A joint venture, as you know, is a business agreement between two parties to develop a new entity whereby each party contributes assets. Those assets could be cash, equity, operating assets or intellectual property. The key is that the companies see greater value in combining the assets than in operating them separately.
The energy industry is the king of joint ventures. There are two driving forces behind this phenomenon. First, energy exploration and production is very, very expensive. Many smaller firms simply cannot afford to develop the resources they've discovered. Energy exploration is also a very risky business. Joint ventures are great for spreading around that risk.
Some companies, like Devon Energy , have a specific rationale in determining how it plans to utilize joint venture partners. The company specifically utilizes partners in new venture exploration because it:
Improves capital efficiency
Accelerates de-risking and commercialization
Mitigates exploration risk
Increase flexibility to generate new prospects
Preserves cash flow for development projects
The company's most recent joint ventures include trading about a third of its emerging exploration acreage in two separate deals with foreign operators. Devon brought in about $4 billion in cash and drilling carries to fund these developments at a faster pace than it would have been able to do on its own.
Others take a slightly different approach. Chesapeake Energy just recently entered into its own joint venture with a foreign producer. In this case, the company just took the cash. The billion dollars will help the cash-strapped company to fund its developments in this acreage as well as across its portfolio. Its Chinese partner is looking to Chesapeake to provide it with on the job training that it can take back home to produce its own unconventional resources. In both cases the foreign partner was looking to exchange cash for access to emerging resources: One deal for the seller was about risk management, while cash management played a key role in the other transaction.
Energy industry ventures aren't just for upstream exploration activities. There are myriad examples in the midstream sector as well. These deals tend to have a slightly more strategic rationale behind them.
One recent example saw Energy Transfer and Enbridge team up to convert several segments of the Trunkline pipeline from moving natural gas to oil in a new 50-50 joint venture. The project will provide crude oil pipeline access from an Illinois hub to the eastern Gulf Coast refining market. The oil from the Illinois hub will be sourced from the Bakken Shale and Canadian oil sands, which currently can't access that market by pipeline.
This deal is about access and diversification. Enbridge has the access to these crude oil basins through its Southern Access Extension that is currently in development, but it needs a way to get that crude to the Gulf Coast. Energy Transfer's Trunkline pipeline would do the trick. Energy Transfer on the other hand has been looking to diversify its revenue into crude oil transportation. By joining forces both companies came out on top.
This venture is another important step forward for Energy Transfer, and its general partner Energy Transfer Equity , to finally be in the position to raise its distribution. The two have worked feverishly to diversify the revenue and simplify the structure. While the joint venture with Enbridge won't be the deal that finally fuels a distribution increase, it's another important venture to better position the company for the future.
As you can see, energy companies engage in joint ventures for a number of reasons. What you need to look for is the overarching reason behind the move. Is it geared toward providing capital for growth or toward delivering an important solution? Or is it more about cash management? Either way, expect to see a steady stream of joint ventures in the future; they really are becoming the way that energy companies do business these days.
Energy Transfer is increasingly using joint ventures as a way to provide a solution to the massive bottlenecks in takeaway capacity. While this is a problem for producers it creates an immensely profitable opportunity for midstream companies. Energy Transfer Partners plans to continue to help alleviate the glut in supply with its 23,500 miles of transformational pipelines. To see if ETP and its sizable dividend payment could be a good fit for your portfolio, you're invited to check out The Motley Fool's premium research report on the company. Simply click here now for a thorough expert analysis of this midstream company.
The article Why Do Energy Companies Form Joint Ventures? originally appeared on Fool.com.
Fool contributor Matt DiLallo has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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