As oil prices have fallen, the stocks of many MLP pipeline companies have fallen in sympathy despite the fact that transportation costs are, at most, indirectly linked to oil and natural gas prices.
In fact, many pipelines enjoy a form of quasi-monopoly status in their local markets since options for transporting crude and natural gas are often limited. This lack of competition has long given pipelines additional pricing power and enabled them to reap big profits for investors. That pricing power seems to be becoming even stronger during the downturn as pipelines consolidate and expansion of alternatives for moving fossil fuels become more difficult due to capital constraints. Related: Iran May Not Be That Attractive To Oil Industry After All
In the face of this environment, it’s not surprising that many pipelines are adhering to the adage of “never letting a good crisis go to waste” and are looking to expand their market power. One of the most successful adherents to this doctrine is Energy Transfer Equity LP. After a long courtship, ETE has finally come to a deal to buy Williams Companies. The importance of this deal to ETE’s future is hard to overstate.
ETE’s agreement to acquire Williams Cos for $37.7 billion will create the largest network of natural gas pipelines in the United States. In addition, the combined company will have a substantial set of infrastructure assets for moving crude throughout the U.S. The drama behind this deal has been going on for a while. In June, ETE originally moved to buy WMB for $48 billion. Williams spurned that offer, and since then, stocks in both companies have largely trended downwards along with a broader sell off in the sector. Natural gas prices have crashed, oil prices have failed to rebound in a significant way, and the outlook for additional growth in exploration and production has dimmed, taking down hopes of significant additional expansion in pipeline assets for now. Related: U.S. Shale Lifelines Running Thin
In the seas of dismal news, ETE’s move demonstrates foresight. Energy markets will not stay moribund forever and ETE is setting itself up to have stronger pricing power and better economies of scale in the future.
In particular, Williams provides ETE necessary access to northeastern U.S. pipeline infrastructure. This is very valuable since it enables the new ETE to bring gas out of the giant Marcellus Shale and into New York and New England where many homes use considerable amounts of gas during the cold winters. In addition, WMB owns the 10,000 mile Transco natural gas network which links gas producing regions of South Texas to the profitable and hungry NYC market. ETE’s new combined 100,000 mile pipeline network stands to be even more profitable once operations between the two firms are melded.
While the merger provides significant pricing opportunities for ETE in the future, the near term outlook for the company will likely continue to be challenging. Oil and natural gas prices show little sign of a fast rebound, and while infrastructure players have been less exposed to price pressures than many of the oil service companies, everyone across the sector is feeling the pinch to some extent. The external pressure on the industry is so great that even behemoth Kinder Morgan is taking a hit. The firm recently cut its guidance for 2016 distribution growth, and the firm is saying the public equity markets are so weak (and equity cost of capital so high) that it will look elsewhere for financing options in the future. Related: NatGas Glut Mirrors The Problems Facing Oil Markets
Moreover, the Federal Trade Commission recognizes the power that ETE is gaining through this merger and they are likely to require some divestitures before allowing the deal to proceed. As a result of this pressure, ETE and Williams are planning to sell WMB’s stake in one of Florida’s main interstate pipelines in a bid to win approval for the deal according to Bloomberg.
With all these storm clouds looming, ETE shareholders may be in for a rough ride for now. But storms eventually pass, and when these clouds abate, the company should be well positioned thanks to its sage decision to team up with WMB.
By Michael McDonald of Oilprice.com
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