Monetising the midstream: some regulatory and commercial considerations

James Plumb.

James Plumb.

IC Ltd’s announcement of a $1.78 billion deal to buy the Iona underground gas facility from EnergyAustralia has sharpened the focus of the Australian oil and gas industry as to the value associated with the sector’s ‘midstream’ infrastructure.

The midstream sector
The midstream sector of the petroleum industry generally involves gathering, processing and transporting oil and gas to downstream distributors or end users. Midstream infrastructure includes pipeline gathering systems, water and gas processing plants, storage facilities and reservoirs, major transmission pipelines and compressor stations and LNG export terminals.

In Australia, it has been common for oil and gas companies to build and operate their own onshore midstream infrastructure, effectively ensuring that their product has a pathway to market. This is in stark contrast to a marketplace like the USA, which has a more clearly delineated divide between its upstream and midstream sectors. Because of the large number of companies operating and competing in the USA midstream sector, upstream exploration and production (E&P) entities in that country are able to concentrate their resources exclusively on finding and extracting petroleum.

Facing low oil prices and balance sheet pressure, many Australian oil and gas companies will be analysing the possibility of selling their midstream assets to specialist infrastructure companies or other local and international investors.

The opportunity
With global interest rates at historically low levels, and capital markets demonstrating high volatility, local and international investors are looking further afield seeking opportunities that offer both reasonable growth and long-term stability.

As noted by Angela MacDonald-Smith in the Australian Financial Review, Australian midstream assets such as the Iona storage facility are attractive to investors like QIC because of their long term, highly contracted nature, with stable and predictable cash flows (the tariffs associated with midstream assets are usually tied to the cost of capital investment, rather than the volatility of actual commodity pricing).

Sales of assets in the Australian midstream sector to date have been largely limited to major stand-alone assets, such as the Queensland Curtis LNG (QCLNG)pipeline which was sold to the APA Group in December 2014. Many commentators are now speculating as to the long-term value associated with other Australian midstream asset types, such as gathering and processing facilities.

However, packaging and selling these types of assets, which are integrated more closely with upstream operations, presents a unique challenge.

The regulatory perspective
Australian companies dreaming of unlocking untold riches in their midstream portfolios will undoubtedly be contemplating the vast number of factors associated with the disposal of any key asset. From a commercial perspective, there will be joint venture approval considerations, the need for secure and long term tolling arrangements, competition and third party access considerations, as well as an overarching need to ensure that future upstream field development is not compromised in any way.

Underpinning many of these issues is the question of exactly how to navigate different regulatory hurdles associated with isolating and selling assets that have, until now, been treated hand-in-hand with upstream production.

Isolated assets
Infrastructure such as major transmission pipelines (like the QCLNG pipeline), storage facilities (like the Iona facility) and LNG export facilities are often held in separate corporate ownership structures, stand-alone entities that have the benefit of all necessary permits, licences, consents and other agreements necessary to own and operate the asset.

Accordingly, structuring a sale of these types of assets will be (at least from a regulatory perspective) a relatively straightforward and well-understood process.

Integrated assets
In contrast, other types of midstream assets that have been tagged for sale by market commentators are not as easily separated from the core upstream function of oil and gas production, at least from a regulatory perspective. For example, gathering networks and processing facilities have historically been constructed pursuant to the same approvals and consents as the production wells themselves.

As a result, the process of sufficiently isolating these midstream assets for the purpose of sale, while preserving the upstream company’s ability to continue to produce and develop its oil and gas fields, will be more challenging and complex.

This should not, however, dissuade the owners of such facilities from exploring the possibilities.

The Queensland example
In Queensland, the holders of a petroleum lease (PL) are afforded the express right to build and operate gathering networks, storage facilities and petroleum and water processing infrastructure within the area of the PL, in addition to the fundamental right to produce petroleum.

For that reason, oil and gas field development in Queensland has historically been undertaken within a single permit regime, with all associated approvals and agreements (such as the necessary environmental authorities, native title agreements and landholder conduct and compensation agreements) held and entered into in contemplation of, or in conjunction with, the applicable PL.

In order to sell a midstream asset that is currently owned and operated pursuant to a PL, it will be necessary for the parties to identify and implement an alternative licensing arrangement for the asset.

One possibility is for the parties to enter into a registrable sublease of the PL, but this may not afford a buyer the long term independence and security necessary to support substantial investment.

A more suitable alternative may be to apply for a new petroleum facility licence (PFL). PFLs are legal rights granted by the Queensland Government (similar to PLs) under the petroleum and gas legislative regime allowing the holder to build, own and operate a facility for the distillation, processing, refining, storage or transportation of petroleum.

PFLs are commonly granted for facilities such as refineries, and can be granted for a term of up to 30 years.

A PFL that is granted over an asset that has historically been the subject of a PL will not be subject to, or otherwise linked to, the PL in any way, but there are a number of additional steps to be completed before the asset can be effectively separated from the other upstream operations.

For example, an applicant for a PFL will need to apply for an appropriate environmental authority, and will also need to separately negotiate for access to the land supporting the facility (whether, for example, by purchasing or leasing the land on which a processing facility has been built, or negotiating for the grant of easements underpinning a pipeline gathering network). The applicant may also need to negotiate for native title agreements if native title has not been extinguished over the relevant land, and may need to develop and seek approval for a new cultural heritage management plan. Depending upon the nature of the asset, a major hazard facility permit may also be required.

Having regard to these complexities, potential acquirers with little familiarity of the Queensland legislative regime may be reluctant to take on the associated regulatory considerations as part of any purchase. Companies considering such a divestment could opt to de-risk and maximise the desirability of the asset by applying for a separate PFL in advance of any sale process.

Other factors to consider
The grant of a PFL will not result in a reduction of the area of the original PL, and the tenure will overlap. As part of the PFL application process, the applicant will be required to identify the possible impacts of PFL activities on the overlapped PL.

Perhaps as part of a long term tolling arrangement that will underpin the sale, the seller may need to consider implementing a regime as to how future overlapping activities are to be coordinated, both to ensure the continued safe development of the upstream field and the midstream asset, but also to contemplate such commercial issues as priority rights to any future development of additional midstream capacity.

Conclusion
The Australian oil and gas industry has now matured to a point at which contemplation of a disaggregated midstream sector is feasible. Divestments would allow oil and gas companies to liberate capital and focus on their core competencies and expertise. While there are hurdles to overcome in de-coupling vertically integrated operations, balance sheet and commodity pricing pressures may now encourage the industry to take another look.

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