Verasen Inc.’s new midstream company will see growth driven by the wealth of Montney resources within an Area of Mutual Interest (AMI) in the Dawson area of northeast British Columbia, says the company’s CEO.
“Development in this region is constrained not by natural gas prices but by gathering and processing infrastructure,” Don Althoff, president and CEO, said in a conference call following the December 22 announcement of the formation of a new entity, Veresen Midstream Limited Partnership.
The new company will be owned equally by Veresen and affiliates of Kohlberg Kravis Roberts & Co. L.P. (KKR), a global investment firm.
Veresen Midstream has entered into definitive agreements to acquire natural gas gathering and compression assets supporting Montney development in the Dawson area from Encana Corporation and the Cutbank Ridge Partnership (CRP), a partnership between Encana and Cutbank Dawson Gas Resources Ltd., a subsidiary of Mitsubishi Corporation.
“This was something Encana had been thinking about over the summer and they went out and asked for proposals,” Althoff said in response to a question from an analyst on the conference call.”
Commercial terms include a 30-year production dedication to Veresen Midstream’s gathering system for all of Encana and CRP’s Montney natural gas production within the AMI which contains approximately 240,000 acres of Montney rights and encompasses Encana and CRP's Dawson South, Dawson North and Tower plays.
Upon closing, Veresen Midstream will acquire from Encana approximately 500 kilometres of gas gathering pipelines and 675 million cubic feet (mmcf) per day of compression capacity from Encana and CRP in the Dawson region. This infrastructure currently gathers Encana and CRP's Montney gas production in the region and delivers it to various processing facilities, including the Hythe and Steeprock plants.
Veresen Midstream also will acquire the 200 mmcf per day Saturn compression station which is currently under construction and scheduled for completion in mid-2015. There are a number of additional projects under construction and in development, all in close proximity to Veresen’s existing asset base at Hythe/Steeprock.
When the transaction is complete, Veresen will have acquired operating assets, assets under construction and future rights for growth in a large area of mutual interest. An independent engineering report prepared by GLJ Petroleum Consultants Ltd. for Veresen effective July 1, 2014, estimates that CRP and Encana have 23 trillion cubic feet (tcf) of dedicated Montney natural gas reserves and unrisked best estimate contingent and prospective resources within the AMI.
“The great thing about these assets are that they are not condensate-dependent,” said Althoff. “They have actually produced gas at sub-$2 (per thousand cubic feet (mcf)) levels and Encana and CRP have been making significant advancements in dropping their costs so we think . . . these are going to flow a lot of gas and a lot of liquids.”
The Montney is the most prolific and actively developed natural gas play in Canada and one of the most competitive gas supply basins in North America, he added. Current production of roughly 3.5 billion cubic feet (bcf) per day is up 300% from approximately 1.2 bcf per day in 2007 and gaining momentum, analysts heard.
Veresen Midstream has committed to fund up to $5 billion of new infrastructure within the AMI to service Encana and CRP’s planned production growth under a 30-year fee-for-service arrangement.
In the near-term, plans include the construction of the Sunrise gas plant (400 mmcf per day) and the Tower gas plant (200 mmcf per day), greenfield sweet gas compression and processing plants with natural gas liquids recovery (shallow cut), and associated incremental gathering pipelines.
Construction of the Sunrise and Tower plants is scheduled to begin in 2015, with in-service dates anticipated in 2017. The projects are in the final stages of development with a final investment decision expected early next year, said Althoff. The estimated total cost of the Saturn, Sunrise and Tower plants is $1.5 billion.
Future infrastructure may include additional gas gathering pipelines, compression and processing facilities to meet CRP's planned volume growth. Asked about the potential for fractionation, he said that while the initial projects will be shallow cuts, “we’ll always keep in mind what our customers need and the ability to build a deep cut down the road might make some sense.”
The agreement with Encana and CRP also allows Veresen Midstream to bring third party producers into the network, Althoff said in the conference call. “When you drive efficiency in the assets, some of that will be shared with Encana and CRP,” he said. “If we can bring third parties in and grow the business, it’s actually an advantage to Encana and CRP as well.”
Veresen Inc. will provide day-to-day management of Veresen Midstream. The existing midstream services agreement between Veresen and Encana relating to the Hythe/Steeprock assets remains unchanged, with Veresen Midstream operating these assets in the future.
