AN INTERVIEW WITH JOHN HOPPER, PRESIDENT AND CEO, AND LUKE SABAN, EXECUTIVE VICE PRESIDENT AND CFO, OF PEREGRINE MIDSTREAM PARTNERS
EDITOR'S NOTE: John Hopper and Luke Saban, CEO and CFO, respectively, of Houston-based Peregrine Midstream Partners LLC, of which the Ryckman Creek gas storage facility in Wyoming is a subsidiary, recently sat down with Oil & Gas Financial Journal to share their company's story.
A panoramic overview of Peregrine's Ryckman Creek project in the snow at dusk
OIL & GAS FINANCIAL JOURNAL: By all accounts, we are in the midst of a Shale Revolution here in the US. We have an abundance of natural gas, which is being used more and more by industry and for power generation because it is very competitive with coal right now. We are on the verge of becoming an exporter of LNG in a few years. What impact has all this had on the midstream market segment and, in particular, the gas storage business?
JOHN HOPPER: Short term, the perception of "too much gas" has depressed seasonal storage spreads and dampened gas price volatility relative to historical norms. However, as you note there has been an increase in the demand for gas in the electric power generation sector, which is great for storage because of the variability in the demand profile for gas-fired electric generation (GFEG). Longer term, even if the shale gas "revolution" continues, there will be a corresponding demand response that will precipitate the demand for more gas storage capacity, especially in the GFEG market. So from our perspective, now is the perfect time to be building new gas storage capacity – during a down cycle and not when the inevitable cycle up-turn occurs. By then it will be too late.
LUKE SABAN: In the past several years there definitely has been a flight to quality with respect to independent gas storage development with only two or three being constructed including Ryckman – projects with superior return on invested capital as evidenced by medium- to long-term firm customer commitments. Willingness to enter into such commitments is primarily due to the ability to identify the appropriate geology near attractive geographies such as the Opal Hub, the location of our anchor project, Ryckman Creek Resources. Our ability to creatively leverage existing infrastructure to optimize overall capital costs allows us to create a margin of safety with respect to overall capital requirements even if the low gas price environment persists.
OGFJ: Would you give us a little background about Peregrine Midstream Partners? I know that John was a founder of Falcon Gas Storage, and he left the company to form Peregrine in 2008 - 2009. Luke and many other Peregrine employees also came over from Falcon as well. That must make everyone feel a bit like Peregrine is a reincarnation of Falcon.
HOPPER: It is a bit like old home week. I like to stick with a winning team and that's what we've got here at Peregrine. Yes, many of us are "refugees" from Falcon Gas Storage Company. We built a very successful gas storage business at Falcon and are on our way to doing the same at Peregrine. It's not our first rodeo, as we say in Texas.
OGFJ: Luke, what is your background?
SABAN: After starting my career in the energy industry as a wireline helper for Halliburton one summer, I returned from a 25-year hiatus to become senior vice president and CFO for Falcon prior to joining Peregrine Midstream Partners. During the previous 25 years, I held positions of increasing responsibility, including leadership positions for two of the four operating divisions of Johns Manville, a Berkshire Hathaway Co., as well as PricewaterhouseCoopers, and AlliedSignal. Besides serving as CFO of two private equity portfolio companies (including Falcon Gas Storage) that achieved successful partial and full exits, I was chief operating officer for an application software subsidiary of Electronic Data Systems.
OGFJ: How did you go about capitalizing Peregrine – bank loans, private capital, etc? What is the role of EQT Partners (Swedish-based private equity group) in the business? Can you explain how you went about funding Peregrine, roughly from concept to date?
|"Many of us are 'refugees' from Falcon Gas Storage Company. We built a very successful gas storage business at Falcon and are on our way to doing the same at Peregrine. It's not our first rodeo, as we say in Texas." —John Hopper|
HOPPER: The first money in was all from the founders – Luke, myself, Jeff Foutch (executive VP and chief commercial officer), and others. That was enough to get us started. Then, when we found our first development prospect at Ryckman Creek, we went out and raised a total of $15 million from "friends and family" and also ponied up more ourselves. Ultimately, the friends and family investors put up about $13 million and management put up about $2 million. When we got Ryckman Creek to the point that it was permitted and ready to develop, we then went out looking for private equity capital. And that's when EQT came in. They put up the equity necessary to develop Ryckman Creek, along with a club of banks that put up the non-recourse debt to build out the project, which we are about finished with.
|Workers at the Ryckman Creek compressor station|
OGFJ: Is Peregrine in the pipeline business as well as the gas storage business?
