From Bloomberg

To get a toehold in the prolific Permian Basin, private equity is increasingly betting on a relatively
obscure, and potentially risky, part of the pipeline industry.

Operations in the Permian that gather oil and gas, and process fuel into propane and other liquids, have drawn almost $14 billion in investment since the start of 2017, with $9.2 billion of that coming from private companies, according to Matthew Phillips, an analyst at Guggenheim Securities LLC. On Sept. 5, Blackstone Group LP’s EagleClaw Midstream said it was paying $950 million for Caprock Midstream Holdings, a closely held company with gathering and processing assets in the Permian. And in July, Crestwood Equity Partners LP said its venture with First Reserve Corp. had opened a processing plant in Orla, Texas, and is working on a gathering Line.

Steel goes into the ground for big pipelines that move oil and gas across states only after producers commit to pay for space over a period of years. But investors in gathering pipes and processing plants are forced to lean on long-term projections, since their projects depend on continuous output over time from the same area. “Any time there’s massive supply growth, there is some risk-seeking behavior,” said Jeff Jorgensen, portfolio manager and director of research at Brookfield Asset Management Inc.’s Public Securities Group. There’s a tendency by some to “invest in production profiles that are, let’s just say, hilariously aggressive in their assumptions” for the future, he said. It’s easy to see where that aggressiveness is coming from.

Researcher IHS Markit predicts output in the Permian Basin will double by 2023 to reach 5.4 million barrels a day. That’s more than every OPEC country except Saudi Arabia. By 2035, it could hit 6.3 million barrels, according to Wood Mackenzie. Unlike in other basins where gathering and processing deals are characterized by price-to-earnings multiples in the low teens, the Permian is seeing ratios average around 18 times, according to Kathleen Connelly, an analyst at Fitch Ratings.

But bullish projections don’t always pan out across every acre in the Permian, leaving the pipes and processing plants that had counted on those volumes for revenue high and dry. “What works in Excel doesn’t necessarily work in reallife,” Jorgensen said.

Bigger companies like Plains All American Pipeline LP and EnLink Midstream Partners LP are probably more shielded from those risks, Connelly said, because they have a variety of projects that can insulate them from hard times in their gathering and processing business. But with the surge of private
equity money giving way to smaller players that may be taking on added debt to pay for pricey projects, the risk increases dramatically. “There’s definitely some sloppiness in the gathering and processing space,” she said. “The cash flow isn’t going to be what they expected, so we could see some of the smaller players financially weaken, and that may lead to consolidation.”

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