Point of View: Gas processing, now established, must manage volatility

Whipsawed by events, markets, and regulations in the last 25 years, few oil and gas industries have had to adjust as nimbly as natural gas processing, especially in the US.

Perceived as a stodgy stepchild to the often more profitable and glamorous production function within the oil companies, gas processing has reacted to industry changes of the late 1970s and 1980s by evolving into a robust "midstream" business, an entity in its own right.

The industry today provides gas producers, on the one hand, with services they must have and petrochemical producers, on the other hand, with light-hydrocarbon feedstock they must have.

The position, however, is rarely comfortable, says Bill Cepica, who has watched and participated in the industry from several vantage points. His long career has included a stint as president of the US Gas Processors Association and vice-president with two major industry players.

Cepica believes the upheavals, especially of the 1980s, have brought the gas-processing industry to a better, surer place among the other segments of the oil and gas business. The economic pressures of having to learn to function "independent of production departments in the 'black oil' companies have made the industry a better industry," he says, forcing it to focus on its core func tion, that of services to the producer.

The future will depend a great deal on gas processors' abilities to operate efficiently: to mold contracts that satisfy interests of both gas producers and processors, and to serve petrochemical markets, which themselves are at the mercy of movements in overall economic activity.

That future, will also bring more consolidations and regulatory pressures, he says.

How we got here

Cepica says the current shape of the gas-processing industry is very much a reflection of decisions by some of the older, mainstream, integrated oil companies-he cites Phillips Petroleum Co., specifically-and by many independent oil producers to make the economics of processing the natural gas they produced stand by themselves.

The idea of a processing unit performing a service for production departments as well as for those independents that had no processing capacity provided economies of scale and opportunities for growth. That business could, in turn, look around for other customers and services to augment the activity in which it was already engaged, thus contributing directly to its own survival and giving rise to the midstream business.

"When that happened," says Cepica, "the infrastructure began building itself a bit stronger. And it was aided by the advent of a centralized fractionation industry that in turn fostered development of a dedicated liquids pipeline network, underground storage, and petrochemical demand."

A mindset change among companies in the 1970s and 1980s also played a major role in this evolution. Before the mid 1970s, he says, security of supply was "paramount in the companies' minds." Hydrocarbon control and interdepartmental transfer of volumes "from production to processing to refining to marketing made companies unwilling to rationalize capacity or sell marginal facilities and thus loose control of their supply."

But as concerns about supply shortages or availability eased, companies became more willing to change, to break out facilities -in this case, gas-processing facilities - creating standalone profit centers that "developed an entrepreneurial focus."

The result was the creation of independent gas-processing units that further developed gathering-processing systems. Economic pressures pushed many of these companies together in joint ventures or consolidations.

At the same time, cryogenic extraction and the turbo expander came into wider use, leading to greater production of ethane, says Cepica. This product, now available in greater volumes, found a ready and waiting market among petrochemical producers seeking to improve ethylene margins with lighter hydrocarbon feedstocks.

During the mid-1980s, with the advent of deregulation, natural gas producers and pipeline companies were fighting out the consequences of "take-or-pay" supply contracts favorable to producers but onerous to pipelines. As a consequence of regulatory changes and contract amendments, pipeline companies were spinning off gathering-gas processing facilities, leading to regrouping and consolidation among processors.

Where we are

Cepica points to the cyclical nature of the gas-processing business as one of its hallmarks, now as much as ever and perhaps more so than the traditionally cyclical nature of the broader oil and gas business.

This condition results from the industry's unique vulnerability to price fluctuations in three markets: natural gas, crude oil, and petrochemicals. "These three commodities, moving in different cycles, can cause gas-processing profitability and the industry to ebb and flow with much greater frequency than the gas industry itself, or even the oil industry."

Just how closely the industry is tied to natural gas production and price was rarely more apparent than in the winter 2000-01, says Cepica, when processors with "keep-whole" contracts could not afford to process gas under prevailing market conditions. Producers, on the other hand, without gas processing, had gas production that, in many instances, could not meet market specifications.

Cepica believes producers and pro cessors must work together to develop a contractual relationship that will not overly penalize either when markets swing out of balance, as they did more than a year ago.

For the midstream industry to function, the new contracts should "cap what the processor makes in very good times and contain some mechanism that triggers fee-based processing to enable the processor to continue the essential processing services it provides the producer during the lean time."

Cepica also points to the growth of energy trading as a new reality for gas processors. Trading, he says, while not always benefiting the energy industry, "allows volatility to be dealt with daily or weekly rather than building up, causing values to move violently after periods of stability.

"Although volatility is difficult on everyone, energy trading is probably the escape valve that prevents severe damage from extremely high or extremely low prices over a longer period."

What's ahead

Cepica believes the consolidation of recent years will only accelerate and that the evolution in process controls will "safely permit further manpower reductions and more cost-efficient operations."

Duke Energy Corp. is an example of a company that "has grown from an electricity producer to one that got into some processing early on and found there was a synergy between the elements: various kinds of power connected to one corporate entity."

But he also believes opportunities exist and will continue to appear for small processors in niche business and geographic markets. Although Cepica admits his perspective is rooted in North America, he believes these opportunities exist worldwide.

Process controls "enable better maintenance with less manpower, less down time because of failures, and more operating time because of preventive maintenance-with probably fewer people doing that work," he says.

"Processors must continue to look for ways to operate more efficiently and reduce costs so that the producer will continue to outsource his processing. In this, the processor must continue to view his operation as a service to be run as safely as possible and to upgrade older facilities and reduce exposure from them, especially in pipelines," he says.

Finally, the gas-processing industry's bête noire-volatility-will remain a fact of business life, to be expected, managed for, and minimized whenever possible. "When times are good, we must enjoy them, for just around the corner lies a time of belt tightening," says Cepica.