Why CONSOL Energy wants to sell its midstream business

Market Realist

Must-know: Highlights from CONSOL Energy's analyst day (Part 3 of 8)

(Continued from Part 2)

CONSOL’s Midstream Asset Overview

CONSOL Energy (CNX), in addition to its traditional gas drilling and production, owns a midstream business that moves gas from the wellhead to interstate pipelines or other local sales points. By the end of 2013, CNX owned or operated approximately 4,600 miles of gas gathering pipelines, 250,000 horsepower of compression for transporting gas, and a number of gas processing facilities. Altogether, the company has a capacity to deliver 300 billion cubic feet (or bcf) of natural gas per year.

Joint venture with Noble Energy

CONSOL Energy has a joint venture with Noble Energy Inc., in a midstream company named CONE Gathering LLC. CONE operates and owns the Marcellus Shale gathering system of both the companies at the Appalachian Basin.

The transaction

On June 12, 2014, CNX announced that it would join with its partner Noble Energy Inc. (NBL) to form a master limited partnership (or MLP), that would take over the activity of providing the midstream operations of both the companies. The new MLP is expected to hold an initial public offering (or IPO) late in 2014—subject to certain conditions. CONSOL and Noble will control the new MLP’s general partner, which will own the incentive distribution rights and the majority of common units of the company. CONSOL and Noble Energy are in the process of drafting a registration statement on Form S-1 to be submitted to the U.S. Securities and Exchange Commission ( or SEC) for an initial public offering of the MLP. The offering is expected to be completed late by 4Q13, or earlier.

Why the MLP structure

The new MLP formation would free up CNX from operating a transportation business and let it concentrate more on taking advantage of high Marcellus production activities. MLPs enjoy some inherent tax advantages because MLPs don’t pay corporate taxes. As a result, they generally trade at higher valuations. Since CNX would hold the general partner and incentive distribution rights, it would be taking a disproportionate amount of the incremental cash flow growth.

How does CNX benefit?

In the Marcellus Shale, the company expected very high rate of production growth. Therefore, a strong midstream business partner would be necessary. CNX believes that spinning-off the transportation segment would unlock more values even when retaining the strategic control. In the conference call of 1Q14 earnings, Nicholas J. DeIuliis, the chief executive officer (or CEO) of CNX, commented, “Our midstream assets currently consist of our stable but lower-growth legacy pipes and processing facilities and the Virginia CBM fields and, also, our high-growth pipes and processing facilities in the Marcellus JV. Now the different expected future growth levels for these two midstream assets, they create different opportunities for value creation. So for example, with the Marcellus midstream, we own and operate within our JV. We see tremendous growth. We saw 100%—nearly 100% year-on-year growth in production for first quarter alone. And it’s important for us to retain strategic control of the asset moving forward to make sure those production growth plans are not compromised. So we’re looking to identify a path there that unlocks the value of the Marcellus midstream but also does so in a way where future growth is recognized and not placed at risk. We continue to work diligently assessing our alternatives, and we expect an announcement on that path that we select for what portion of our midstream assets it pertains to by midyear, with the transaction consummated sometime in 2014.”

As a result of CONSOL Energy’s vast mix of asset back-up, the new MLP would hold some strategic advantages. CONSOL Energy sources a part of its gas production from coal bed methane (or CBM), which has energy content lower than pipeline specification. CONSOL captures coal bed methane, a type of natural gas that leaks from its mines and would otherwise be wasted, and sells it at a profit. In the Marcellus Shale production, it produces natural gas with higher energy content. These different combinations of natural gas can reduce or eliminate the need for the costly processing of CBM. In addition, as ethane price goes down compared to natural gas price, the lower CBM and dry Marcellus production offers the new unit an opportunity to blend ethane back into the gas stream. On the other hand, when ethane price rises faster relative to natural gas, it is more profitable to process ethane out of the wet gas stream and re-sell it separately after “fractionating.” This will allow CNX more flexibility in producing gas at the Marcellus Shale wells at qualities that meet interstate pipeline specifications.

CONSOL Energy Inc. (CNX) is a producer of natural gas and coal. Some of the master limited partnerships (MLPs) operating in the midstream natural gas energy space are Williams Partners (WPZ), Access Midstream Partners (ACMP), and Energy Products Partners (EPD). Some of these companies are components of the Alerian MLP ETF (AMLP).

Continue to Part 4

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