We Just Disagree, Part 2 - Perceived Value at Heart of Dispute Over Questar Pipeline Sale

The recently announced acquisition of Questar Pipeline LLC by Southwest Gas has stirred up a hornet’s nest. Southwest sees it as a milestone moment that will allow it an increased role in the energy transition, but activist investor Carl Icahn sees it as a serious blunder that would make all previous management missteps pale in comparison. As Dave Mason sang in “We Just Disagree,” a dispute over value is at the heart of the matter, one which has led to a proxy fight, a tender offer for Southwest Gas, and a lot of harsh words. In today’s RBN blog, we take a closer look at Questar’s natural gas pipelines and other assets, the roles they play in relation to the Rockies’ other pipelines, and how it all factors into Questar’s perceived value.

As we noted recently in We Just Disagree, Part 1, the planned acquisition of Questar Pipeline LLC by Southwest Gas has brought with it a lot of conflict. The story began with Dominion Energy’s decision to sell a broad set of its gas transmission and storage assets to Warren Buffett’s Berkshire Hathaway Energy for $9.7 billion in July 2020, but it turned more complicated when Dominion and Berkshire decided to terminate the Questar part of the sale in July 2021 over lingering concerns it would be held up by the Federal Trade Commission.

That put Questar back on the market, and Southwest Gas quickly moved in, announcing a deal for Questar on October 5. The price tag — $1.975 billion, which included the assumption of $430 million in debt — brought with it a lot of attention, and questions. For starters, it’s significantly more than the $1.3 billion that Berkshire had committed to pay for the same assets a year earlier. But the price tag did more than just raise a few skeptics’ eyebrows — it got Icahn involved as well. On October 4, as reports of the planned Southwest Gas-Dominion deal for Questar came to light, Icahn revealed that he held a 4.9% stake in Southwest and would fight to block the transaction. The price tag was one of the primary objections he raised in a letter to investors.

Southwest Gas responded to Icahn’s letter October 11 by announcing what it called a stockholder rights plan, what amounts to a “poison pill”, which would make it more difficult for Icahn or others to acquire a larger stake in the company. If the rights become exercisable, rights holders would be entitled to acquire shares at a 50% discount to the market price at that time, or Southwest could elect to exchange each right for one share of common stock. In a follow-up letter posted October 14, Icahn decried the stockholder plan, announced his intention to launch a proxy contest to replace the entire Southwest board, and put forth a tender offer for all company shares at $75/share.

In a subsequent letter issued October 20, Icahn called for Southwest Gas to sell its Centuri construction unit and repeated calls to cancel the Questar deal. “If SWX really wanted to improve its balance sheet, it would cancel this absurd acquisition, sell Centuri, and use a portion of the proceeds to improve the balance sheet, allocating some portion of the proceeds towards the funding of future growth.”

Questar’s value remains central to Icahn’s objections. To understand the debate over the sale and Icahn’s fight with Southwest Gas, let’s start with a look at Questar Pipeline LLC and the Rockies production areas that its pipelines and other assets serve.

Rockies Production and Questar

There are five major natural gas producing basins in the Rockies area (shaded areas in Figure 1). Questar Pipeline LLC’s namesake asset, Questar Pipeline (green lines), primarily serves areas where production has been declining in recent years. A large portion of Questar Pipeline is located within the Greater Green River Basin (purple-shaded area), which is mostly in Wyoming but also includes parts of Colorado and Utah. Depending on where you stand on the Questar deal, the basin’s production rates are either good news or bad news. On one hand, Green River is the second-highest gas-producing basin in the region, at about 2.3 Bcf/d, second only to the Denver-Julesburg (DJ) Basin. On the other hand, Green River production has been steadily declining for years, and the rig count dropped like a rock in late 2019 and early 2020, for a time down to zero. Production in the basin was steady at about 3.5 Bcf/d for 2013-19 before beginning its recent decline.

