MERGERS & ACQUISITIONS • PRIVATE CAPITAL• STRATEGIC ADVISORY

AN OVERVIEW OF NONDESTRUCTIVE TESTING

Energy Sector Report

Introduction Nondestructive testing (NDT) is the use of non-invasive analysis techniques to
quantitatively inspect, measure and evaluate the safety and integrity of
mission-critical infrastructure and systems without interfering with the overall
operation or future usefulness of those assets. This creates an interesting
proposition for asset owners and operators within the oil and gas industry, who
must balance increasingly stringent, non-discretionary regulatory and
environmental compliance and safety requirements placed on energy drilling,
production, transportation, storage and processing assets and systems.

The NDT market represents a sub-segment of the broader testing, inspection and
certification (TIC) industry, a $125 billion global market. The TIC industry spans a
diverse range of primary end markets, including energy, manufacturing,
transportation, aviation and healthcare. Driven by the perpetual and increasing
demand for safety, quality and compliance, companies in the TIC industry
provide a vast array of services throughout the full lifecycle of the underlying asset.
The NDT market has displayed considerable expansion recently as a result of
secular growth driven by recurring maintenance spending and expansionary
capital investment, resulting in an estimated $3.5 billion in annual spending in the
industry across all end markets. However, improvements in safety remain the
primary motivator for TIC services as firms attempt to minimize the probability of
catastrophic failure, especially as a result of the several recent, high-profile
incidents noted in CHART A. This graphic illustrates the evolution of the NDT
industry in response to technological advancements, end market demands and
regulatory forces over the past two centuries.

CHART A: Evolution of the NDT Industry

1800s 1920s-1950s 1950s-1980s 1980s-Present

“Oil and Whiting” and Visual Magnetic Particle; Digital Radiography,

Inspection methods
Technological
Innovation 1895: X-Rays discovered by
Wilhelm Conrad Röntgen
Eddy Current; Industrial
Radiography; Ultrasonic;
Acoustic Emissions
Testing developed
Automated Phased Array
9 Data management, risk-based
analysis and predictive analytics
services

Application of NDT Shale play proliferation

Growth spurred by WWII
End Market Emergence of and quality requirements
NDT within the rail and across the transportation,
Developments automotive industry maritime, aerospace and
industrial sectors
Regulatory
Forces Growing, but highly
fragmented regulatory
framework
across numerous end markets
such as energy,
healthcare, chemicals
Increased globalization of
international standards and
best practices
1976: ASNT establishes NDT
level III certification program
April 2010: BP Macondo
oil spill – catalyst for
heightened compliance
requirements in the GOM
September 2010: San Bruno
pipeline explosion – triggered
national pipeline regulation
movement
Workplace Safety Rule/SEMS
Mandatory MI programs for all
production assets

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NDT services validate the integrity of materials and process equipment by detecting
defects/deficiencies that could lead to failure and by providing analyses on asset life, asset
usage, etc., offering a balance between quality control and cost effectiveness. This results in
improved performance economics due to reduced repair costs, extended asset life,
greater levels of safety, higher asset quality and compliance with standards and
governmental regulations. Additionally, capacity utilization is improved as a result of
reduced scheduled or unexpected downtime. The most common methods of NDT include
visual inspection, liquid penetrant inspection, magnetic particle inspection, radiography,
Eddy current testing and ultrasonic inspection, which are described in further depth in
CHART B.

CHART B: Common Methods of NDT

 Most basic inspection method, which utilizes tools such as fiberscopes, borescopes and magnifying glasses
Visual Inspection  Large tanks, vessels and sewer lines can be inspected with the a portable video inspection unit
 Robotic crawlers permit observation in hazardous or tight areas, such as air ducts, reactors and pipelines

 A liquid with high surface wetting characteristics is applied to the area of inspection and allowed to seep in to
Liquid Penetrant the surface breaking defects
Inspection  A developer in the form of a powder is applied to the area’s surface to pull out and collect the trapped liquid
 The accumulated liquid is loaded with a dye and inspected under UV light to reveal potential defects in the area

 The part to be inspected is first magnetized and coated with finely milled iron particles
Magnetic Particle
Inspection  The iron particles are attracted to magnetic flux leakage fields and will cluster directly over any discontinuity in
the part, creating a visually detectable indicator under correct lighting conditions

