Show Me the Money! - Midstream Pay-to-Play in the Permian's Delaware Basin

First came the “aha moment,” the realization that the Permian’s unusually complex geology — with multiple layers packed with hydrocarbons — is a solvable puzzle, and that the financial rewards for exploration and production companies could be very attractive. Then came the highly competitive scramble to acquire acreage in the most promising parts of the Permian’s Delaware and Midland basins. Now, with many producer’s acreage largely de-risked, competition to provide needed gathering systems and processing plants is white-hot, with some midstreamers in the prolific Delaware offering to write big checks to producers up front for commitments to infrastructure that in some cases is still on the drawing boards. These pay-to-play deals are ricocheting through the Permian business development community — at least in the Delaware. Today, we discuss recent developments in producer/midstreamer relations in the nation’s most active hydrocarbon play.

Drilling activity and production in the Permian continue to ratchet up, and so is the competition to develop the infrastructure that will be needed to gather and process ever-increasing volumes of crude and associated gas in the region’s busiest neighborhood: the Delaware Basin in southeastern New Mexico and West Texas. Some of the biggest producers have opted to develop the gathering systems and processing plants themselves, figuring that 1) they have the wherewithal to do it, and 2) managing the build-out of these critically needed assets is the best way to ensure things get done right and on time. But the do-it-yourself approach is too much of a resource drain for most mid-size and smaller producers. Frequently these producers have turned to midstream companies (often a MLP — master limited partnership), where the midstreamer agrees to develop the gathering and processing capacity the producer expects to need and the producer agrees to pay the midstreamer a fee: X dollars per month for Y number of years for no less than a specified volume throughput. Under such a “Minimum Volume Commitment” (MVC) agreement (a.k.a., a “take-or-pay” deal), the producer gets the infrastructure it requires and the midstream company is protected (by those monthly payments) even if the producer’s big drilling-and-production plans don’t pan out.

In any fast-growing and highly competitive market — the midstream sector in the Delaware Basin being a prime example — some aggressive companies hoping to gain a foothold (and make lots of money) get very creative. The traditional take-or-pay approach we just discussed can leave a good bit of the risk with the producer, who after all has committed to make monthly payments to its midstream partner even if the producer’s drilling and production plans go awry. So, to get a producer’s attention — and hopefully its business — a small-but-eager midstreamer might suggest to the producer, “If you share detailed information about the geology of your acreage with us and dedicate that acreage to us, we would develop the gathering and processing capacity required as you need it without you, Mr. Producer, having to make any take-or-pay commitment.” In other words, the eager-beaver midstreamer is willing to assume more risk (that is, develop infrastructure without a take-or-pay commitment) in order to get the producer’s acreage and (presumably) its hydrocarbon flows. Over the past couple of years in the Permian, these “Acreage Dedication” deals have become more the rule than the exception.

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