U.S. gas midstream sector hopping, more deals seen

HOUSTON (Reuters) - U.S. natural gas producers are parting with their pipeline and processing plants in some of the most established fields in a bet to woo investors with new discoveries.

This year, natural gas prices fell to their lowest levels in about seven years, prompting banks to rein in the amount they were willing to lend the smaller players in the sector.

At the same time, those companies are also increasingly trying to cut their debt by monetizing gas gathering, processing and pipeline -- or midstream -- assets, through sales, joint ventures or partnerships.

All of this has left energy bankers convinced there will be more deals in the next year as valuation fears moderate and the credit markets improve.

Because investors value exploration companies more for their oil and gas reserves, it makes sense for them to shed some midstream assets and pay down debt so capital can be redeployed to drilling, investment bankers said.

"The companies get credit for their reserves in the ground, not ancillary assets like midstream," said Robert Lane, an investment banker at SMH Capital Inc in Houston. "But shareholders are pretty indifferent as to whether a company gathers their own gas or someone gathers it for them."

Recent deals include Carrizo Oil & Gas Inc's closing of a $34.7 million deal to sell its pipeline and gathering systems in the Barnett Shale in North Texas to Delphi Midstream Partners LLC, a firm backed by private equity.

GMX Resources GMXR.O and Exco Resources Ltd (EXS.AX) have struck similar deals for pipeline or processing operations this year. And larger companies Chesapeake Energy (CHK.N) and Anadarko Petroleum Corp (APC.N) have both wrung cash from their midstream assets in 2009.

MORE DEALS?

As last year's crippling credit crunch has eased, firms have moderated their view on deal valuations.

While distance between the bid and the ask side remains, people no longer expect the type of double-digit returns they scored several years ago, bankers said.

"Buyers still need to come up on their valuations and the sellers of midstream need to come down on their valuation expectations," SMH Capital's Lane said.

And while credit is still relatively hard to come by, there are some hopeful signs.

"We're seeing acquisition financing getting done, but we're seeing it for assets with cash flow," Jim Warren, managing director of energy banking at SunTrust Robinson Humphrey, told a recent gas storage finance conference in Houston.

Likely buyers of midstream assets in coming months include private equity firms and master limited partnerships. The partnerships were hit especially hard during the credit crisis because they need access to capital markets to grow. But now, the sector has shed its weaklings and is poised to grow again.

Private equity firms, previously attracted to the steady cash flow of fee-based assets like pipelines, have been big buyers in the sector. But the credit crisis severely restricted private equity's ability to strike deals.

The defensive nature of fee-based midstream companies seem likely to continue to attract private equity players and infrastructure funds, especially if low interest rates and risk adverse investors push up demand for lower risk equity investments, consulting firm Deloitte said in a recent study on energy mergers and acquisitions.

Private equity is also shopping around for natural gas assets, but they have to be a good fit for their existing businesses, bankers said.

LOCATION, LOCATION

Companies that have had midstream assets up for sale have operations located in older basins that have less potential for growth than a shale play like the Marcellus in the Northeast or the Haynesville in Northern Louisiana.

"Our E&P clients are telling us there is some merit to owning these plants," said Robert Hallett, managing director for energy at FBR Capital Markets & Co, noting that companies with midstream assets in high-growth areas like the Haynesville or Marcellus Shales are not likely to put them up for sale.

El Paso Corp (EP.N) is one example of a gas company that sees the importance of owning its midstream assets. After exiting that business in 2005, Houston-based El Paso said on October 19 that it will reenter midstream at a "measured pace." No other details were provided.

On the other hand, a sale of processing and gathering assets might make more sense for companies that have assets in more mature, noncore areas like the Permian Basin in West Texas, FBR's Hallett said.

(Reporting by Anna Driver in Houston; editing by Patrick Fitzgibbons)