 The source of radiation can come from either an X-ray generator or a radioactive source to examine a part
Radiography  In film radiography, the part is placed between a radiation source and a film piece, which will display relatively
darker or lighter areas of development depending on the density of specific sections of the part

Eddy Current  Uses electromagnetic induction to detect flaws in conductive materials

Testing  Well suited for detecting surface cracks but can also be used to make coating thickness measurements

Ultrasonic  High frequency sound waves are introduced into a material and are reflected back from surfaces or flaws
Inspection  Reflected sound energy is displayed as a cross section of the part’s depth of features that reflect sound

The NDT universe is a highly fragmented market of service providers that includes small,
locally operated companies, as well as a select group of larger, more diversified players.
Within this market, few independent companies possess the size and scope (across both
service lines and end markets) to operate as a one-stop shop for all end market customers.

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 A Shifting A variety of factors continues to influence the evolution of the TIC and NDT
Landscape for the markets:
TIC/NDT Industry
Increasingly stringent regulations, codes and standards

Trend towards outsourced services

Consolidating base of service providers

Increasingly Stringent Regulations, Codes and Standards

Within the broader TIC industry and NDT sub-sector specifically, significant
standards and oversight of engineering services and non-destructive testing are
already in place both domestically and internationally through organizations such
as the American Society of Mechanical Engineers (ASME) and International
Organization for Standardization (ISO). However, in response to high profile
incidents, including the BP Macondo disaster (2010), the San Bruno pipeline
explosion (2010) and the BP Texas City refinery explosion (2005), a more stringent
focus on safety, environmental sustainability and regulatory compliance continues
to develop. According to a recent study by Forbes magazine, more than half of
executives interviewed cited
CHART D: Biggest Concerns Facing
regulations and environmental
Energy Industry Over the Next 5 to 10 Years
opposition as the biggest (% of Executives Interviewed)
concerns facing the energy
industry over the next 5 to 10 Regulations 66%

years (summarized in CHART Environmental Opposition 52%

D). As a result of the Shortage of Skilled Workers 27%

heightened public and Foreign Market Instability 23%

regulatory focus on safety, asset
Lack of R&D Financing 21%
owners and operators across the
Difficulty Finding New Supply 20%
industry are continually faced
Other 7%
with high economic and
0% 20% 40% 60% 80%
reputational costs of
Source: Forbes 2012
non-compliance.

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 Trend Towards Outsourced Services

As a result of the increasing sophistication of NDT methods and stricter

regulations, combined with the increased usage of data for compliance, insurance
and engineering purposes, asset owners and operators across the energy spectrum
are: i) increasingly complementing their in-house NDT and mechanical integrity
testing functions to third-party providers and ii) tightening the selection criteria in
their choice of vendor partners. Given the mission-critical nature of NDT services,
the industry shift away from smaller, less-capitalized operators to larger,
professional service providers with broader capabilities has
disproportionately benefitted more established companies over the past few years.

Consolidating Base of Service Providers

The global TIC industry remains highly fragmented, with nearly 60% of the market
comprised of small companies generating less than $13 million in annual revenues.
However, a select group of major players and
several mid-sized service providers have CHART F: TIC Market Share
remained highly acquisitive in an attempt to
bolster their portfolio of service offerings and
gain access to new end markets. One particular 41%

driver behind consolidation trends is the

59%
limited and aging workforce of certified
technicians, with the average age of NDT
inspectors having increased from 41.5 years in
<$13 Million of Revenues
2006 to 45 years in 2010. CHART F illustrates
Large-Cap Providers
the highly fragmented nature of the TIC
industry. Source: Analyst research

End Market Primary customers for NDT services across the energy markets include: i) oil and
Customers of NDT gas exploration and production companies; ii) offshore oil and gas structure
Services in the fabrication contractors; iii) offshore and onshore oil and gas pipeline owners,
Energy Sector
operators and contractors and iv) oil and gas drilling and production equipment
manufacturers. CHART G, displayed on the following page, presents the NDT
requirements associated with primary energy infrastructure across the primary end
market in the energy sector.

