The oil and gas business in Texas is big and complex. Yet, Texas business leaders not in the energy sector may know little about how the transport side of the industry functions.
Melcher Hall, home of the Bauer College of Business at The University of Houston, may be the ideal place not only to learn about the oil and gas business, but to freshen up on Economics 101 – the lessons of supply and demand as attendees did at the Texas CEO Magazine Speaker Series event. Supply and demand is the backbone of a market economy and the oil and gas business represents one of the biggest markets there is.
Joining the conversation on: Midstream Challenge: Getting Supply to Demand, were:
Terry McGill, President of Enbridge Energy Company. Enbridge is a company whose pipelines carry nearly 70 percent crude oil and 30 percent natural gas. Enbridge has the world’s longest pipeline starting in Alberta, Canada, crossing into the U.S. in Minnesota, traveling across the upper U.S. into Buffalo, New York, and back into Canada in Montreal.
Mark Gorman, Senior Vice President of Operations and Business Development for Plains All American. Plains is predominantly in the oil business as an aggregator, moving product from the wellhead, aggregating it into larger batches, then shipping it down pipelines into refineries.
Latha Ramchand, Ph.D., Dean of the Bauer College of Business at U of H. For the second consecutive year, Entrepreneur Magazine named the undergraduate program in entrepreneurship at the University of Houston the number one program in the U.S.
Marsha Hendler is the President and CEO of TerraFina Energy, an oil and natural gas exploration company based in San Antonio. TerraFina partners with Scully Exploration in the Heart of Texas Field located in Bell, Burnet, Coryell and Lampasas counties. Production estimates for the Heart of Texas Field are between 30 billion to 100 billion cubic feet of natural gas.
Whether it’s called disruptive technology, disruptive innovation or destructive technology, the concept behind the words is the same – innovation that disrupts an existing market and displaces earlier technology. The term disruptive technology was first coined by Harvard Business School professor Clayton Christensen to describe a new technology that unexpectedly displaces an established technology.
“Starting in 2008, we had a new technology that was a game changer, or what we call a ‘destructive technology’ that revolutionized the way we are doing business in the oil and gas industry,” shared Ramchand, “and with that new technology, fracking, supply has gone up at a lower price. Ramchand noted for the technology to last, the demand has to go up for it to be sustainable, prices have to react and consumers have to need more product.
On the demand side of the supply and demand equation, the story is different when comparing oil to natural gas.
“From a supply and demand standpoint,” said Gorman, “the balancing factor is a little easier on the oil side than it is on the natural gas side because we’ve been balancing the system for years with foreign production coming in by imports.”
With the increases in production both in the U.S. and in Canada due to new plays like Eagle Ford in Texas, Bakken in North Dakota and Marcellus in Pennsylvania, the balancing mechanism between supply and demand is imported product. Because of the new plays, the U.S. import figures for oil have been declining for the past couple of years.
As Gorman sees it, the challenge for midstream energy, and even more for the refining industry, is going to be a shift in the types of oil processed. Oil can be sour or sweet, depending on the amount of sulfur; and heavy or light, depending on how thick it is. The product coming from shale production like Eagle Ford is what the industry calls “light oil” along with condensates or wet gas. Investments in the refining sector in the last ten to 15 years have been primarily to refine heavy, sour production. Consequently, there’s a mismatch in what’s coming out of the ground and what has typically been processed in the past. Observed Gorman, “If you take a spreadsheet, it’s very easy to make supply and demand match on a macro basis. The challenge is match up the quality of what’s being produced, with what the refining customer wants to run.” That’s the challenge in supply and demand on the oil side of the business.
According to Marsha Hendler of TerraFina Energy, the issue on the natural gas side is too much production. In 2011, the U.S. produced 62 billion cubic feet of natural gas per day, which was a 25 percent increase over 2006. While production has risen dramatically, consumption has only grown half as fast. “From November to March, demand has fallen five percent due to the warm winter, but production has grown eight percent,” stated Hendler.
