The Next Wellhead

The Next Wellhead

U.S. Energy Services became one of Minnesota's fastest-growing companies thanks largely to natural gas deregulation. Climate change legislation could fuel its next boom.

It’s a damp, late October morning. A chill is in the air, but the cold that’s coming in another month or so is what’s of most concern at U.S. Energy Services’ 12th-floor office overlooking the western suburbs.

Soon, pipelines carrying natural gas to the Twin Cities will be pushed to capacity as Minnesotans fire up their furnaces for the season. It’s the responsibility of this roomful of buyers and analysts at U.S. Energy Services in Plymouth to keep the fuel flowing to the company’s customers, even on the coldest of winter days.

It’s a calm scene for a space where more than $400 million worth of transactions passed through in 2008. A financial network’s tickers scroll past on a muted television, while employees quietly toggle between price charts and instant-message windows, which they use to talk with buyers and sellers.

The day before, in Beatrice, Nebraska, there was a mechanical failure at a pipeline compressor, which pushes gas through the pipeline. Since that meant gas wasn’t flowing normally through one of the pipeline system’s primary arteries, U.S. Energy Services’ employees were negotiating to transport their customers’ gas via a different route. “Every day has its own set of potential issues,” says Todd Overgard, the company’s president.

U.S. Energy Services’ primary business is helping large users of natural gas buy direct from producers or pipelines instead of settling for standard utility rates. That couldn’t be done before the federal government deregulated natural gas in the 1980s. Now, two decades later, U.S. Energy Services is preparing to capitalize on another regulatory shift.

Congress is widely expected to pass legislation this year that will either tax carbon emissions or establish a carbon cap-and-trade system. U.S. Energy Services believes that it’s well positioned to help its clients meet new carbon reporting requirements and participate in what some predict could become a $100 billion carbon-credit trading market.

“We’re sitting between the producers of energy and the consumers of energy. We’re in an ideal place to participate,” says Casey Whelan, the company’s vice president for business development. “It’s too early to figure out exactly what is our role, but we know there will be a role for us.”

The changes could usher in a reprise of the company’s beginnings, when its founders carved out a role created by changes in natural gas regulation.

The Anti-Enron

When U.S. Energy Services’ CEO William Bathe took a job out of college with Northern Natural Gas, an Omaha pipeline company, in 1979, the natural gas business was a different, and duller, industry than it is today. Gas producers were allowed to sell only to a single customer—namely, whichever regional pipeline company covered a particular territory. What’s more, the federal government determined the price, which in the mid-1970s was around 25 cents per unit.

Then came President Ronald Reagan. As part of a wave of industrial deregulation that began in the Carter Administration, the federal government voided the lifetime contracts that pipelines had with producers. In a gradual process that began in 1985 and was largely completed by 1992, the government scrapped price controls and dropped restrictions on who could own pipelines.

“The federal government said, ‘You know what, we’re going to let people build pipelines. We’re going to let end-users build pipelines. We’re just going to unravel this whole thing,’” Bathe recalls. “They just said, ‘We’re rewriting the rules.’”

Mergers and acquisitions followed the deregulation. In 1986, Bathe’s employer, now called InterNorth, purchased a company called Houston Natural Gas, whose CEO was one Kenneth Lay. In 1987, the company changed its name to Enron; under Lay’s leadership, the new entity would soon move its headquarters from Omaha to Houston.

Faced with leaving the Midwest if they wanted to maintain their positions, Bathe and a group of his colleagues decided instead to hit the road for Minnesota, a place where Bathe spent his first few years with Northern Natural Gas, and a place where there weren’t yet any companies marketing natural gas.

Bathe’s company changed its name and focus a couple of times in the early years before settling on being an agent for customers with large natural gas and other power needs, notably manufacturers, ethanol plants, and school districts. The role is similar to that of a realtor or a travel agent, someone who knows the market and how to get a fair deal.