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CHART G: NDT Requirements of Key Energy Infrastructure

Critical Infrastructure NDT Requirements

Onshore  Evaluation of pote ntial we llhe ad site s and

inspe ction of fabricated piping
 Exte nsive drill pipe and tool inspe ction, utilizing
Well Completion bottom hole assembly inspe ction and full le ngth
Equipment ultrasonic inspe ction
 Casing and coil tubing inspe ction using EMI
e quipme nt to e valuate we ll de te rioration
 Re curring e valuation of e quipme nt and material
inte grity once we ll be comes productive due to
Onshore Production incre asingly harsh ope rating conditions of ne w
Facilities drilling te chniques
Upstream

Offshore  Inspe ction of fabricated piping and pre ssure

ve ssel we lds and valve s
 Ongoing inspe ctions and maintenance of
Offshore Fabrication production platform piping syste ms and critical
Yards infrastructure
 Me chanical inte grity programs mandated for all
production e quipme nt and systems in the GOM
 In-line inspe ction of rise rs, inte rnal we lds and
othe r difficult to access platform infrastructure
Oil and Natural Gas
 Industry pre ssure mounting to incre ase
Production Platforms
inspe ction fre quency

 Inspe ctions for pipe line inte rnal and e xternal

corrosion and cracking
Onshore Oil and
 We ld inte grity te sting
Natural Gas Pipelines
Midstream

 Point-to-point inspe ctions and assessments of

pipe wall thickne ss to de te ct le aks and localize
de ficie ncies
 Inte grity management, fitne ss-for-purpose
Offshore Oil and assessment and risk-based assessment required
throughout the ope rating life of the pipe line
Natural Gas Pipelines
 Ce rtification of distribution pipe line safety,
pursuant to re gulatory standards

 High-te mpe rature corrosion monitoring of

critical plant e quipme nt and piping systems
Petrochemical /
 In-line assessments of rotating equipment to
Downstream

Chemical Plants
minimize downtime and improve utilization
 Me chanical inte grity and pre dictive
mainte nance to prolong the ope rability of
rotating e quipment and plant assets

Oil and Natural Gas  Ce rtification of asset installation, maintenance

and re pair
Refineries
 Re pe titive service ne eds drive n by pe rpetual
ope rating schedule s

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 Overview of the Upstream Energy Sector

Upstream Energy The upstream energy market is comprised of oil and gas exploration and
Sector Overview production (E&P) companies that drill for and extract oil and natural gas from
inland and offshore deposits. According to industry resources as of May 2014,
there are approximately 1,854 onshore and offshore drilling rigs currently operating
in the United States producing approximately 7.8 million barrels of oil per day.
Upstream activity reflects the global demand for oil and gas, which has continued
to rise in large part due to the sustained growth in long-term energy demand,
particularly from emerging economies.

Onshore Market Onshore Market

Overview The onshore oil and gas value chain starts with the exploration of suitable drilling
areas and is set in motion after wellsite activity is permitted at either the federal or
state level. After identification, investment in infrastructure and equipment is
necessary to complete the wellsite in preparation for drilling activity. During the
well completion phase, NDT services are necessary to ensure operational safety and
productivity once the wellsite becomes active. Drill pipe and tool inspection has
been made increasingly effective through the use of computerized electromagnetic
inspection, which quickly and accurately detects pipeline wall deterioration and
other defects. Once well production begins, NDT inspection services are required
on a continual basis to conduct follow-on testing and to ensure all equipment
functions properly. CHART H illustrates the onshore oil and gas process.

CHART H: Oil and Gas Operations Process

Advanced Drilling Techniques Spur Escalating Wellsite Cost Ensure Environmental Disasters Drive
Continued Growth Demand for NDT Services Increasingly Stringent Regulation

Exploration and Drilling, Casing and Well Oil and Gas Onshore
Drilling Activity Completion Well Production Pipelines
Recurring
Pipeline
 Manages
Exploratory Drilling Well Completion Well Production Inspection and
 Identification of suitable z
 Casing and tubing  Continual follow-on Maintenance
conservation of
federal lands areas to initiate large-scale, inspection necessary to work and inspection
and natural profitable drilling operations enable wells to produce oil necessary once well
resources or gas becomes operational

> 60% ~ 75% 140 $6.5 M - $9.5 M

First year decline rates of of all U.S. drilling activity in Year estimated supply of to drill a horizontal well,
natural gas shale plays 2013 was horizontal and domestic natural gas nearly double the cost of
directional drilling reserves conventional well drilling

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The onshore market has been influenced by three primary trends, including: 1)
increasing onshore drilling activity; 2) greater wellsite costs as a result of escalating
operational complexity; 3) growing service intensity; and 4) more stringent
environmental regulation.

