JT: In our Economics of Reliability report for US and Canadian Midstream Oil & Gas, the scatter plot shows two things, with all data averaged from a 3-year period from 2019 to 2021. First, the y-axis shows the fraction of reliability spend that is capitalized. A portion of companies breaks out their capital expenditures between “growth” and “sustaining” capital. Growth capital expenditures are those that are expected to increase production or revenue. Sustaining capital expenditures are those that maintain current levels of production or revenue. We define sustaining capital expenditures as one type of “reliability spend,” with the second type of reliability spend being expensed. The further up you go on the y-axis, the higher the fraction of reliability spend that is capitalized rather than expensed. This is intended to show the financial reporting methodology of the various companies. Second, the x-axis shows the total reliability spend relative to service revenue. Many midstream companies derive a significant portion of their annual revenue from the sale of hydrocarbons; to focus on revenue that is generated from productive assets, we stripped out any non-service revenue. The further to the right you go on the x-axis, the higher the percentage of service revenue that a company spends on reliability measures, such as improving asset integrity or replacing aging pipelines.
AL: In our report, we highlighted 17 large, publicly-traded US and Canada-based midstream operators. On average, these companies spend 19% of service revenue on reliability initiatives. While most of the companies fall within a small range on either side of this average, a few companies significantly diverge from the average. ONEOK, Plains All American, and DCP Midstream spend between 45-51% of service revenue on reliability programs; this is significantly higher than any other company in our report, with the 4th highest spender averaging ~27% of service revenue on reliability. These three companies most likely have some level of waste in their reliability initiatives and would benefit from examining their spending habits and identifying and eliminating this waste. Other companies, such as MPLX and Equitrans, have lower than average spend. This suggests that these companies have underinvested in their equipment, and this could have significant consequences in the near future, especially if upstream operators begin increasing production and exploration of crude.
What are some practical takeaways from the report? How can midstream operators use this report?
JT: There are a few key takeaways from this report. First, the midstream industry is not investing in its productive assets at the rate expected, given the current price of crude oil. As crude prices increase, upstream operators typically increase the level of oil production and extraction. This incentivizes midstream operators to invest in their equipment to ensure reliable operations and increase the throughput ability of their asset base. Capital expenditures have remained significantly below 2019 levels, even though crude prices are much higher. Second, midstream industry margins are being compressed; even though revenues have increased significantly, inflation and labor/equipment shortages have led expenses to increase more rapidly than revenues. This margin compression should lead midstream operators to focus intensely on improving operations and reliability. Lastly, some companies in our report should increase their reliability spend, while others likely have a significant amount of wasted reliability spend. Midstream companies should examine their reliability initiatives through a microscope to identify any wasted financial resources or to determine whether they are spending enough on reliability measures. A data-driven reliability approach can help to ensure that midstream resources are being utilized at an efficient and effective rate.
Q1 reports were recently published – have you seen any notable trends? Has the Q1 performance of these midstream operators differed from 2021 performance?
JT: The first quarter of 2022 continued the recent trend in both capital expenditures and operating margin for the midstream industry. The first graph below shows midstream capital expenditures and average WTI crude price on a quarterly basis. One of the key takeaways from the report is the deviation between normally-correlated midstream capital expenditures and crude price. At the current crude price, one would expect midstream operators to grow their asset base to facilitate increasing supplies of crude from upstream operators. However, production and extraction of crude oil have not been increasing; therefore, midstream operators have not been investing in their asset base as they typically have in the past. This could have long-term effects on the reliability of assets.