According to McGill everyone is not drilling for natural gas, but for condensate, crude oil and natural gas liquids. “In the Panhandle, gas is your lifting mechanism. Producers up there are getting about $10.50 to $11.00 for every million cubic feet – $1.90 is for the gas and everything else comes from the liquid content.” As McGill noted, producers have to do something with the gas because it can’t put it back into the ground, so producers send it off to the market. “The more they go after liquids, the more they keep the price of dry gas suppressed” said McGill. He believes it will be another eight years before things even out on supply, demand and prices.
What Is Midstream?
The oil and gas business is divided into three sectors: upstream, midstream and downstream. In the simplest terms, upstream is the production side of business – the producers that drill wells looking for oil and gas.
Companies in the downstream sector refine the oil into gasoline or they process natural gas. There are two types of gas – dry gas and wet gas. Dry gas is used to heat homes and power energy plants. Wet gas, also called condensates, is a liquid hydrocarbon often used in the production of plastics.
Those in the midstream sector provide the infrastructure to get the producers’ product from the wellhead to the refinery or processor. That infrastructure most often takes the form of pipelines. When there are no pipelines, as in areas with new production like the Eagle Ford shale play in South Texas, other methods of transportation have to be found to provide transport.
Today’s market has a great deal of product coming out of wells because of the new technology, yet the infrastructure to transport the oil and gas is not yet all in place. “As you see the shale plays opening up, like Eagle Ford, in places that don’t have the infrastructure, the wells they are drilling in today’s world are five to seven times bigger than what the old wells used to do with vertical technology,” observed Enbridge’s Terry McGill. “The future is very bright as all this infrastructure needs to be put in to move product.”
How The Midstream System Works
According to Mark Gorman of Plains All American, the entire oil distribution system in the U.S. was designed to take production from the Gulf Coast to feed the inland refining systems. “We took production from the Gulf of Mexico, pushed it north, and took imports of crude to the ports along the Gulf and sent it north for refining,” said Gorman. That system changed starting with Canadian production, while the real game changer was the discovery of the Bakken field in North Dakota.
Production came in waves, first filling the refineries in the northern part of the U.S., then pushing into the mid-continent area, and now incremental production is driving its way south because those refineries are full. What’s left? “It has to push all the way to the Gulf Coast,” stated Gorman.
For the midstream industry there are two challenges on the oil side of the business. First is to take the existing northbound infrastructure and turn it around to flow south – Enbridge is in the process of turning around their pipeline running” between Cushing, Oklahoma, to Houston. The second challenge comes where there’s new production. A feeder system has to be built to take production from the new fields to feed it into the mainline pipelines.
For Plains All American, creating the feeder system is the core of their business. The challenge for the midstream industry as a whole is the majority of the feeder systems are either at, or very close to capacity. For Gorman, the challenge is to optimize those systems. “Now that they are full, the next wave is to build new systems to feed into the trunk line systems that have to flow down to the Gulf Coast.”
Want A Higher Price? Create More Demand.
“If you look at natural gas, there is the opportunity for demand to go up,” stated Ramchand. “We could think about power plants needing more natural gas, we could think about automobiles being powered by natural gas.” Yet, for all of that to happen, industries need incentives. Ramchand can imagine the day when there are gas stations to fill up cars with natural gas, and the production of vehicles powered by natural gas. As Ramchand observed, “For this technology to have the fullest impact, there are parts of the supply chain that are not yet in place. Once that happens, can you imagine what can be done with this new technology? As far as incentives go, the only people who can do that are the regulators. Unfortunately, they are not here today to listen to these folks.”
Ramchand knows those who invest in exciting projects and build something new will enjoy the first mover advantage. “It’s fascinating to me to see how this whole thing is panning out because in the long term we are going benefit from energy independence and benefit from having a cleaner way of doing things and benefit from creating jobs.
“If we build out the pipelines as projected between now and 2035, it’s going to result in more jobs and increasing the GDP, and higher revenues for the state and higher taxes. It’s a duh – why is nobody listening to this?”
As for the midstream industry, Marsha Hendler noted Goldman Sachs has put midstream oil and gas pipeline companies on their “conviction buy” list.
Stated McGill, “The future has never been brighter for midstream.”
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