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Water Midstream Sector Positioned To Handle Rising Permian Volumes

CDN Smith

Permian Basin oil production has been a major global shock absorber. Last month, the US Energy Information Administration reported nearly 600% growth in new well oil production per rig from 2010 to 2019, and total output has grown by 2.5 million BOPD from its January 2008 baseline, a figure greater than the total loss in Venezuelan oil production over the last 2 decades. While produced water production reports are limited in scope and vary in availability, the rising volumes of water expected to go with the rising oil volumes are a cause for concern on the operator side.

Gabriel Collins, Baker Botts Fellow in energy and environmental regulatory affairs at the Baker Institute for Public Policy’s Center for Energy Studies, said produced water will likely account for approximately 80% of the lifetime mass moved from many Permian Basin wells, and that the region can expect at least 4 million BOPD of incremental growth in produced water volumes by 2021. The costs of moving such mass are a problem, but water midstream companies have positioned themselves to take advantage of the possibilities borne from this problem.

“Mass is what destroys the roads. Mass is the diesel fuel it takes to move water around on trucks. Mass is the thing that really makes your lives complicated in many ways, but it also creates business opportunity,” Collins said.

Speaking during a panel discussion held at the Permian Basin Water in Energy Conference in Midland, Texas, Collins described water midstream—the sector of companies who own and manage the infrastructure to store produced water and transport it to other locations, such as saltwater disposal wells (SWD) or other frac sites for reuse, via pipeline—as a sector that will help the region stay competitive.

Unconventional development incorporates several elements that are fiscally dynamic, such as drilling and completion costs and midstream sourcing. These elements are subject to cost reduction via technological improvements and solutions delivered through deeply integrated infrastructure. He cited Devon as an example of an operator making headway there: the company’s lease operating expenses have dropped from $16.87/BOE in 1Q 2015 to $4.90/BOE in 3Q 2018 thanks in large part to its investments in fixed infrastructure like power and pipelines.

If M&A activity picks up, billion-dollar valuations for water midstream companies in the near future could become a reality. 

Water midstream companies are another means to help control costs for operators who do not want to build their own pipeline networks. Instead of investing further in SWD, building their own infrastructure to transport produced water, or having more trucks on the road handling increased volumes, operators can have someone else handle their water at a fixed cost.

“One of the nice things about putting water in a midstream system with a long-term contract is that you’ve basically fixed a service cost in a largely inflation-resistant way. I think that’s a special opportunity to not have to do that with pressure pumping and other things that can fluctuate wildly along with the commodity prices,” Collins said.

Michael Dunkel, global upstream technology leader for upstream water at Jacobs, said cost is the top water infrastructure driver in the Permian. On top of that, reliability and provenance are critical to ensuring further operator buy-in. With a water midstream system, operators are essentially giving up water to another entity to use in a pipeline network they likely do not own, so Dunkel said midstream companies have to ensure them that they will be able to deliver their water when and where it is needed.

“One of the negatives to midstream is that you might give up control, so one of the things these midstream companies have to do is satisfy the producer’s need for control, and ensure them that they’re going to be able to execute their business plan, that they’re going to complete more wells,” he said. 

Scale drives value in water midstream, and integrated water services will be operationally necessary to help realize increased demand from operators. While there are several new, smaller companies trying to establish position in the Permian, Collins said CAPEX-intensive commodity markets like water midstream naturally evolve toward sector domination by a few new players.

A smaller midstream company whose portfolio consists of a small number of high-quality wells, Collins said, would likely have greater value as part of a bigger midstream firm. To that end, mergers and acquisitions (M&A) will become par for the course moving forward, as good strategic acquisitions will help increase the stability of the larger firms’ revenue profiles. He predicted that at least three additional large private equity companies will enter the water midstream sector within the year, and at least three sizeable water midstream firms in the Permian will be acquired by a larger player in that same timeframe.

If M&A activity picks up, Collins said billion-dollar valuations for water midstream companies in the near future could become a reality.

“I think we’re seeing a much greater diversity of participants, and we’re setting ourselves up for consolidation,” Collins said. “There’s a compelling case in many instances where you see overlapping acreage footprints or companies that may have slightly different competencies that they’re strongest at, while still being in the water midstream space. You can make a pretty strong case for greater integration between them, and this may come through mergers and acquisition activity.”

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