30 August 2019
Where is the Permian water midstream sector heading?
Several factors will impact the financial outlook for the water midstream sector
Thriving unconventionals activity in the Permian Basin is fueling a rapid growth in produced water volumes, attracting larger investors to stake claims in the developing water midstream sector. At the same time, traditional water management approaches, such as disposal, are coming under industry scrutiny, signaling that key changes may be in order.
The sector was once driven by small financial backers and producers’ dedicated water management divisions, but the recent interest of the private equity market has led valuations for water midstream companies to be higher than some exploration and production (E&P) companies. Several speakers at the Produced Water Society Permian Basin 2019 conference predicted that these valuations would eventually come down in the coming months and years.
Regulatory procedures are making saltwater disposal well (SWD) drilling permits more onerous, partly spurred by induced seismicity and environmental concerns. Further exacerbating disposal challenges, SWD injection capacities are often based on ideal scenarios and are therefore exaggerated, which could lead SWD operators to overestimate expected revenues by hundreds of thousands of dollars.
Zachary Sadow, CFO of Antelope Water Management, presented a scenario in which one SWD was injecting at a rate under 50% of the one permitted. If disposal wells “pressure up and don’t perform as advertised, then ultimately, an E&P company can be on the hook to manage excess volumes at the early stages of a well coming online, which can actually lead to higher costs,” Sadow said. “In a lot of ways, the technical challenges are going to dictate the market challenges for the water midstream space.”
Water management alternatives such as in-field recycling and beneficial reuse could help the industry move away from growing problems in pipe and dispose systems. Several operators at the conference, including ConocoPhillips, discussed their recycling programs, suggesting that it is becoming more appealing.
As the industry begins to acknowledge that reliance on disposal is less stable operationally than originally thought, equity valuations for SWDs and related midstream infrastructure will come down and eventually converge with lower credit market valuations. Sadow predicts that companies will need to restructure distressed water assets as lower valuations impact their debt.
In his keynote address, Gabe Collins, fellow at Rice University’s Baker Institute, predicted that at least two large restructures would occur over the next 12 months. “There’ve been entrants into the space that have come in at massively high prices. I don’t think, especially if we’re in a $45-50 WTI world, that these are necessarily going to be sustainable,” Collins said.
B3 Insight president Kelly Bennett told attendees that smaller E&P companies in the Permian Basin will also come under pressure to consolidate, creating opportunities to divest disposal assets. That trend will also likely bring down water midstream valuations, particularly in the Midland Basin where a large share of disposal capacity is operated by producers.
For some producers, it might be rational to turn water assets over to third-party midstream companies. For others, it may make more sense to keep water management in-house, especially if nearby SWDs are already at capacity or if those assets could be used to plug holes in future balance sheets.