What is midstream energy?
It’s the middle of a story where the plot thickens. That can be said for the U.S. energy industry.
The oil and gas (O&G) business chain is divided into three main parts. These are upstream, midstream and downstream. The upstream segment includes the exploration, recovery and production of oil, natural gas and natural gas liquids (NGLs). The image of the O&G drilling process may be a familiar one to many. The massive machinery used to dig into our Earth’s core is hard to miss whether in person or on television.
The downstream segment is another concept that should be common. It includes the distribution and sale of energy to end users. These are our utilities and what we use when we turn on our stoves to cook dinner.
What then is the midstream segment? It is the processing, storage, gathering and transport of energy. We would see these as pipelines, rail cars and processing plants. We just don’t always notice them, at least not when it comes to investment opportunities.
Investment in midstream assets has risen over the years to keep up with energy storage and transport needs. Spending in midstream assets by the O&G industry has bumped up to over 15% as a proportion of U.S. exploration & production (E&P) spending, compared to about 10% from the early 1990s to mid-2000s.1
There are three primary ways that investors have looked into the U.S. midstream energy infrastructure sector.
The first is through large diversified energy companies, a traditional form of investing in assets. The second and third are somewhat less conventional. These are master limited partnerships (MLPs) and private equity (investing directly and through fund vehicles).
MLPs are yield-oriented, publicly-traded partnerships. They are typically listed on exchanges such as the New York Stock Exchange (NYSE). The bulk of their operating income is paid out in the form of quarterly cash distributions. MLPs are tax-advantaged entities because they have flow-through structures similar to that of Real Estate Investment Trusts (REITs).
MLPs had historically been held by retail investors, although more recently have witnessed and influx of institutional capital. Master limited partnerships are considered attractive because they can offer income by distributing the majority of their free cash flow on a quarterly basis.
The third investment method is private equity. Although there have historically been few dedicated midstream managers, the universe is growing in response to the attractive underlying dynamics in the sector. This ongoing deployment of private capital could provide a healthy and needed boost to the midstream energy sector.
As energy needs in the U.S. continue to expand, midstream energy infrastructure will play a critical role in making sure that energy can be properly stored and transported so it can power homes, factories, schools, hospitals and offices around the world.
1 Deloitte Center for Energy Solutions, “The rise of the midstream: Shale reinvigorates midstream growth” 2013.
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