This Strong MLP Is A Big Winner From Gas Flaring Rules

In North Dakota's Bakken shale, natural gas flaring -- or the burning of gas that cannot be processed or sold -- is a major issue. Currently, roughly a third of gas produced in the shale formation is flared, mainly because there isn't sufficient infrastructure to take it to market.

Since gas flaring pollutes the environment, state regulators are cracking down on the practice. Last week, they adopted a more stringent set of rules that require Bakken operators to capture produced gas, as part of a broad strategy to slash flaring from around 33% currently to 10% by 2020.

While positive for the environment, the new regulations have mixed implications for Bakken operators. On the one hand, they could reduce the Bakken's oil production potential, hurting producers. But on the other hand, they will boost demand for gas infrastructure, benefiting midstream firms like ONEOK Partners (NYSE: OKS  ) .

A Statoil-operated rig in the Bakken. Photo credit: Ole Jørgen Bratland Statoil ASA

Impact on oil production
According to analysts at investment bank Raymond James, the new gas flaring rules could prompt Bakken producers to focus more capital on midstream infrastructure, as opposed to drilling and completing wells, which "could potentially suppress crude oil production."

The new rules require producers to take specific steps to curb gas flaring from their wells. A year after a well begins producing, it must either be capped, hooked up to a gas gathering line, or outfitted with an electrical generator and/or a compression or gas liquefaction system that consumes at least three-quarters of the gas.

By imposing these rules, the North Dakota Industrial Commission hopes to reduce statewide gas flaring by 26% by the fourth quarter of this year and by an additional 23% by the first quarter of 2015. Meeting these targets means additional costs for Bakken producers that could force them to reduce oil production. But for midstream companies, the new rules may spell opportunity.

According to Raymond James, an additional 400 MMcf/d of gas processing capacity will be required to accommodate expected gas production growth through the end of the decade. This means operators will need to add more assets and capabilities to the existing gas transportation network including gathering pipelines, processing and compression facilities, looped pipelines, and additional trunk lines.

ONEOK a potential winner
One midstream company that's leading the pack when it comes to building the requisite infrastructure to reduce Bakken gas flaring is ONEOK Partners, a master limited partnership (MLP) that gathers, processes, and transports natural gas and natural gas liquids (NGLs).

The partnership has an ambitious plan to bring online three new gas processing facilities in the Bakken by the end of next year, which will provide a big boost to its gas processing capacity. The first of these facilities -- the Divide County Gathering System -- was placed in service in the second quarter of last year and is expected to be fully operational by year-end.

The other two facilities -- Garden Creek II and III and Lonesome Creek -- are slated to start up in the first quarter and fourth quarter of 2015, respectively. Combined, these projects will boost ONEOK's gas processing capacity by about 400 MMcf/d, in addition to the 300 MMcf/d of capacity the partnership has added since April 2011.

Strong distribution growth prospects
Combined with its existing NGL pipelines serving the Bakken, these projects will further cement ONEOK's dominant position as a midstream leader in the Mid-Continent region. And with $6.0 billion to $6.4 billion worth of growth projects slated for completion by year-end 2015, ONEOK's distributable cash flow should keep growing sharply, allowing for continued growth in distributions.

ONEOK has raised its distribution every quarter for more than four years. In April, it announced an increase in its quarterly cash distribution of 1.5 cents to 74.5 cents per unit. The partnership expects to grow its annual distribution by an average of 6%-8% between 2013 and 2016, while maintaining a minimum coverage ratio of 1.05x-1.15x.

Investor takeaway
While new gas flaring rules could potentially reduce North Dakota's oil production potential due to the additional costs associated with complying with the regulations, they will increase the demand for ONEOK Partners' gas processing services. With a distribution yield of 5.3%, a relatively healthy coverage ratio, ample liquidity, and strong distribution growth prospects, ONEOK may be worth a closer look.

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Arjun Sreekumar

Arjun is a value-oriented investor focusing primarily on the oil and gas sector, with an emphasis on E&Ps and integrated majors. He also occasionally writes about the US housing market and China’s economy.

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9/2/2015 4:04 PM
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