Encana will continue to construct new infrastructure within the AMI and will operate the gathering pipelines and compression and processing facilities on behalf of Veresen Midstream on a contracted basis.
Veresen Midstream will assume operatorship of compression and processing facilities at either its or Encana's option after an interim operating period which is built into the contract, said Althoff who declined to be more specific. “It’s not a long period and it also starts when it begins operation,” he said.
The arrangement gives Encana and CRP some flexibility, Althoff suggested. “As their production grows they can pace the investment — they know where the construction is and where operations [are],” he said. “It gives them a really strong feeling that infrastructure won’t hold up production.”
The contract also helps to derisk the project a bit because it has some elements that provide some protection around capital cost and operations, especially around start-up, said Althoff. “We think it’s a real win-win piece but ultimately we plan on being an owner-operator of these facilities.”
The transactions are expected to close in the first quarter of 2015 and are subject to normal closing conditions, including receipt of approvals under the Competition Act and the Investment Canada Act.
"We are pleased to expand our relationship with Veresen, and now KKR, in what we believe is one of Western Canada's most innovative midstream service structures," Renee Zemljak, executive vice-president, midstream, marketing and fundamentals with Encana, said in a news release.
"This transaction will ensure reliable, efficient midstream service to support our ongoing operations."
KKR’s strategic partnership with Encana, one of the premier North American resource play companies, represents an exciting foundational asset for Veresen Midstream, Brandon Freiman, KKR's head of Canadian energy and infrastructure, said in a statement.
“This investment is a part of our long-term commitment to the Canadian energy and infrastructure sector, and we look forward to working with Veresen to support the growth of the partnership for many years."
With additional projects in the planning stages by Encana and CRP, Veresen Midstream has a clear line of sight to additional growth opportunities which include growth potential from third party expansions, said Althoff.
“Given the infrastructure constraints throughout the Montney, I am confident that Veresen Midstream is well positioned to assist producers in unlocking the value of this resource play by flexible, tailored and innovative infrastructure solutions,” he said.
Responding to a question, Althoff said that although Veresen has an interest in the Alliance pipeline, it would be up to Encana and CRP to determine where their gas goes. However, “we do think it gives us some understanding of how gas is moving which could help us provide services that our customers want.”
The transaction has been structured in such a way that it requires no upfront funding from Veresen and is earnings and cash flow accretive to Veresen as projects come onstream, said Althoff. “This structure is important to us because it allows us to support our current dividend payout through a period of significant capital expansion.”
The transaction is cash flow neutral to Veresen in 2015 and as new projects come onstream the transaction is cash flow accretive, he said.
Veresen Midstream structure
All of Veresen's and half of KKR's Veresen Midstream equity will be held in partnership units that are eligible to receive cash distributions, Theresa Jang, senior vice-president, finance and chief executive, said in the conference call.
The remaining half of KKR's initial equity investment will be in the form of payment-in-kind (PIK) units which do not receive cash distributions and instead accumulate at a rate equal to the cash yield on the remaining equity plus four% per year. The PIK units are convertible to cash-paying units after four years at either KKR's or Veresen's option.
This structure provides Veresen with a disproportionately higher share of cash flow during the construction period, prior to the Sunrise and Tower gas plants being placed in service.
Veresen and KKR will have equal governance rights in Veresen Midstream so long as either partner's equity interest remains above 35%.
Partnership financing and Veresen funding strategy
Veresen Midstream has obtained an underwritten commitment from a syndicate of banks led by RBC Capital Markets, TD Securities and HSBC Bank Canada to provide senior secured credit facilities to finance a portion of the initial acquisition price and expected growth funding. These facilities, which are non-recourse to Veresen, include a US$600 million term loan B, to be drawn on transaction closing, a $1.275 billion non-revolving expansion facility which will be largely undrawn initially and available to fund future growth, and a $75 million revolving credit facility which will be available for operating and working capital requirements.
Veresen Midstream expects to fund approximately 55% to 60% of its growth program with debt and the remainder with future equity contributions from Veresen and KKR. All future equity requirements for Veresen Midstream will be funded by the partners in cash-paying units on a pro-rata basis.
Veresen intends to use the $420 million in cash proceeds it will receive on closing to repay the majority of its bridge credit facilities which were drawn in connection with its acquisition of a 50% convertible preferred interest in the Ruby Pipeline in November 2014.
