MIDSTREAM CAPITAL FORMATION
CAPIT
ALFORMATIO
N
2015
CF
F I N A N C I N G T H E B U I L D O U T
June 2015
The REIT AlternativeThe innovative capital market spurred the move to midstream’s popular MLP structure.
Could real estate investment trusts be next?
By David Schulte, CFA
CAPIT
ALFORMATIO
N
2015
CF
Ayear ago, America’s energy
boom was hurtling forward with
a momentum no one ques-
tioned. The wave of unconventional explo-
ration and production was driving oil and
gas companies’ growing appetite for mid-
stream infrastructure. Capacity needed to
expand—and fast. Capital poured into the
midstream sector through varied private
and publicly traded vehicles.
Then came the second half of 2014 and
the first half of 2015.
After four years of growing volumes at
crude oil prices fluctuating around $100
per barrel (bbl), the commodity plunged
to around $50 per bbl by the start of 2015.
Exploration and production companies
retrenched, projects were canceled, capital
expenditures cut and more than 100,000
people were laid off. Some midstream
operators fretted about the solvency of
their upstream partners and future
demand in the midstream sector seemed
less certain.
June 2015 | www.MidstreamBusiness.com | CAPITAL FORMATION
Wyoming’s majestic Wind River Rangeprovides a backdrop for oil and gas activity along the Pinedale Anticline.All photos courtesy of CorEnergy Infrastructure Trust Inc.
CAPITAL FORMATION | www.MidstreamBusiness.com | June 2015
The energy capital markets have reacted
dramatically since the summer of 2014.
The S&P 500 Energy Index of large-cap
and mid-cap companies lost 22% of its
value. The Tortoise MLP Index retreated
18% from its summer peak through the
first quarter of 2015. In place of steady
growth, investment in MLP funds and ex-
change traded funds (ETFs) fluctuated be-
tween inflows and outflows. These public
markets remain volatile, reacting to daily
news on energy supply and demand.
No longer is abundant capital a given in
the energy sector, whether upstream or
midstream. More than ever, cash is a
precious ingredient that E&P companies
need to deploy for optimum return. Re-
ducing operating costs or making costs
more predictable is a priority. As a result,
many energy companies are looking for
transactions to restructure balance sheets
or operations.
Despite the bumpy road in 2014 to
2015, we believe the long-term fundamen-
tals are intact for midstream energy. U.S.
oil and gas production continues to grow,
and infrastructure needs in the coming
years will be immense.
So what do the challenging times today
mean for capital formation? Let’s look first
at the nature of midstream assets, then the
evolution of capital markets for midstream
investment and finally at recent develop-
ments and what lies ahead.
Midstream characteristicsMidstream energy assets are a type of in-
frastructure—physical components of the
interrelated systems that are essential to
gathering, processing, transporting and
storing society’s supply of energy. These
midstream assets and the associated serv-
ices perform critical functions for energy
producers on the upstream side and energy
distribution channels downstream.
From a capital market perspective,
the midstream sector has four basic char-
acteristics:
� Long-lived physical infrastructure es-
sential to customers’ ability to get en-
ergy to market;
� Recurring revenues based on toll-road
or utility-like models and long-term
contracts;
� Demand tied mostly to volumes and
less sensitive to commodity price
swings; and
� High barriers to competitive entry,
such as fixed costs and proximity to
customers.
Based on recurring revenues and pre-
dictable operating costs, investment in as-
sets like pipelines and storage facilities
offers potentially attractive, risk-adjusted
total returns. At CorEnergy, we target total
returns from energy infrastructure of 8%
to 10% per year.
The midstream sector appeals to in-
vestors seeking cash income as a large com-
ponent of total return, although energy
infrastructure does offer growth potential
over time.
Capital markets developmentIn the two decades I have worked with en-
ergy infrastructure, the capital market
mechanisms and structures for investing in
midstream assets have evolved. The mar-
kets always innovate in response to needs
for capital formation, and innovative fi-
nancial structures have emerged—and will
continue to come along—in midstream
energy. These vehicles deliver greater effi-
ciency in capital deployment, as well as
suitability for the varied needs of the
world’s investors.
I have been a witness to these changes,
first helping fund energy startups as a pri-
vate equity manager, then developing MLP
portfolios as a co-founder of Tortoise Cap-
ital Advisors, and recently helping our
team create CorEnergy Infrastructure
Trust, the first publicly traded Real Estate
Investment Trust (REIT) focusing on en-
ergy infrastructure.
Midstream assets began as systems
within integrated oil and gas companies.
