Streamline Energy Partners: Teaching Note & Financial Analysis

SEM is a case study on managing pipeline capacity using incremental cost analysis for use in graduate and executive education. This is its teaching note.

This case focuses on pricing strategy within the capital-intensive midstream energy sector, which transports natural gas and other hydrocarbons from production areas to processing plants and markets. After analyzing this case, participants will develop skills in cost classification, incremental analysis, and strategic financial decision making under infrastructure and capacity constraints. They will also examine how asset-heavy industries must balance contract structures, spot market opportunities, and long-term capital investments to remain competitive.

Learning Objectives

By the end of the case discussion, participants should be able to:

1. Distinguish between fixed, variable, and semi-variable costs in capital-intensive industries.

2. Perform incremental revenue and cost analysis for strategic pricing decisions.

3. Evaluate multiple strategic options using a pricing strategy lens.

4. Analyze the role of capacity utilization in impacting company profitability.

5. Apply pricing strategies in capital-intensive, regulated industries.

The Industry Context

The midstream segment of the oil and gas industry plays a crucial connecting role in the transportation, storage, and initial processing of hydrocarbons. This sector includes companies that operate pipelines, compressor stations, terminals, and related infrastructure. Midstream companies are distinguished from upstream producers (which extract oil and gas) and downstream entities (which refine and market finished products).

At least five significant characteristics amplify the significance of incremental cost pricing strategy approaches for the midstream industry sector.

1. Capital-intensive business model: Midstream companies must invest heavily in infrastructure that often has a lifespan of 20 to 30 years. These assets incur high upfront costs and ongoing regulatory and maintenance expenses.

2. A high proportion of fixed costs: Due to the inherent nature of pipeline operations, a large proportion of costs is fixed. These include depreciation, control room operations, and right-of-way payments. Profitability is highly sensitive to throughput volume.

3. Contract structures: Revenue is typically derived from long-term contracts with shippers, based on either fixed fees on a per volume basis or capacity reservation. Additionally, excess capacity may be marketed using spot contracts, allowing for a variable pricing component in the company’s price structure.

4. Regulatory environment: Midstream operations are subject to federal and state regulations covering safety, emissions, and land use. Compliance costs are often substantial and are independent of transported volumes.

5. Competitive pressure and overcapacity: In certain geographical areas of the United States, such as the Permian and the East Texas basins, pipeline overbuild has resulted in fierce competition. Companies are under pressure to set themselves apart from competitors through pricing, service differentiation, or cost control.

Key teaching points and insights provided by this case

Understanding the cost structure and classifying costs: Participants must classify a complex set of costs into fixed, variable, and semi-variable components to understand operating leverage and pricing flexibility.

Incremental analysis: Participants learn that only costs and revenues that change as a result of the business decision should be included in the analysis, which means many seemingly relevant costs should be ignored. Sunk costs and allocated overheads that are unaffected by volume changes should also be excluded. What this does is make prices that seem too low far more profitable than they appear at first blush.

Asset utilization vs. asset expansion: In infrastructure-heavy industries, increasing the throughput of existing assets is often more profitable than building new capacity. This case helps illustrate how marginal improvements in utilization can reverse significant losses. Dramatic new investments or strategy overhauls are not necessary.

Service differentiation and pricing power: By offering premium services, companies can practice price discrimination, extracting additional value from customers with specific needs, such as guaranteed capacity or flexible scheduling.

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Financial Analysis Framework

Step 1: Current Situation Analysis

Current Monthly Performance:

• Revenue: $4,050,000

• Total Expenses: $4,495,000

• Operating Loss: ($445,000)

Key Metrics:

• Total available capacity: 600 MMcf/d

• Current volume: 450 MMcf/d

• Contracted volume: 400 MMcf/d

• Spot volume: 50 MMcf/d

• Capacity utilization: 75% (450/600)

• Monthly volume: 450 MMcf/d × 30 days = 13,500 MMcf/month

Revenue Calculations:

Contracted Revenue: 400 MMcf/d × 30 days × 1,000 Mcf/MMcf × $0.30/Mcf = $3,600,000