Increase of Onshore Drilling Activity

The need for E&P investment and related NDT service support has grown in
tandem with greater onshore drilling activity. Industry sources agree that the
“easy” energy sources are becoming scarce as a result of this increase in activity. In
response, E&P companies allocated a record high $678 billion in 2013 to capital
spending, a increase of 10.0% from 2012.

The migration towards advanced extraction techniques and processes, such as

directional drilling and hydraulic fracturing has been dramatic, unlocking
significant reserves in unconventional formations. However, the use of new
drilling techniques has resulted in much higher production decline rates between
resource plays: while a standard
vertical well historically CHART I: Rising Well Count and Footage Drilled
experienced decline rates of about Average Footage Drilled Per Well

20% to 30% in its first year of 2009: 6,233 ft. 2013: 7,284 ft.

production, initial observations 60

U.S. Well Drilled (000s)

45 47 48
50 40
suggest a first year decline rate in 40 34
excess of 60% for natural gas and 30
20
liquid-rich shale plays. This shift
10
is expected to drive shorter 0
duration, but more frequent 2009 2010 2011 2012 2013
450
Footage Drilled (mm ft.)

expansionary drilling activity. 375 335 346

311
CHART I supports the increased 300 264
215
importance of wellsite NDT 225
150
services as operators are forced to 75
drill more wells in closer 0
2009 2010 2011 2012 2013
proximity to maintain the
Source: Analyst Research
production levels of their
positions.

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 Escalating Operational Complexity Resulting in Greater Wellsite Costs

The widespread adoption of advanced drilling techniques has culminated in

significantly higher service intensity levels and wellsite costs that average two to
three times more than conventional methods. According to an EIA analysis of
well-related expenses in the Eagle Ford, Marcellus and Bakken shale plays, the
average cost of drilling horizontal wells can range from $6.5 million to $9.0 million
compared to approximately $2.0 million to $5.0 million for conventional vertical
wells. Driving these escalating costs are the greater lateral lengths and fracturing
stages per well that characterize unconventional drilling applications (reflected in
CHARTS J and K). Notably, the extended lengths of underground infrastructure
required for horizontal drilling increase the incidence of malfunction.

CHART J: Increasing Lateral Lengths CHART K: More Fracturing Stages

12,000 45
2008 Average: 4,060 ft. 40 2008 Average: 9 Stages

Average Frac Stages Per Well

Average Lateral Length (Feet)

10,000 2011 Average: 8,333 ft. 2011 Average: 25 Stages

35

8,000 30

25
6,000
20

4,000 15

10
2,000
5

0
0
Bakken Eagle Ford Fayetteville Haynesville Marcellus Woodford
Bakken Eagle Ford Fayetteville Haynesville Marcellus Woodford
2008 2009 2010 2011 2008 2009 2010 2011

Source: Baker Hughes, Analyst Research Source: Baker Hughes, Analyst Research

Growing Service Intensity

In combination with a shift by operators in the United States from dry gas to more
liquid-rich oil reserves and geographies, additional services are required to manage
the extraction and separation of CHART L: Compounding Service Intensity
hydrocarbons. Notably, advanced 10.0x
8.0x
gas systems are one of several add-on 8.0x
Service Intensity

services provided in liquid-focused

6.0x
regions. CHART L illustrates the 4.0x
4.0x
compounding service intensity
factors by: (i) drilling convention and 2.0x 1.0x

(ii) natural resource type. 0.0x

Horizontal Horizontal Oil Vertical Well
Gas Well Well
Source: Baker Hughes, Analyst Research

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 Greater Emphasis on Environmental Regulation

In the onshore market, the shift to more challenging resource plays and the use of
service-intensive extraction techniques are drawing scrutiny and increased
compliance requirements from regulators and environmental advocacy groups.
Safety concerns around drilling in complex formations, coupled with the real and
perceived environmental fears related to hydraulic fracturing and groundwater
contamination (particularly in densely populated and earthquake prone regions)
has culminated in a renewed focus on safety, environmental sustainability and
regulatory compliance. This tightening regulatory environment, which
increasingly resembles the more stringent offshore requirements, continues to
impact the decision making of operators across the energy landscape.

