Bossier Parish to Franklin Parish, Louisiana, and is expected to be in service by year-end.

About 92% of the pipeline’s capacity is committed by 10-year contracts (85% are based on demand charge), and Regency has requests in excess of the remaining capacity. The pipeline will more than double the company’s pipeline system in the area.

At 1.1 billion cubic feet per day, the Haynesville Expansion is a large project. Yet, the current plan is a somewhat scaled-back version from the initial plan. The decision to downsize was made last September when the financial markets became difficult to access.

“The Haynesville joint venture allowed us to maintain our first-mover advantage and keep operational control of the assets,” says Byron Kelley, chairman, president and chief executive for Regency Energy Partners LP.

“We intended to finance our original project using a combination of debt and equity,” says Kelley. “When the financial crisis hit, those were no longer feasible financing options.”

Also off the table was any decision to delay the project until financial markets recovered.“We had already purchased the materials for this project,” says Kelley. “That was a fairly sizable expense. We knew there were competitors who would build this pipe if we didn’t, so the opportunity would be gone. We had the first-mover advantage and we did not want to lose that. Also, we made a commitment to our customers who were already drilling, and they needed take-away capacity, so we had to find a way to make this work.”

Subsequent to the decision to go forward, the MLP redesigned the pipeline capacity, cutting it to 1.1 billion cubic feet from the originally planned 1.45 billion. As a result, the cost was reduced by nearly half, from $1.1 billion to $653 million. The new design serves the shippers’ near-term needs and can be easily expanded via additional compression and looping construction.

“Since September of last year, the change in the global economy has impacted every industry,” Kelley says. “These changes forced Regency to reevaluate our business. I sat down with my team and discussed our options moving forward.”

Regency took a look at the possible financial impacts, reassessed its position, and refocused on what needed to be done in the environment in which it found itself. It set three objectives.

First, the company had an immediate need to address the liquidity concerns around the Haynesville project. It already had financial commitments for the pipeline prior to the economic crisis, but the availability of capital and the total cost of financing options did not justify the project as originally envisioned. Also, Regency was determined to maintain service for its committed shippers, who were also understandably concerned.

A crane offloads 42-inch-diameter pipe for the Winnsboro-line section of Regency Energy Partners’ Haynesville pipeline.

Kelley and his team set three criteria for managing liquidity for the Haynesville project: avoid making irrational decisions in a pressured environment, develop a creative solution by making reasonable compromises to move forward, and ensure a solution would be beneficial to unit holders. The solution was to form a joint venture.

“The joint venture allowed us to maintain our first-mover advantage and keep operational control of the assets. It also positioned us for future growth in the Haynesville shale,” Kelley says. The JV structure allowed Regency to secure financing at terms accretive to Regency’s unit holders.

“As a result of getting the joint venture in place, we saw our bonds begin to trade up significantly, moving from about 19% in December 2008, to currently about 10%. The tightening in yield allowed us to move into our second objective,” he says.

Regency’s second objective was to reduce the outstanding balance on its revolver. On May 15, the company issued $250 million of senior notes. The 9.375% notes were priced at 94.496% of the principal amount, to yield 10.5%, and will mature in 2016. The net proceeds will be used to repay a portion of the outstanding balance under its revolving credit facility.

“Those two events addressed our liquidity issue and strengthened our ability to raise money in the debt market,” says Kelley.

Regency’s third objective was to “recognize that the world had changed, but there will be better days ahead.” The firm is now poised for growth, especially in the Haynesville and Eagle Ford shale regions. “Both of those shale plays are right around our existing pipeline assets, and drilling is still quite active there,” says Kelley.

Kelley isn’t worried about overbuilding his shale-gas infrastructure. “Haynesville producers are seeing production levels that far exceeded their expectations. They expected good results, and they found better.”

Initial production rates are still higher than originally expected, and now drilling and completion costs are beginning to fall. Returns are good, even at today’s gas prices, says Kelley. “In fact, we’ve seen a number of producers announce an increase in the number of rigs in the Haynesville area, more than there were just two months ago.”

By 2010, the Haynesville could be producing more than 2 billion cubic feet per day, says Kelley. By some accounts, production will further increase to more than 4 billion cubic feet by 2012. While Regency’s project alone will move 1.1 billion cubic feet per day, other smaller projects added together will move another 500 million cubic feet daily. Also proposed is Energy Transfer Partners LP’s 180-mile Tiger Pipeline system, which is expected to transport about 1.5 billion cubic feet per day by the first half of 2011. That project, if completed, will ensure take-away capacity of about 3.5 billion and nicely align producer-and-pipeline-operator supply and demand.

“Going forward, we are looking at a number of other possible expansion projects in the Haynesville and Eagle Ford shales, including compression and fee-based gathering,” Kelley says. “As the capital markets continue to recover, we will look to finance this growth with a combination of debt and equity.”

Overall, the midstream sector may recover from the financial crisis more quickly than exploration companies, due to lower revenue risk as midstream operators move away from commodity-price-based revenue to service-fee-based revenue.

Over the last few years, Regency’s focus has been to add fee-based assets designed to generate stable cash flows and limit commodity exposure, says Kelley. The company’s margin derived from fee-based contracts has moved from about 43% in 2007 to about 70% for 2009.“With aggressive hedges in place, we anticipate only 3% of our segment margin will be subject to commodity-price fluctuations in 2009. Our commodity exposure is low, and that is favorable for us,” he says.