Understanding the Midstream Oil and Gas Sector: A Comprehensive Investment Analysis

The midstream oil and gas sector represents the vital link connecting upstream production to downstream consumption in the energy value chain. While upstream operations focus on extraction at the wellhead and downstream activities serve end users, the midstream ecosystem handles the critical processes of transportation, processing, storage, and distribution of crude oil, natural gas, and natural gas liquids (NGLs). This infrastructure backbone enables the energy market to function efficiently while generating substantial cash flows that attract income-focused investors.

Core Infrastructure and Operations in Midstream Oil and Gas

The midstream oil and gas industry comprises three interconnected operational pillars: gathering and processing systems, long-distance transportation networks, and storage-logistics infrastructure. The operational chain begins when raw hydrocarbons emerge from a producing well. A gathering pipeline system—typically constructed by a midstream company or the producer itself—channels these raw materials to a central processing facility. At this hub, the mixture separates into distinct commodity streams: oil, natural gas, and NGLs, each following its own specialized value chain downstream.

Three primary operator categories participate in this sector. Integrated energy corporations manage assets across the entire value chain to maximize per-barrel returns. Sponsored midstream entities, created by upstream producers as standalone public companies, serve both their parent companies and third-party clients. Independent midstream operators fill infrastructure gaps by providing services to producers lacking direct access to transportation and processing assets.

Revenue Models: How Midstream Oil and Gas Companies Generate Cash

Midstream oil and gas firms employ three primary monetization approaches, each suited to different infrastructure types:

Fee-Based Structures: Gathering pipelines typically operate on fee contracts. Producers sign long-term agreements committing to specified volume throughput, paying per barrel transported—analogous to highway tolls. Similarly, storage facilities charge capacity fees for space rental, comparable to metered parking arrangements. These models provide revenue predictability and lower volatility.

Regulated Tariff Framework: Long-haul interstate pipelines crossing state boundaries operate under Federal Energy Regulatory Commission (FERC) oversight in the U.S. The regulator sets tariffs to prevent monopolistic pricing, ensuring fair rates based on distance traveled. This creates a toll-road dynamic where midstream operators earn progressively higher revenues as hydrocarbons traverse greater network distances.

Commodity-Based Margins: Processing and fractionation facilities often employ margin structures, capturing value differentials. When a company purchases raw natural gas-NGL mixtures, then separates and sells components like ethane and propane at premium prices, the spread constitutes profit. While potentially more lucrative during commodity price surges, this model introduces cash flow volatility compared to fee-based alternatives.

The Three Distinct Value Chains Within Midstream Oil and Gas Operations

Crude oil follows its dedicated pathway from wellhead through gathering tanks, moving via pipeline, truck, or tanker to offsite blending and storage facilities. Large regional hubs, such as Cushing, Oklahoma, function as consolidation points before final transport to refineries for processing. Post-refining, products move by multiple transport modes to retail endpoints like fuel stations.

Natural gas and NGLs begin their journey together through gathering pipelines to processing centers that separate methane from the NGL stream. Natural gas then travels through transmission pipelines to storage facilities housed in underground salt caverns or depleted wells. Upon dispatch, it enters distribution networks serving residential and commercial users, or undergoes liquefaction for LNG export markets. NGLs proceed to fractionation complexes that separate them into propane, butane, ethane, and natural gasoline—each destined for specific industrial, commercial, or export applications.

Key Market Players and Their Strategic Positioning

Cheniere Energy: Pioneering LNG Exports in North America

Cheniere Energy operates as North America’s primary LNG producer with capacity projections placing it among global top-five producers by 2020. The company’s operational footprint spans two Gulf Coast facilities: Sabine Pass and Corpus Christi. Sabine Pass initiated LNG production in 2016, marking the first U.S. lower-48 state LNG export achievement. The facility operates four liquefaction trains—refrigeration systems that cool natural gas to minus 260 degrees Fahrenheit, reducing volume 600-fold and enabling maritime transport via specialized carriers to international regasification terminals.

Cheniere’s expansion pipeline includes one additional Sabine Pass train scheduled for 2019 operations, alongside two trains at Corpus Christi launching production concurrently. The company controls sufficient land to potentially double capacity through additional train construction. Revenue derives primarily from fee-based liquefaction margins secured through long-term contracts representing 85%-95% of expected production. This contractual framework provides cash flow stability that supports ongoing capacity expansion while building toward future shareholder distributions.