HOPPER: Not really. We do build pipelines but only to the extent necessary to move gas into and out of our storage facilities to the nearest interconnecting pipelines. That said, at Ryckman Creek we connect with five different pipelines and moving gas between them at our storage facility interchange header is a significant part of what we do. We have the capability of moving as much as 500,000 MMBTU/day from one pipe to another without necessarily going into or coming out of our storage facility. We are in effect a pipeline hub within a gas storage facility.
OGFJ: How did you select the Ryckman Creek site? What were your criteria?
HOPPER: We selected Ryckman Creek for two reasons: (1) Its location proximate to the major pipelines in the western Rockies and (2) its favorable reservoir properties. The best place for gas storage is where you can interconnect with as many different gas pipelines as possible. We looked at over 100 potential storage development sites (reservoirs) in the western Rockies and Ryckman Creek was by far the best of those. It also happens to be the only independent gas storage facility in the western Rockies – and we like that a lot.
OGFJ: Can you give us a ballpark figure as to how much a facility like Ryckman Creek costs to construct? How does this compare with other gas storage facilities around the US?
HOPPER: By the time all is said and done we will have around $300 million invested in Ryckman Creek, including financing costs and other soft costs such as legal, regulatory, permitting, environmental, etc. With an ultimate working gas capacity of 35 Bcf, that comes to about $8.50/Mcf of working gas capacity all-in. That compares with $12-$15/Mcf of working gas capacity for greenfield reservoir gas storage projects and $15-$25/Mcf of working gas capacity for greenfield salt cavern projects. We are very happy with our unit development cost.
OGFJ: Do you have plans for additional storage facilities?
HOPPER: We have plenty to say grace over right now and are entirely focused on getting Ryckman Creek fully operational for injections this spring. We do have some ideas about other locations but won't really focus on those until we have Ryckman Creek up and running and fully lined out.
OGFJ: In your presentation about Ryckman Creek on Sept. 13, you mentioned that the facility produces lots of water during the gas storage/cycling operations – and that you are looking into the possibility of reclaiming the water for agricultural purposes rather than disposing of it in wells. How far along are you with this plan?
HOPPER: That turned out to be a great idea in concept and not so good once we put the numbers to it. Apparently there aren't as many "thirsty" folks in Wyoming as we thought!
OGFJ: Are Peregrine Midstream Partners, Peregrine Rocky Mountains, and Ryckman Creek Resources all structured as limited liability companies? Any plans to form an MLP or use some other business structure, which is fairly common among some midstream companies?
HOPPER: All of those companies are affiliated with one another, with Peregrine at the top of the LLC structure. We set all of our companies up that way to give us the greatest optionality in terms of how we ultimately monetize either the company as a whole or individual projects or groups of projects. It is most efficient from a tax standpoint – at least for the time being as far as we know.
OGFJ: What are the risks involved with your business and how are you managing them?
HOPPER: Project development is a risky business – and underground gas storage ever the more so. It's enough of a challenge to engineer and build a major construction project above ground that you can see. With gas storage, a large part of what you build in effect is underground. While it may not be the most expensive part of the overall project, it certainly is the most important – because that's where the gas is stored. Everything above ground is there to either put the gas in the ground or take it out and deliver it to the pipelines. That's important too, but not the same challenge as the underground part if for no other reason than you can't see what's going on 8,000 feet underground. So we manage those risks the same way we manage the above-ground risks – with rigorous engineering evaluation and risk assessment to ensure that we minimize all risk to the maximum extent possible, while also recognizing that you simply cannot eliminate all risks inherent in a project of any kind, let alone an underground gas storage project. And, oh yes, there is market risk as well – but that's the easy part.
|Ryckman Creek progress since May 2010|
OGFJ: Do you see political and regulatory risk as serious threats to the natural gas industry (hydraulic fracturing, EPA, etc.) and your business?
HOPPER: I can't really speak to that in respect to hydraulic fracturing and the kinds of issues that pertain to the E&P industry. I only know what I read and hear about. In our business, there are a host of regulatory and permitting issues that we have to be cognizant of – that's just part of the project development process. It may be a bit more of a burden from a time and cost perspective than it was 10 years ago but I wouldn't say that it's excessive. We get it done, regardless. That's part of what we get paid for.