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Offshore Market Offshore Market
Overview
The Gulf of Mexico (GOM) is one of the largest offshore hydrocarbon reserves in
the world with an estimated 6.1 billion barrels of oil and 27.2 trillion cubic feet of
natural gas. After a period of declining new drilling activity in the wake of the BP
Macondo oil spill, capital spending activity in the U.S. GOM has rebounded over
the past two years.

The production of hydrocarbons within the GOM reflects the cumulative efforts of
a wide range of parties and begins with leasing and permitting activities. Once a
permit is obtained, drilling and production activities commence, which, in turn,
lead to significant capital expenditures and the demand for production
infrastructure. During the phase for offshore production infrastructure, NDT
companies provide testing and inspection services, along with baseline mechanical
integrity (MI) services, for fabrication yard operators. NDT services are
required even after the completion of the construction phase, as a recurring base of
demand is generated upon the commissioning of production infrastructure.
Finally, new production facilities typically require the installation of new offshore
pipelines to transport the produced hydrocarbons onshore for processing. CHART
M illustrates the GOM operations process.

CHART M: GOM Oil and Gas Operations Process

Expanding Drilling and Ongoing NDT Needs Throughout Increased Regulatory Oversight –
Production Activity the Full Production Asset Lifecycle SEMS Mandatory MI Program

 Leasing
Activity Exploration and Production Platform Oil and Gas Offshore
Drilling Activity Fabrication and Installation Production Pipelines
Petrochemical
Plants
Fabrication Yards Offshore Platforms Offshore Pipelines
 Permitting and
 Testing, inspection and  Continual platform
z MI as  Testing and inspection
Compliance
front-end MI assessments mandated by Safety & services for offshore
Requirements
of oilfield production Environmental Management pipeline systems
for Operators
equipment and systems System (SEMS) and riser
̶ Drilling / Refineries
Workplace inspection (RADAR)
Safety Rules

30% > 2,800 25,000 < 40%

Increase in GOM Production Platforms and of GOM Operators Have
Infrastructure Spending Structures in the GOM, with Miles of Offshore Fully Implemented the
in 2013 to $40 Billion an Average Life of 40 Years Pipelines in the GOM Mandated MI Program

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Similar to the onshore oil and gas sector, drilling and production activities in the
GOM have evolved considerably in recent years. The primary factors that continue
to shape the complexion of the U.S. offshore oil and gas industry in the GOM
include: 1) the resurgence of GOM drilling and production activity, 2) increased
capital spending and infrastructure requirements to support growth, 3) installation
of the offshore infrastructure base and 4) an increasingly stringent regulatory
environment.

Resurgence of GOM Drilling and Production Activity

Continuing its recovery from the downturn that followed the BP Macondo oil spill
of April 2010, the GOM has re-emerged as one of the world’s most prominent oil
and gas producing regions. One CHART N: GOM Drilling Permits and Rig Activity,
of the leading indicators of the 2008 to 2013
Permits Rig Count
resurgence of GOM production
500 75
is permitting activity, which has
steadily increased since the 400 60

lifting of the federally imposed,

300 45
six-month deepwater drilling
200 30
moratorium in 2010. The
number of offshore drilling 100 15

permits issued to operators in

0 0
the GOM increased by 2008 2009 2010 2011 2012 2013
Deepwater Drilling Permits Shallow Water Drilling Permits
approximately 31% from 2011 to
Total Rigs in the GOM
2013, as shown in CHART N. Source: Baker Hughes, Quest Offshore Resources, Inc.

In line with improved permitting and leasing trends, drilling activity in the GOM
has returned to pre-Macondo levels and continues to rise.

Increased Capital Spending and Infrastructure Requirements

The accelerated growth in drilling and production activity across both the shallow
water and, more notably, the deepwater regions of the GOM has resulted in
unprecedented levels of capital spending. For 2013, total offshore spending across
the GOM exceeded $40 billion, an increase of 30% over prior year levels.