Questar Pipeline, Key Producing Basins

Figure 1. Questar Pipeline, Key Producing Basins. Source: RBN

It’s a similar story for the Piceance Basin in Colorado (yellow-shaded area in Figure 1), where production reached as high as 2 Bcf/d in 2013 but has fallen to about 1.2 Bcf/d in recent months. Most of the rest of Questar Pipeline covers the Uinta Basin in Utah, which has huge reserves of waxy crude (see our Do Ya’ Think I’m Waxy? series) but has seen gas production decline of late, just like in the Green River and Piceance basins. Uinta gas production topped 1.3 Bcf/d in 2013 but has since dropped to about 600 MMcf/d. For the three basins as a group, production has fallen from about 6.8 Bcf/d in 2013 to about 4.1 Bcf/d this year, a decline of roughly 40%.

The situation is somewhat different for the two other main basins in the region: the DJ (blue-shaded area in Figure 1) and the Powder River (green-shaded area), neither of which has direct connections to the Questar Pipeline, although Questar would still likely play a role in moving that gas. Production in the DJ Basin was below 1 Bcf/d in 2013, but has climbed steadily since, reaching 2 Bcf/d by 2018 and approaching 3 Bcf/d in 2021.

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Powder River Basin production averaged about 800 MMcf/d in 2013, slipped to just under 500 MMcf/d by 2017, but then rebounded to about 550 MMcf/d by 2021. That puts combined production for the DJ and Powder River basins at around 3.5 Bcf/d in 2021, nearly double the 1.8 Bcf/d the basins were producing in 2013.

One reason for the better performance of the DJ and Powder is that over the past few years drilling activity the two basins has been primarily crude oil directed.  So most of the gas production growth has been associated gas that comes along with crude oil production.  RBN production forecasts show continued production increases in these basins.  On the other hand,  total production out of the the Greater Green River, Uinta and Piceance, which are primarily gas basins, is forecast to decline. But it’s important to note that those forecasts do not fully reflect the recent run-up in gas prices, as we recently described in High Voltage.The Henry Hub price, which was around $2/MMBtu a little more than a year ago, closed at $6.202/MMBtu on Wednesday. If gas prices stay elevated, it’s possible that production could turn around and begin to increase again in the gas-focused basins, particularly the Green River.

Pipelines in the Rockies

As noted above, Questar Pipeline (green lines in Figure 2) serves several producing basins in the Rockies. It moves that gas to other major pipeline systems for delivery to markets in the West and Midwest, including Dominion local distribution systems that serve gas-utility customers in Utah, southwestern Wyoming, and southern Idaho.

Key Regional Pipelines

Figure 2. Key Regional Pipelines. Source: RBN

Through the Overthrust Pipeline (yellow line in Figure 2), a sister pipeline, Questar connects with the Ruby, Rockies Express (REX), Kern River, and Wyoming Interstate Company pipelines. The nearby Colorado Interstate Pipeline does not connect with Overthrust, but it does link up with the larger Questar system. Northwest Pipeline ties into the Questar system at the Clay Basin storage facility in Daggett County, UT. With working storage capacity of 54 Bcf, Clay Basin is the largest underground storage system in the Rockies. Let’s take a closer look at the region’s major pipelines, the areas they serve, and the connections they make:

