Is the Water Midstream Sector Ready to Scale?

TPG’s recent deal for water-infrastructure provider Goodnight Midstream suggests the sector may see larger players emerge

Not long ago, some private-equity investors set out to profit from the need to better manage the huge volumes of water being produced as a byproduct of oil-and-gas drilling in the U.S.

A recent $1.2 billion deal suggests that a few of these bets may be ready for the big leagues.

TPG Capital, the private-equity arm of asset manager TPG, recently bought a majority stake in Goodnight Midstream LLC, a provider of water infrastructure for the oil-and-gas industry, for $930 million from private-equity fellow Tailwater Capital and other investors. The deal included an additional $300 million in investor commitments to fund the company’s expansion. Midmarket-focused Tailwater first backedGoodnight Midstream in 2016 with an $80 million commitment.

TPG’s transaction is a sign that some water-management businesses are growing large enough to attract deep-pocketed private-equity investors.

“The $1.2 billion [deal] is a high mark for water-infrastructure transactions,” Evan Tikka, a senior consultant at the oil-and-gas practice of consulting firm Wood Mackenzie, said in an email.

Water infrastructure is attracting more attention and capital as oil-and-gas producers increasingly turn to pipelines as a replacement for the less efficient and more hazardous option of hauling water away by truck, industry executives said. That’s particularly true in the Permian Basin of West Texas and southeast New Mexico, where much of U.S. oil-and-gas drilling is concentrated today.

“Water investors still get exposure to Permian activity but aren’t exposed to as many risks,” Mr. Tikka said. “We’re certain produced water volumes will grow.”

Goodnight Midstream’s network, for one, has a total capacity of more than 350,000 barrels of water a day. Another private equity-backed water company, WaterBridge Resources LLC, which was formed in 2016 with a $200 million investment from Five Point Energy, can dispose up to 1.5 million barrels of water a day through its network in the Permian, Five Point said.

Until recently, however, not all large energy-infrastructure investors were convinced the water space could gain enough critical mass to generate a significant number of investment opportunities.

“The question is, how can you scale it up? Can you build a company of enough magnitude to find someone to ultimately buy it?” Greg King, a managing partner at private-equity firm EnCap Flatrock Midstream, said during an interview back in August.

TPG began to search for investment opportunities in water infrastructure a few years ago, but it had to wait until potential targets achieved a certain size and capability, according to Christopher Ortega, a partner who leads TPG Capital’s energy and natural resources group.

“We did look at pretty much all the water assets out there,” Mr. Ortega said. “Many of them had a significant trucking component to their businesses, which we were not attracted to.”

It’s too early to tell how many large players the water-infrastructure sector eventually will be able to sustain. Mr. Ortega said he’s confident Goodnight Midstream, at least, can expand to a point it could attract a buyer or go public down the road, if TPG chooses this exit path for the investment.

“I don’t think we’re going to end up with a fragmented industry,” he said. “But I think we’re going to see a small handful of platforms emerge that are able to achieve scale over the next five to 10 years.”

— Luis Garcia