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CHART O illustrates the CHART O: GOM Offshore Capital Spending
($ in Billions)
historical capital spending levels $30
across the shallow water and $22.5
$25 Billion
deepwater regions of the GOM.
$20
In conjunction with heightened Average:
levels of offshore spending, the $15 $10.5 Billion

movement of producers into

$10
deeper, more demanding
$5
regions of the GOM has driven
significant growth in fabrication $0
2008 2009 2010 2011 2012 2013
yard activity as increasing
Deepwater Shallow Water
amounts of infrastructure, such
Source: Quest Offshore Resources, Inc.
as floating production systems
(FPS), are needed to support CHART P: GOM Offshore Fabrication Backlog
Metric Tonnes
deepwater production. The 800,000
growing complexity of 700,000

deepwater infrastructure assets 600,000

has contributed to the 500,000

400,000
substantial increase in the GOM
300,000
offshore fabrication backlog.
200,000
CHART P highlights this growth
100,000
since 2003 for GOM fabrication
0
across the types of offshore 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Floating Production Systems Fixed Platform Drilling Other
infrastructure.
Source: Quest Offshore Resources, Inc.

Installed Offshore Infrastructure Base

Currently, there are more than 2,800 active production structures and subsurface
facilities in the GOM, as well as more than 25,000 miles of oil and gas pipeline on
the GOM sea floor. Production operations, which are driven primarily by sustained
energy demand, are much less sensitive to changes in oil and natural gas prices
than drilling operations, as the marginal costs of operating production platforms
are relatively low. Producers will typically operate platforms for up to 40 years
because the ongoing costs to operate the platforms are minimal when
compared to the revenues generated from production. As a result of their

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perpetual operating schedules, the extreme environmental conditions in which they
operate and the increasingly CHART Q: Offshore Opex Spending
stringent safety and operating ($ in Billions)
$20 $17.9 $17.9 $17.8 $18.1
requirements, production platforms $16.8
$17.4

$10.5
throughout the GOM require a high $11.1
$11.2 $11.3 $10.8 $10.6
$15
degree of inspection, maintenance
and mechanical integrity support. $10
According to Quest Offshore
$7.3 $7.6
Resources, annual operating ex- $5
$5.7 $6.2 $6.7 $7.1

penses across the GOM have from

$16.8 billion in 2008 to $18.3 billion $0
2008 2009 2010 2011 2012 2013
in 2013 (reflected in CHART Q). Deepwater Shallow Water

Source: Quest Offshore Resources, Inc.

Increasingly Stringent Regulatory Environment

In response to the BP Macondo oil spill of April 2010, the U.S. Department of the
Interior’s offshore regulatory structure was overhauled. This reorganization
resulted in the Bureau of Ocean Energy Management, Regulation and Enforcement
(BOEMRE), which, on October 1, 2011, was divided into two individual entities:
the Bureau of Ocean Energy Management (BOEM) and the Bureau of Safety and
Environmental Enforcement (BSEE). Since its creation, the BSEE has undertaken
aggressive and comprehensive reforms to offshore oil and gas regulation, provid-
ing clarification as to the minimum inspection standards and strengthening a range
of requirements from well design and workplace safety to corporate accountability,
as depicted in CHART R.

CHART R: Major Legislation Affecting the Offshore Oil and Gas Industry
 Applies to all offshore oil and gas operations in federal waters and makes mandatory the previously voluntary
practices in the API’s Recommended Practice 75 (RP 75)
 Requires that offshore oil and gas operators develop and maintain a SEMS program with the initial SEMS
Workplace audits to be completed by November 2013
Safety Rule
 A SEMS program is a comprehensive management program for identifying, addressing and managing
(October 2010) operational safety hazards and impacts
 Requires all operators to implement a comprehensive mechanical integrity program for all equipment and
systems used in the production of hydrocarbons and report annual performance measures data to the BSEE

 Prescribes heightened equipment standards, safety practices and environmental safeguards that must be met
Drilling Safety prior to the commencement of exploration and development activities
Rule  Permit applications for drilling projects must meet new standards for well-design, casing and cementing, and
(August 2012) be independently certified by a professional engineer – operators must demonstrate that they are prepared to
deal with a potential blowout and worst-case discharge

Modified  Enhances the original SEMS rule by supplementing operators’ SEMS programs with greater employee
Workplace participation and oversight, while also improving guidelines for reporting unsafe work conditions to BSEE
Safety Rule  Imposes new requirements for job safety analysis, stop work authority, employee participation plans and
– SEMS II mandatory audits to be conducted by accredited third-parties
(April 2013)  Audits of SEMS II compliance must be completed by June 2015

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 Overview of the Midstream Energy Sector

Midstream Energy Current North American midstream infrastructure exceeds 2.5 million miles of
Sector Overview pipeline that transport trillions of cubic feet of natural gas and hundreds of billions
of ton-miles of liquid petroleum products each year. This existing midstream
infrastructure network creates annual spending in excess of $6 billion for
maintenance, inspection and integrity services.