Around the country, hundreds of companies act as natural gas brokers or agents. U.S. Energy Services distinguishes itself by also offering consulting and engineering services related to natural gas procurement. In 1991, the company used its engineering ability to become the first private pipeline to go around the utility’s distribution system. Its client, Shakopee-based Rahr Malting, was negotiating for a better price, and when the utility balked, Rahr built a pipeline from its facility directly to an interstate pipeline.

“We were trying to get a competitive price, and really the only alternative we had was to build,” Bathe recalls. “Once the pipeline is built, now we have negotiating power with a lot of other customers in Minnesota because we can actually do it. It created an opportunity for us to negotiate in good faith.”

Natural gas buyers need to negotiate two separate prices. One is the price they pay for natural gas. The other is the rate they pay to transport it. The pipelines work a bit like airlines. Whoever owns them or owns the rights to their capacity can sell space for whatever the market will pay. And pipelines in a Minnesota winter are in the same position as airlines on Thanksgiving Eve.

“It’s a high travel season. The airlines are managing seats on an airplane. We’re managing space on a pipeline,” Bathe says. Using that analogy, building the Rahr Malting pipeline was like introducing a Southwest Airlines to the market.

It’s the kind of service that’s valuable to companies big enough to run up large energy bills but not big enough to dedicate full-time resources to manage energy purchases, says Bill Coldwell, facility development and asset manager at Donaldson Company. The Bloomington-based filter manufacturer has been a client of U.S. Energy for a couple of years. “They provide some expertise that we don’t have,” Coldwell says. “We could get it, but why would you want to?”

Inc. magazine has ranked U.S. Energy Services as one of the fastest-growing private firms in the country—341 out of 500, or number 16 in the energy category. The company’s gross revenue nearly quadrupled in 2008 to $439 million from $112 million in 2007. About $400 million of that is pass-through revenue from its customers’ energy purchases. Taking that amount out, U.S. Energy Services’ revenues were $23 million in 2008, up from $13 million in 2007.

However its money is measured, U.S. Energy Services is growing fast. And more fast growth might be on the way: U.S. Energy Services believes its next opportunity could come from other colorless, odorless gases: those containing carbon.

 

The Carbon Conundrum

The company has been preparing a new unit for the past two years to help clients comply with and capitalize on new carbon legislation and regulation expected out of Washington. Whelan, who heads the unit, said it already can provide clients with carbon reporting data associated with energy consumption, something many of its customers are required to report to federal environmental regulators as of January 1. “We’re assisting our clients in understanding what the rule is and what needs to be done to comply,” Whelan says.

The carbon emissions reporting rule is only the beginning. Legislation that was working its way through the House and Senate as of this story’s publication would have a “very, very dramatic” effect on how energy is consumed in the U.S., Whelan says. In preparation, the company is assisting clients with managing carbon credits.

Carbon credits can be considered a blanket term that covers both carbon offsets and carbon certificates. Offsets are certified proof that a company has done something to lower its carbon emissions—planting trees, say, or reducing their products’ packaging. These offsets can be sold to companies that wish to claim a reduction in their own “footprint.”

Carbon certificates are documents that would be established under a cap-and-trade system. A certificate would be created for each unit of carbon allowed. No company would be allowed to emit more than the number of certificates it owned.

One example of this in action from U.S. Energy’s own practice is a landfill that captures methane and transports it to a nearby industrial user, which burns it as an alternative fuel to natural gas. U.S. Energy Services assisted with the accounting and certifying associated with creating carbon-offset credits. Those offsets could then be sold, either via a voluntary market such as the Chicago Climate Exchange, or else directly to private buyers.

Regardless of what the final federal legislation looks like, it’s going to affect the risk-management profile of most if not all of U.S. Energy Services’ customers, says Eric Jackson, president and chief sustainability officer of Minneapolis-based Conservis, which provides advisory and software services to help companies manage sustainability programs and track greenhouse gas emissions. It makes great sense, he says, for U.S. Energy to then offer services to help their customers manage that risk.

