Natural Gas, Demand-Pull Pipelines & Midstream Valuations

• Supply-push pipelines typically move hydrocarbons from a producing region to a hub. Meanwhile, demand-pull pipelines supply long-lived infrastructure like power plants or liquefied natural gas export facilities.
• Demand-pull pipelines tend to be superior given longer contract terms, less competition, and potentially stronger customers, which typically results in higher valuations for those assets.
• With midstream largely investing in demand-pull growth opportunities focused on natural gas, this could help the space or certain names re-rate higher over time.

Typically in midstream, pipelines are classified by the hydrocarbon they are transporting. However, most pipelines can also be classified as supply-push or demand-pull pipelines. Admittedly, some pipelines may be a bit of both.

Today’s note discusses these two types of pipelines and why the growth opportunities for demand-pull pipelines could contribute to a re-rating for the space.

Supply-push pipelines typically move hydrocarbons from a producing region to a market or hub. The customers for the pipeline are often producers trying to get their output to end markets. While supported by long-term contracts, supply-push pipelines may see shorter terms and may be more sensitive to production trends over time. Supply-push pipelines may also face greater competition, as producers may have more than one pipeline solution to move their oil and gas to markets.

Prior to the pandemic, many newbuild pipelines were supply-push, largely transporting oil and gas out of the Permian to end markets. Ten-year contract terms were likely common for those pipelines. For example, Exxon (XOM) signed a 10-year contract for the Double E Pipeline, which transports gas out of the Permian and is operated by Summit Midstream (SMC). Double E started up in late 2021. It bears mentioning that XOM had the option to acquire an equity stake in Double E and owns 30% of the pipeline.

In its 2018 annual report, producer Apache (APA) disclosed 10-year contracts for different Permian natural gas, crude, and natural gas liquid (NGL) pipelines that were under construction at the time. APA owned an interest in the pipelines or had an option to acquire a stake in them.

Gathering pipelines are also admittedly supply-push lines. These shorter, smaller pipelines in producing areas connect wells to processing facilities or aggregation points. They are particularly dependent on production. Gathering pipelines tend to receive the lowest valuation (i.e., lowest EBITDA multiple) of any pipelines.

Demand-pull pipelines typically move hydrocarbons to (or close to) where they will ultimately be used. An example would be a natural gas pipeline supplying a power plant or local gas distribution company (LDC). Natural gas pipelines supplying LNG export facilities are also demand-pull pipelines. Similarly, oil pipelines feeding refineries or an ethane pipeline supplying a petrochemical facility fall into this category. Demand-pull pipelines typically serve long-lived infrastructure that requires long-term supplies.

For midstream, demand-pull pipelines tend to be superior to supply-push pipelines. Demand-pull pipelines often garner longer contract terms and may have stronger customers. For example, an investment-grade utility customer is preferable to a smaller producer, albeit consolidation among upstream companies has led to larger, stronger producer customers. (Yesterday’s Devon-Coterra merger announcement provides the latest example.) Demand-pull pipelines tend to garner higher valuations compared to their supply-push counterparts. For example, a demand-pull pipeline may command an EBITDA multiple 1-2x higher than a supply-push pipeline transporting the same hydrocarbon (i.e., 13x for demand pull vs. 11x for supply push).

Currently, there are a handful of natural gas pipelines from the Permian under construction (read more). One could argue that these pipelines are a mix of supply-push and demand-pull. More natural gas is coming out the Permian and needs to get to markets. However, some of these pipes will help feed LNG facilities and power demand.

For example, Energy Transfer’s (ET) Hugh Brinson is originating in West Texas but will help supply natural gas needed for Oracle’s data centers (read more). Similarly, ET’s Desert Southwest pipeline is originating in the Permian but is really geared to meet power demand in Arizona and New Mexico, making it more demand-pull. On the other hand, the Eiger Express Pipeline, backed by ONEOK (OKE), Whitewater, MPLX (MPLX), and Enbridge (ENB CN) was announced as a solution for growing production. It has contract terms of 10 years or longer. That said, the line will have connectivity to demand markets like LNG facilities and power plants.

A key tailwind for midstream in recent years has been the expected growth in natural gas demand in North America. This is being driven largely by growing US LNG export capacity (read more), which is set to approximately double by 2031. LNG facilities typically sign 20-year contracts with pipelines to match the normal tenure of their sales agreements.

Other key growth areas are power demand, including data centers (read more), and industrial demand. With this expected natural gas demand growth, the slew of expansion projects underway are largely for demand-pull pipelines. Notably, projects span the U.S., instead of being concentrated in Texas.

Many natural gas expansion projects are backed by 20-year contracts. Examples in the Midwest include DT Midstream’s (DTM) Guardian Pipeline expansion, which is anchored by five investment-grade utilities, and TC Energy’s (TRP CN) Northwoods Project, also backed by an investment-grade counterparty. Similarly, Kinder Morgan’s (KMI) South System Expansion 4 will help meet power and LDC demand in the Southeast. Williams’ (WMB) Southeast Supply Enhancement will also service the Southeast and Mid-Atlantic. These are only a handful of examples, but all are backed by 20-year contracts, putting expiration of the contracts near 2050.

With midstream growth opportunities largely driven by demand, one could argue that multiples for midstream companies should re-rate higher. The Alerian Midstream Energy Select Index (AMEI), which includes the large C-Corps with natural gas infrastructure, is trading at 10.4x 2027 EBITDA as of January 29, whereas its ten-year average forward multiple is 10.7×.

The space saw some re-rating in 2024 when natural gas names noticeably jumped. However, as these higher-value projects come online over the coming years, the stronger source of growing EBITDA should be properly appreciated by the market, compared to the bias towards supply-driven EBITDA growth in the past. Additionally, natural gas pipelines tend to garner higher EBITDA multiples than oil pipelines (longer terms, stickier demand, take-or-pay contract features). In time, more natural gas demand should require more supply, which should broadly benefit midstream, including those focused on gathering and processing.

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AMEI is the underlying index for the Alerian Energy Infrastructure ETF (ENFR) and the ALPS Alerian Energy Infrastructure Portfolio (ALEFX).

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