CHART S: The Midstream Infrastructure

Recurring Maintenance, Repair Increasing Regulatory, Safety and Extensive New Infrastructure
and Testing Demands Environmental Requirements Construction Needs

Gathering Gas NG/NGL/Oil NG/NGL/Refined

Crude Oil
Pipeline Processing and Pipeline Products Pipelines
Refining/NGL
Compression Fractionation

z
 Enforces safe operation Storage
 Proliferation of U.S. pipeline  Manufacturing
of Shale Plays transportation and  Petrochemical
infrastructure  Power
Trucks/Barges Trucks/Barges Generation

2.5 Million 400 525 1,400

Number of Domestic Number of Domestic Number of Natural Gas
Miles of Pipeline in the Underground Storage Gas Processing Compressor Stations in
United States Facilities Facilities the United States

Long-term industry trends have created demand for NDT, integrity and
maintenance services among midstream asset owners and operators. The three
primary trends are: 1) an aging midstream infrastructure, 2) increasingly stringent
regulatory requirements and 3) the transformation of domestic midstream
infrastructure in response to the development of new shale locations.

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 Aging Midstream Infrastructure

The North American midstream infrastructure is aging and requires consistent

maintenance, and inspection. Approximately 50% of non-distribution pipelines in
the United States are more than 40 years old, and an estimated 30% of existing
pipelines are beyond their useful lives. CHART T illustrates the estimated age
distribution of domestic pipeline infrastructure for gas transmission and gathering,
hazardous liquids and gas distribution infrastructure, respectively.

CHART T: Aging Midstream Infrastructure

Gas Transmission Hazardous Gas

and Gathering 8.0%
Liquids Distribution

9% 8%
19%
31%
36.0%
32% 56.0%
36%
59% 56%

50%

> 40 Years 10 Years to 40 Years < 10 Years

Source: U.S. Department of Transportation

Increasingly Stringent Regulatory Requirements

Mirroring the broader energy landscape, the midstream infrastructure sector has
become subject to increasingly stringent regulatory requirements and escalating
costs of non-compliance. Pressure to strengthen regulation has resulted from a
handful of major incidents, including the San Bruno pipeline explosion in 2010 and
the Enbridge Energy oil spill into the Kalamazoo River in 2010, which was the
largest and most costly on-land oil spill in U.S. history. Disasters such as these over
the past decade drove major legislation changes that have affected midstream asset
owners and operators. CHART U (following page) presents a summary of recently
implemented legislation.

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CHART U: Aging Midstream Infrastructure

Key Legislation Direct Implications for Owners/Operators of Midstream Infrastructure

 Mandates pipeline operators and owners prepare and implement an Integrity Management Program
Pipeline Safety Improvement
 Requires owners to identify High Consequence Areas in the area of their assets, conduct risk analysis,
Act (2002) perform baseline integrity assessment and inspect the entire pipeline system on a prescribed schedule

 Establishes minimum standards for Integrity Management Programs regarding distribution pipelines
Pipeline Inspection and
 Sets standards for maintaining hydrocarbon pipelines to minimize erosion and corrosion
Protection Act (PIPES) (2006)  Statutes enforceable by DOT

 Requires operators of gas distribution pipelines to develop and implement integrity management
49 CFR Part 192 (2010) programs (DIMP), including threat identification, risk assessment, risk mitigation strategies, regular
testing and reporting

Pipeline Safety, Regulatory
Certainty and Job Creation
Act (2012)
 Increases the maximum fines for safety violations to $250,000/day for a single violation, and to
$2.5 million for a series of violations
 Permits the DOT Secretary to evaluate whether integrity management should be expanded
 Permits the DOT Secretary to mandate use of remote-controlled shutoff valves

Shale Development Drives Transformation of Midstream Infrastructure

The development of new drilling techniques such as hydraulic fracturing and

horizontal drilling have enabled exploration and production firms to access trapped
hydrocarbons that were previously considered inaccessible. The result has been a
significant migration of production activity and investment directed at North
American unconventional liquids-rich shale plays. However, these liquids-rich
plays are underserved by existing midstream infrastructure. The significant
geographic disparity between new shale plays and legacy infrastructure confirms
that existing pipelines are not suited to access new production locations.