But starting in the 1980s, private equity
firms emerged to focus on capital forma-
tion specifically for support systems in the
40
50
60
70
80
90
100
110
120
130
Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15
Tortoise MLP Index S&P 500 Energy Index WTI Crude Price
CCRRUUDDEE PPRRIICCEE VVSS.. EENNEERRGGYY SSTTOOCCKKSS
Source: CorEnergy Infrastructure Trust Inc.
June 2015 | www.MidstreamBusiness.com | CAPITAL FORMATION
energy sector. For investors, funding mid-
stream infrastructure through private
equity funds meant buying into private eq-
uity rounds—illiquid investments in un-
traded vehicles, often with 10-year terms,
which also could be undiversified from a
portfolio viewpoint.
Then we began to see MLPs in the 1990s,
and these publicly traded partnerships have
been major enablers for the buildout of en-
ergy infrastructure. For investors, MLPs
added liquidity and diversification via a
broader portfolios of assets. Today, more
than 120 U.S. energy MLPs have a total eq-
uity value of more than $500 billion. Still,
some investors avoid MLPs—largely over
tax suitability issues.
Another innovation came a decade ago.
Tortoise Capital Advisors LLC and others
began creating closed-end funds to invest in
MLPs, offering still more liquidity and di-
versification. Today, about 40 closed-end
and open-end funds offer investors portfo-
lios of energy MLPs.
The REIT structureOnce again, need is spawning capital mar-
kets innovation. The tax-advantaged struc-
ture of a REIT holding energy infrastructure
assets. In 2007, the Hunt family obtained a
private letter ruling from the Internal Rev-
enue Service (IRS) confirming that a util-
ity’s transmission and distribution assets
could constitute real estate assets. In 2010,
the Hunt interests formed InfraREIT as a
privately held REIT, and the Texas company
went public through an IPO in late January.
In 2011, Tortoise collaborated with Rick
Green, former chairman of Aquila Inc., to
develop a publicly listed REIT as a vehicle
for institutions and retail investors to di-
rectly access energy infrastructure. The re-
sult was CorEnergy Infrastructure Trust
Inc., an NYSE-listed company. Green is now
executive chairman of CorEnergy.
Since then, CorEnergy has built a grow-
ing portfolio of midstream and downstream
energy infrastructure, funding a liquids
gathering system in Wyoming; an interstate
natural gas pipeline in Missouri and Illinois;
a rail, truck and marine terminal in Oregon;
a natural gas distribution system in Mis-
souri; and salt water disposal wells in
Wyoming and North Dakota.
Investors are intrigued by the REIT struc-
ture. It offers the yield characteristics of mid-
stream energy assets, a risk profile based on
stable fixed-fee leases and mortgages and
growth prospects—plus a simple tax regimen
involving ordinary income shown on an IRS
Form 1099. The tax-advantaged structure is
a good match for infrastructure investors
seeking current income as a large component
of total return, because U.S. regulations ex-
empt REITs from income taxes at the corpo-
rate level as long as they distribute at least
90% of their income to investors.
Innovation in capital formationEach new step in the evolution of capital
structures also offers distinct characteris-
tics for midstream operators, whether
integrated oil and gas companies, explo-
ration and production independents
with assets in gathering and storage or
midstream businesses such as pipelines
and terminals.
Especially in today’s volatile environ-
ment, going to the equity or debt markets
may not be the most desirable option
for some energy companies. Many opera-
tors are looking at strategic transactions
for opportunities to monetize midstream
assets and redeploy capital to higher-return
E&P activities, growth capital for acquisi-
tions or expansion or even exit funding.
In considering a transaction to benefit
the balance sheet or profit and loss, a com-
pany might examine several key character-
istics of prospective partners for funding or
operating midstream assets:
� Experienced partners—Management
teams that have operations experience,
including engineering and regulatory
expertise, in addition to financial or
deal-making skills.
� Long-term commitment—Contracted
agreements such as long-term triple-
net leases to ensure permanent solu-
tions for operational needs—and
predictable costs.
� Operational control—A priority for
some upstream and midstream com-
panies seeking funding while continu-
ing to run midstream operations
critical to their core business.
� Competitive cost of capital—Optimiz-
ing capital costs by working with a tax-
advantaged corporate entity and
structuring a deal blending equity, debt
and terminal value.
One thing is certain: Capital markets will
continue to innovate and in the next 20
years, the midstream sector will see new op-
portunities and options emerging for capi-
tal formation. �
David Schulte CFA, is president and CEO
of CorEnergy Infrastructure Trust Inc.
This tank battery forms part of CorEnergy’s mid-stream assets in Wyoming’s Pinedale Anticline.
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