“I think it’s actually brilliant,” Jackson says. “The reason they set up the business originally was that the old utilities where they all used to work were slow moving and slow to act, even in a deregulated environment. These guys are nimble and smart, and they’re able to see the forward need and act upon that, rather than [have to] sit around and die a thousand deaths from committee meetings that the utilities face.”

Jackson believes that as a result of adding carbon management services, U.S. Energy Services’ core gas and electric business will grow, too, “because they’ve recognized an up-and-coming customer need and they’re attending to it.”

Greenhouse Bandwagon

How big the market for carbon services gets and how much of it goes to U.S. Energy Services is still anybody’s guess. The company has lots of competition. Utilities, law firms, technology companies, and scores of entrepreneurs are all preparing similar efforts to help carbon emitters manage the change.

“It’s something a lot of people are paying attention to, not just from the cost side but also in terms of what opportunities might be available out there,” says Jonathan Dettmann, a leading attorney in Minneapolis-based law firm Faegre & Benson’s climate change and sustainability practice. It’s one of several law firms to recently launch practices centered on climate issues.

Dettmann is seeing a few different types of companies emerging to address carbon management. One is offering consulting services such as those provided by law firms or companies like U.S. Energy Services. Another is developing software and hardware for measuring carbon emissions, and a third is working on techniques for mitigating or reducing carbon emissions.

In Chanhassen, Rosemount Measurement is seeing an uptick in demand for its air flow meters, used to measure the volume and composition of gases moving through an emission stack. A division of St. Louis–based energy-controls manufacturers Emerson Process Management, Rosemount Measurement employs about 1,800 people in Chanhassen and Eden Prairie.

Rosemount Measurement’s devices have been used for years by large emitters to comply with reporting requirements on sulfur, nitrogen, mercury, and other regulated gases. Many of its products already had the capability to measure carbon. “It fortunately doesn’t require a lot of new product development for us,” says Alan Novak, director of alternative fuels for Emerson. “It’s just a new market that’s opening.”

The U.S. Environmental Protection Agency’s greenhouse-gas reporting rules that went into effect January 1 apply to even relatively small emitters. Indeed, Novak says that much of the new demand is coming from smaller emitters that previously weren’t required to measure their emissions.

Conservis, meanwhile, is selling software to help companies manage all the data collected from devices like the ones that Rosemount manufactures. Jackson partnered with Minneapolis-based StoneArch Software last year to launch the new company, which has since grown to about 20 employees, with offices in Palo Alto and Brussels.

“Regardless of whether you want to trade carbon or simply need to gather data and manage your carbon exposure, you will need a software platform that can deal with all the nuances of this as professionally as a normal accounting software program will,” Jackson says.

Jackson believes that Conservis’s software does just that. His company took existing StoneArch software used for Sarbanes-Oxley compliance and combined it with a greenhouse-gas management system. The program is unique, says Jackson, in that it allows companies to easily manage data from multiple sources and facilities.

Conservis is targeting its software and services at Fortune 1000 companies, large institutions, and government agencies, and it’s already seeing plenty of demand well in advance of carbon taxes or cap-and-trade legislation. The January 1 reporting rule is one factor, but companies have other reasons for wanting accurate carbon reporting, too. The U.S. Securities and Exchange Commission requires public companies to disclose risks to investors, and that includes risk due to carbon regulation and global warming. Also, companies making environmental claims about products may be subject to legal action if they can’t prove statements they make about their carbon footprints.

For U.S. Energy Services, the new federal rules are “going to create essentially a whole new commodity, which is carbon emissions, that has to be managed, and it’s going to impact literally hundreds of thousands of entities,” the company’s Whelan says. “If we execute, it could be as big as our existing business. The potential is limitless. It could improve growth by 10 percent, or it could become the driver of our company.”

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