  • Kinder Morgan’s Colorado Interstate Gas Pipeline (brown line) stretches from Texas, Kansas, and Oklahoma in the south, through Colorado, then all the way up to the Wyoming-Montana state line. It transports gas from the Rockies and the Anadarko Basin to customers in Colorado and Wyoming, and indirectly to areas outside the Rockies. It connects with the White River Natural Gas Hub (lime-green circle), which is operated and 50%-owned by Questar Pipeline LLC.
  • Kern River Pipeline (light-purple line), owned by Berkshire Hathaway Energy, takes Rockies gas through Utah and Nevada to Southern California, terminating near Bakersfield. As noted above, antitrust concerns kept Buffett’s company from buying Questar Pipeline LLC as part of a larger sale announced in 2020.
  • Northwest Pipeline (NWPL; orange line) connects with the Questar system at the Clay Basin storage facility (red tank icon). NWPL begins in southern Colorado and runs through Utah, Wyoming, and Idaho before serving its main customer base in Washington and Oregon. It connects with the White River hub and the Opal pricing hub.
  • Rockies Express (REX; light-blue line) was built in the middle-to-late 2000s to serve the Rockies’ rapidly growing natural gas production. Since its first eastbound-only segments started moving natural gas out of the Rockies in 2008, flows on the pipeline have evolved due to market events, primarily the onset of the Shale Revolution, which has resulted in a surge of gas supplies in the Eastern U.S. and increasing gas-on-gas competition across North America. As noted in Express Yourself, REX has undergone a number of transformations to adapt to the shifting gas flow patterns and price relationships, including reversing flows on the eastern zone of the pipe to move gas west from Ohio. On the western end of the pipeline, some gas volumes still move east from the Cheyenne Hub in Wyoming, but there are also increasing volumes moving west from there. REX has a lease with Questar Pipeline LLC’s Overthrust Pipeline to move gas east from the Opal pricing hub in Lincoln County, WY, to the Wamsutter hub in Sweetwater County, WY. But in the past couple of years, REX also took out firm westbound capacity on two Overthrust expansions. (More on REX’s Overthrust lease and firm capacity below.)
  • Kinder Morgan’s Ruby Pipeline (dark-blue line) receives Rockies supply directly from production and processing interconnects, as well as from a couple of other pipeline systems — including Overthrust — that are also connected to eastbound capacity on REX. Ruby supplies gas to customers in California, Nevada, and the Pacific Northwest. The pipeline was also planned as a conduit for gas to the proposed Jordan Cove LNG project in Oregon, which is officially on pause after it failed to receive state and local permits. Jordan Cove is unlikely to be revived. (For more on Pacific Coast LNG projects, see Go West, Part 1, and Part 2.)
  • Kinder Morgan’s Wyoming Interstate Pipeline (dark-purple line) extends from eastern Wyoming to northern Colorado and has takeaway capacity from the Piceance, Green River, Powder River, and Uinta basins. It connects with the Cheyenne Natural Gas Hub.

Overthrust’s Importance

Questar Pipeline is sometimes referred to as “the hub of the Rockies,” and its Overthrust Pipeline is an important spoke. Aside from its connections to several pipeline systems that run through the region, Overthrust also leases 625 MMcf/d of west-to-east pipeline capacity (out of 2.568 Bcf/d) to REX. The status of that lease, as well as recent pipeline flows on the leased segment, reveals a lot about what’s happening in the Rockies and why questions about the price Southwest Gas has agreed to pay for Questar may lead back, at least in part, to Overthrust.

REX signed its west-to-east lease with Overthrust in 2006; it came into effect in 2008 and is set to expire January 1, 2028. The leased section (green line in Figure 3) stretches from the Opal hub eastward to the Wamsutter hub, a distance of about 140 miles. The leased capacity (again, 625 MMcf/d) is operated as part of the REX system.

Overthrust Pipeline and Rockies Express Zone 1

Figure 3. Overthrust Pipeline and Rockies Express Zone 1. Source: RBN

The lease allows REX to serve 10 receipt points along Overthrust east of Opal. Of those 10 areas, only two were reliant on the leased capacity — both in the area around Opal and served production from Ultra Resources, which has a difficult history with REX. The first agreement between Ultra and REX began in 2009 and when the economics of moving gas from west to east dried up, that helped drive Ultra into bankrtupcy in 2016. When it emerged from bankruptcy in 2017, it was with a new agreement with REX that started in 2019 and was to run through 2026. Ultra filed for Chapter 11 bankruptcy protection again in May 2020 and won court approval to reject its contract with REX, which appealed that decision. REX then suspended gas service to Ultra in February 2021, saying the Wyoming producer had defaulted on its obligations.