Energy Transfer: Comprehensive Midstream Oil and Gas Integration

Energy Transfer exemplifies the diversified midstream operator model, having consolidated control of formerly affiliated MLPs through recent acquisitions. Following its Energy Transfer Partners acquisition completion, the entity now commands fully integrated midstream assets spanning the entire value chain. The natural gas segment encompasses 33,000 miles of gathering pipelines coupled with substantial processing infrastructure accommodating both fee-based and margin-based business models. Gas subsequently flows across one of America’s largest intrastate and interstate transmission networks where fee-based arrangements underpin 95% of revenue streams.

Energy Transfer’s NGL platform represents world-scale capability in processing, transportation, fractionation, storage, and export functions. Substantial crude oil operations include long-haul transmission pipelines, storage terminals, and export infrastructure. Equity stakes in subsidiary MLPs—including USA Compression Partners and Sunoco—provide exposure to compression services and fuel distribution respectively. Overall, fee-based contracts and regulated tariffs secure approximately 90% of revenue stability. The organization projects $2.5-$3.0 billion in annual excess cash flow post-distribution payments, enabling aggressive expansion including Permian Basin crude extraction pipelines, NGL transmission expansions, ethane export terminals, and major LNG export development along the Gulf.

Enbridge: North America’s Energy Transportation Leader

Enbridge operates the world’s most extensive and technologically advanced oil and liquids transportation network spanning 17,000+ miles of pipeline infrastructure. The primary system transports approximately 2.9 million barrels daily, representing 28% of North American crude oil production. Beyond crude transportation, Enbridge commands natural gas leadership through 65,800 miles of gathering lines, 25,500 miles of long-haul transmission, and 101,700 miles of distribution serving 3.7 million Canadian and New York State customers.

The company’s earnings composition reflects this diversification: oil and liquids transportation generated 50% of 2017 earnings (declining from 75% prior to Spectra Energy acquisition), with gas transmission and midstream services contributing 30%, and utility operations providing the remainder. The asset base—predominantly pipelines and utility-grade infrastructure—ensures fee-based agreements and regulated tariffs supply 96% of cash flow, creating exceptional revenue predictability. This stability finances both substantial dividend payments and growth investments. Enbridge has allocated 22 billion Canadian dollars ($17.2 billion USD equivalent) toward expansions through 2020, targeting 10% compound annual earnings growth accompanied by proportional dividend growth—positioning the company for market-outperforming returns.

Corporate Structures and Tax Implications for Midstream Oil and Gas Investors

Midstream oil and gas companies adopt varying structural frameworks affecting investor outcomes. Master Limited Partnerships (MLPs) avoid corporate-level income taxation but mandate 90% taxable earnings distribution to unitholders, who pay personal income taxes on those distributions. This structure complicates retirement account eligibility since Schedule K-1 tax forms replace standard 1099 reporting. Traditional C-Corporation structures follow standard corporate taxation models while enabling broader retirement account compatibility.

These structural differences significantly impact investor portfolio strategy, requiring careful analysis before midstream position establishment.

Projected Industry Growth and Investment Requirements

The Interstate Natural Gas Association of America Foundation projects midstream sector investments reaching approximately $800 billion through 2035—averaging $44 billion annually. Natural gas infrastructure captures majority focus with $417 billion allocated toward gathering systems, transmission lines, processing capacity, and LNG export facility development. Crude oil infrastructure requires $321 billion for gathering, transmission, storage, and export infrastructure. NGL-related assets demand an additional $53 billion for pipeline, fractionation, and export capabilities.

These capital requirements underscore the sector’s expansionary trajectory over the coming decades, creating substantial opportunity for enterprise growth and corresponding investor value creation.

The Investment Case for Midstream Oil and Gas Exposure

The midstream oil and gas sector presents compelling investment characteristics. Revenue models built on fee-based contracts and regulated tariffs produce cash flows demonstrating stability superior to broader energy sector volatility. This cash generation capacity funds some of the market’s highest-yielding dividend distributions while financing growth capital expenditures. Projected infrastructure investment requirements spanning two decades suggest midstream operators will experience substantial capacity expansion and cash flow growth, translating to dividend escalation potential and capital appreciation opportunities for equity investors seeking energy sector exposure coupled with current income generation.