Summary
- Natural gas offers unique advantages to data centers, including superior reliability and speed to market compared to renewables.
- Data centers are just one of the drivers of structural demand growth for US natural gas anticipated over the coming years.
- Midstream can be an attractive way to play the long-term growth in natural gas demand given fee-based business models that support generous dividends and provide some insulation from volatility in natural gas prices.
Midstream’s second quarter earnings calls reinforced the positive outlook for US natural gas demand driven in part by expected power demand from data centers. This note discusses the advantages of natural gas for data centers, additional factors contributing to demand growth, and how midstream is uniquely positioned to benefit from these trends.
Why natural gas for data centers?
Technology has been a leading sector for sustainability with a focus on renewable power, so why are these companies now looking to natural gas to power data centers? There are multiple factors at play. First, the overall need for power is likely too great to be met by renewables alone (read more). Beyond that, natural gas offers superior reliability for facilities required to run 24/7 compared to the intermittency of solar and wind. For tech companies in a race to build out data center capacity, natural gas also provides speed to market.
One of the challenges with using renewable power is the need for new transmission lines, which are difficult to permit and timely to construct as noted on Kinder Morgan’s (KMI) recent earnings call. Former energy secretary Ernest Moniz acknowledged that natural gas is needed to fill the gap, citing the “huge impediment” caused by the inability to quickly construct transmission infrastructure.
With data center operators looking to quickly advance projects, access to natural gas is a necessity. Today, companies are looking to build data centers in areas with ample natural gas supplies, a constructive regime for air and pipeline permits, and relatively easy pipeline access as discussed on Williams’ (WMB) recent call.
Data centers add to an already-robust outlook for US natural gas demand.
Data centers are just one contributor to structural demand growth expected for natural gas in the coming years. On the power side, coal plant retirements and new natural gas capacity to back-up renewables are also driving growth. S&P Global estimates 133 new natural gas power plants are under development in the US. Industrial reshoring has also been topical. Separately, US LNG export capacity is set to rise by 80% or over 11 billion cubic feet per day (Bcf/d) later this decade (read more), and exports to Mexico are also expected to increase (read more).
In April 2024, Wood Mackenzie projected US natural gas demand growth of 20 Bcf/d to 2030, which includes growing LNG exports and 3.9 Bcf/d of incremental power demand. The forecast implies growth of 19% relative to 2023. However, KMI management believes power demand could result in even greater growth than forecasted. The opportunity set for midstream companies related to natural gas demand for power generation and data centers described on 2Q24 earnings calls seems to support that the forecast could be low.
Midstream projects are already advancing and commercial discussions are ongoing.
A few pipeline expansions have already been announced in connection with growing natural gas demand for power generation. In July, KMI announced an expansion to its Southern Natural Gas pipeline system by 1.2 Bcf/d to meet growing demand in the Southeast. WMB is developing Transco’s 1.6 Bcf/d Southeast Supply Enhancement project to serve the Southeast and Mid-Atlantic. WMB management described this as the first of a few expected projects related to growing natural gas demand for power generation and noted that Southeast Supply Enhancement has the best return of any large Transco project.
While a few expansions are advancing, most opportunities are still under discussion. KMI noted over 5 Bcf/d of power demand opportunities, including 1.6 Bcf/d related to data centers, on its 2Q24 earnings call. DT Midstream (DTM) is having commercial discussions around six potential projects to support data centers. DTM indicated opportunities primarily relate to laterals (i.e. smaller pipelines branching off from larger pipelines, called main lines) but should be supportive for their overall network as they look to meet new demand and leverage existing infrastructure.
ET also highlighted conversations with multiple data centers on its 2Q24 call, noting that many want to have power generation on site. WMB is seeing strong demand across its operations, including the Southeast, Mid-Atlantic, the Rockies, Idaho, Utah, and Washington. While not all of these conversations will lead to agreements and projects for every company, the level of activity across geographies is encouraging.
Why midstream?
Given the bullish outlook for natural gas demand, investors may be contemplating the best way to play this trend. Midstream is uniquely positioned to benefit from growing demand and the production growth required to meet that demand, while also offering other portfolio benefits.
Recall, midstream companies predominantly earn fees by transporting, storing, and processing energy commodities. Some companies operate long-haul natural gas pipelines like Transco and Southern Natural Gas. Some of those companies and others also operate gathering and processing (G&P) businesses, which collect natural gas from wells using smaller pipelines and then process natural gas into usable form. G&Ps facilitate production growth, while large natural gas pipelines help meet increased demand. Leveraging existing networks can also lead to more attractive project returns as highlighted by WMB’s Southeast Supply Enhancement project.
Importantly, midstream’s fee-based business models provide insulation from natural gas prices, which have been historically volatile and seasonal given weather impacts. Midstream can also be an attractive way to play a multi-year trend due to its attractive yields. As of August 22, the Alerian MLP Infrastructure Index (AMZI) was yielding 7.4%, and the Alerian Midstream Energy Select Index (AMEI) was yielding 5.7%.
For context, companies primarily focused on the pipeline transportation of natural gas represent 24.5% of AMZI and 40.7% of AMEI as of August 22. Constituents classified as G&P companies represent 25.5% of AMZI and 26.9% of AMEI.
Bottom Line:
Midstream companies are well positioned to benefit from a robust outlook for US natural gas demand over the coming years driven by rising power demand and growing exports.
Related Research:
Midstream/MLPs: AI Adds to Positive Natural Gas Outlook
For Midstream, It Pays to Have Natural Gas Storage
US LNG Export Capacity to Rise 80% by 2028
Midstream Connects US Gas with Growing Mexican Demand
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