OGFJ: Schlumberger and some other large oilfield service companies say they have identified something like 270 prospective shale basins around the globe. Have you given any thought to expanding your business outside the US? Why or why not?
HOPPER: OMG! 270 shale plays worldwide, huh? Well, I can't get my head around that number. But to answer your question, we have in the past considered developing gas storage projects outside of the US – specifically, in Europe and the UK. The thing is that over there you are really playing in someone else's back yard, and our perception is that the incumbent utilities can really make it tough to compete over there – that and a much more difficult permitting environment than in the US has given us pause for concern. So after looking at it, we decided not to embark on that journey, at least not now. But as they say, "never say never."
|"Our ability to creatively leverage existing infrastructure to optimize overall capital costs allows us to create a margin of safety with respect to overall capital requirements even if the low gas price environment persists." —Luke Saban|
OGFJ: What is the end game for Peregrine? At what point do you monetize the company, as happened with Falcon? How do you determine what is the right time?
HOPPER: The end game for me personally is to play more golf, and sooner rather than later. But we really don't have any control over what the market does and when, so what we do is execute on our strategy to the best of our ability, and we think we are pretty good at doing that. If we execute well, then the market will decide when it's time to sell or maybe create an MLP or implement whatever exit strategy makes the most sense. We have an equity partner in EQT that is very patient and not looking to flip out of the investment in Peregrine quickly. If the market presents that opportunity, then of course they would do that, as would any other investor. But that is not their investment paradigm, nor is it ours. We built up Falcon over eight years, and it turned out to be a very successful investment for us and for two different private equity partners we had back then. If it takes five, eight, or 10 years to get there with Peregrine, then we are prepared to take the time necessary to make Peregrine a successful company just as we did at Falcon. To paraphrase an old commercial about wine, "We will sell no company before its time". As for my golf game, well, I will just have to be patient as well.
EQT discusses Peregrine investment
NOTE: Alex Darden, a partner with EQT Partners based in New York, recently spoke with OGFJ about the private equity provider's investment in Peregrine Midstream.
OGFJ: How did you happen to meet John Hopper and Luke Saban, and how did EQT Partners become an equity provider for Peregrine Midstream Partners?
ALEX DARDEN: We had developed a strategy around midstream assets, and gas storage was one leg of that strategy. We were looking for a gas storage facility that met the requirements we were targeting, which was basically a predictable cashflow base, a depleted reservoir – that type of asset. After researching the market, we were introduced to John Hopper and his team at Peregrine and that's how it all started. That was back in the third or fourth quarter of 2010.
OGFJ: At what point was this in the development of Peregrine's Ryckman Creek storage facility?
DARDEN: We began to talk with Peregrine early in their development stage. Once they acquired the gas compression facility on site and the reservoir rights, and had signed a couple of base contracts, we began to fully evaluate the company. After Peregrine received the permit for the facility, we were able to finalize our investment.
OGFJ: Is investing in midstream less risky than upstream?
DARDEN: Generally speaking we do not invest in upstream because of the direct commodity price exposure for upstream assets. We tend to look for assets that have an infrastructure base, a hard asset base, that are not necessarily commodity-driven.
OGFJ: What criteria do you use in evaluating potential investments?
DARDEN: We're looking for companies that have stable, predictable cashflows, that provide an essential service to society, and that clearly have room for operational improvement.
OGFJ: Do you require the management team to put up a substantial investment as well?
DARDEN: Yes. We want to see both the management team and the board of directors invest in the company.
OGFJ: What type of exit strategy do you have?
DARDEN: It really depends on the company. Obviously we're looking to invest for a finite period of time. We want to take a good company and make it great. With that as a thesis, there are always several different exit strategies, such as selling to another midstream company, which is usually pretty straightforward because of the MLP market. Another is selling to another investor, and there are plenty of them in the midstream sector. The third option is an IPO.
OGFJ: What other investments does EQT have in the energy sector?
DARDEN: In all, EQT has about 20 billion euros (US$26 billion) under management in various funds. About 30% to 40% of our infrastructure fund is invested in businesses related to oil and gas. We have a mineral oils facility in Rotterdam, a couple of additional terminals that store products like base oil and lubes, and a gas transmission system in Sweden. We have a fair amount of oil and gas investments, but in midstream – not upstream or downstream.