Boosting midstream asset value capture

This decade has been a tough one for owners of flexible midstream gas assets such as storage, pipelines & regas terminals. Asset returns have been hit by a post financial crisis overhang of supply flexibility in the European gas market.  At the same time, market drivers are structurally altering the risk/return profile of midstream assets.

But as is often the case, commercial strength is born from adversity. Midstream asset owners are improving returns by evolving commercial models and optimising margin & costs.

A combination of sharper commercial strategies and recovering market fundamentals is set to underpin midstream value recovery into next decade.

In this article we set out:

1. 3 structural market trends supporting European midstream asset value
2. 3 resulting commercial trends impacting midstream asset value capture
3. 5 ways asset owners are responding to boost value capture.

While 1. applies generally across all midstream assets, our coverage of 2. and 3. focus on flexible TPA exempt assets.

3 structural market drivers supporting midstream value

Energy markets are cyclical in nature. Several years of tough conditions and low investment tends to set up a market recovery. But in addition to cyclical factors there are three structural drivers of a recovery in the value of European gas supply flexibility across the next 5 years:

1. Import dependency: European domestic production is in structural decline. This means the European gas market is becoming more dependent on longer import supply chains e.g. LNG imports and Russian pipeline flows from Western Siberia. Longer response times increase market price volatility and the frequency and magnitude of price shocks.
2. Power sector swing: Gas fired power plants are set to play an increasingly important flexibility provision role over the next 5 years. Regulatory driven closures of nuclear, coal and lignite plants will increase gas plant load factors. In parallel, the requirement for flexibility is set to rise with a substantial increase in intermittent wind & solar output.  The increased ramping of gas-fired power plants depends on supply flexibility from the gas market.
3. Ageing infrastructure: European midstream gas infrastructure is ageing. Yet investment in both maintenance and renewal capex for midstream assets has been relatively low this decade given weak market price signals.  Infrastructure outages and retirements are likely to increase as a result into next decade.

These drivers are underpinning a gradual recovery in flexibility price signals since 2016.  This recovery has been more pronounced in the UK market with the closure of Rough.  But TTF volatility has also been rising in 2018.

These structural market drivers are supporting several key commercial trends impacting midstream value capture.

3 commercial trends impacting value capture

The market drivers described above are resulting in important trends in the way TPA exempt midstream asset owners are capturing value.  These are summarised in Table 1 below.

As contracts roll off, value shifts to the prompt and volatility increases, more market risk is being pushed onto midstream asset owners and investors. With that higher risk comes the potential for enhanced returns.

In other words, there is a structural transition in asset risk/return profiles that favours companies with the ability to absorb market risk and the commercial capability to manage that risk and commercially optimise asset returns.

5 ways asset owners are responding to boost value capture

Midstream asset owners have not been idle in responding to these evolving market and commercial trends. Midstream business models are adapting to reflect the increasing importance of optimising physical asset flexibility against hub prices to provide a more targeted range of customer products and services. This business model transition is summarised in a simple schematic in Diagram 1 below.

An enhanced commercial function sits at the centre of the new midstream business model.  This often consists of only 2-4 capable commercial staff.  And it does not necessarily involve a trading function and associated overheads. There are examples of both pipeline and storage operators in Europe that retain asset flexibility into the day-ahead horizon to enhance value capture, before selling capacity to trading counterparties with direct market access.

In Table 2 we list five ways midstream asset owners are enhancing value.

The actions in Table 2 can significantly enhance midstream asset margin, even in the absence of any flexibility market recovery.  But these are also powerful tool to enable asset owners to maximise their benefit of market recovery, rather than that benefit only flowing to customers.