Since REX has no meaningful commitments to maintain the west-to-east capacity from Opal, whether REX decides to seek an extension of its lease beyond 2027 is an open question.

REX has set up subsequent agreements with Overthrust for 250 MMcf/d for moving gas volumes from Wamsutter to Opal, or east to west, and then on to Kern River, which allows for flows to reach California. The capacity is split between two Overthrust expansions, 120 MMcf/d on the Wamsutter West expansion that went into effect November 2020 and 130 MMcf/d on the Point of Rocks West expansion another that is due to begin service December 1, 2021. These agreements expire March 31, 2024. As of earlier this year, REX’s contracted volumes accounted for about 10% of Overthrust capacity.

Overthrust has grown slightly less reliant on REX over the last several years as its firm contract mix has become increasingly diverse. In 2013, REX accounted for 27% of that mix (out of about 1.68 Bcf/d  at the time), and was one of six shippers. By 2021, REX made up 24% of its firm contract mix (of about 2.57 Bcf/d) and was one of 21 shippers with firm commitments, with many smaller shippers added to the stew. But while Overthrust has come to rely a little bit less on REX for filling its pipeline space, the same can’t be said for its financial importance. Overthrust revenues totaled $63 million in 2020. Of that, $29 million, or about 46%, came from the REX lease thanks to its higher shipping rates from that legacy lease. That’s a figure that can’t be overlooked, especially when the lease’s long-term future is up for debate, but Overthrust’s role as a high-value conduit for regional producers is a feather in its cap as well. If the west-to-east REX lease ends in a little more than six years, it’s possible that Overthrust could make up some or all of that revenue by seeking a FERC sanctioned rate increase for remaining shippers on the pipeline.

The changes in eastbound flows on the REX lease, and the long-term status of the lease itself, add more questions about the overall value of the Questar system — that is, is Overthrust as important and valuable as some apparently think? In Part 3 of this series, we’ll discuss the challenges that Questar Pipeline LLC will face in maintaining its long-term relationship with its local distribution company, also referred to as DEUWI (rhymes with Huey, as it Huey Lewis), if the sale to Southwest Gas is completed.

"We Just Disagree" was written by Jim Krueger and appears as the second song on Dave Mason's seventh studio album, Let It Flow. Released as a single in August 1977, the song went to #12 on the Billboard Hot 100 Singles chart. The tune featured its author and Dave Mason band member Jim Krueger on 12-string guitar, and high harmonies. "We Just Disagree" was covered by country music singer Billy Dean in 1993. His version went to #9 on the Billboard Hot Country Songs Singles chart. Personnel on the Dave Mason record were: Dave Mason (lead vocals, guitar), Jim Krueger (12-string guitar, backing vocals), Gerald Johnson (bass), Mike Finnigan (keyboards, backing vocals), Rick Jaeger (drums), Bobbye Hall (percussion), Ernie Watts (sax), and Karen Patterson, Verna Richardson, Stephen Stills (backing vocals). 

Let It Flow was released in April 1977 and went to #37 on the Billboard 200 Albums chart. Produced by Dave Mason and Ron Nevison, the album would become Mason's biggest seller while on Columbia Records. Three singles were released from the LP.

Dave Mason is an English singer, songwriter, and musician. He was a founding member of the rock band Traffic, with whom he was inducted into the Rock and Roll Hall of Fame in 2004. Mason has played on records by Jimi Hendrix, Eric Clapton, The Rolling Stones, Delaney & Bonnie, and David Crosby. As a member of Traffic, he appeared on three studio albums. As a solo artist, he has released 15 studio albums, seven live albums, 12 compilation albums, and 13 singles. He continues to record and perform.