An Overview of Nondestructive Testing | BlackArch Partners | 17

 Overview of the Downstream Energy Sector

Downstream The downstream energy sector is comprised primarily of refineries and

Energy Sector petrochemical plants. Refineries engage in the distillation of crude oil,
Overview re-distillation of unfinished petroleum derivatives and other processes to produce
gasoline, kerosene and residual fuel oils. Approximately 143 refineries are
currently located in the United States. Over the last three decades, consolidation
among refinery owners and a trend towards expanding existing facilities rather
than building new refineries have driven an increase in average refining capacity
per facility from 70,000 barrels per day (bpd) in 1985 to 125,000 bpd in 2013. At the
same time, U.S. refineries continue to operate at extremely high utilization rates
that have averaged more than 85% since 1990. The perpetual uptime and extreme
operating requirements placed on the assets in the petrochemical refinery sector
have resulted in significant needs for NDT, maintenance and repair
services. As a result, industry operators have turned to service providers to
implement mechanical integrity programs that provide continual evaluation and
preventative maintenance to reduce downtime and maximize operating capacity.

The main trends have shaped the development of the downstream energy sector,
including: 1) the increasing worldwide use of petroleum-based products, 2) the
lack of capital expenditure on new equipment and 3) generating the capability for
international trade of LNG resources.

Increasing Use of Petroleum-Based Products

The increased worldwide use of petroleum-based products was a considerable

driver of expansion in the downstream energy end market. Hydrocarbon
processing is becoming increasingly ingrained in the global economy and
developing nations, such as China, India and Brazil, are new centers of
hydrocarbon demand. Notably, large-scale refinery maintenance projects create
significant demand for NDT service providers. Although individual refining units
do not typically need servicing on an annual basis, on average, the refining
industry spends a relatively stable amount on large-scale maintenance projects each
year.

An Overview of Nondestructive Testing | BlackArch Partners | 18

 Necessary Capital Expenditure

In addition to refineries, there are currently several hundred major petrochemical

processing plants in the United States and internationally. Historically low costs of
feedstock materials, which are favorably impacted by upstream trends in U.S. shale
gas, have driven recent increases in utilization across the petrochemical sector.
Consequently, a significant amount of capital investment is being directed towards
new facilities and restarts of once-idle plant locations. Total capital and
maintenance spending in the hydrocarbon processing sector exceeded $225 billion
in 2013, a 9.5% increase from 2010 levels. Furthermore, maintenance and repair
expenditures and capital spending within the refining and petrochemical and gas
processing segments have grown at a 4.3% and 2.0% CAGR, respectively, since 2007
and exceeded $16.7 billion and $9.7 billion, respectively, in total for 2013 (reflected
in the charts below).

CHART X: U.S. Downstream Maintenance and CHART Y: U.S. Downstream Capital Spending,
Repair Expenditures, 2007 to 2013 2007 to 2013
($ in Billions) ($ in Billions)

4.3% CAGR from 2007 to 2013 2.0% CAGR from 2007 to 2013
$10.0 $10.0
$9.7
$9.2
$8.7 $8.8
$8.0 $8.4 $8.0
$8.0
$7.6
$7.0
$6.0 $6.5 $6.6 $6.0
$6.3
$6.0 $6.0
$5.7
$5.4 $5.4 $5.3 $5.4 $5.4
$5.1 $5.1
$4.0 $4.0 $4.7
$4.2 $4.2 $4.4 $4.3
$4.2
$3.5

$2.0 $2.0

$0.0 $0.0
2007 2008 2009 2010 2011 2012 2013E 2007 2008 2009 2010 2011 2012 2013E

Refining Petrochemical & Gas Processing Refining Petrochemical & Gas Processing

Source: HPI Market Data Source: HPI Market Data

Prospects for the Exporting of LNG

The proliferation of domestic shale plays has dramatically altered the global
hydrocarbon marketplace and expanded international trade of LNG. The
migration of E&P activity and investment directed towards significant shale
resources has led to radical increases in domestic oil and gas production, resulting
in abundant natural gas reserves, estimated to exceed a 140-year domestic supply.
Shale gas has recently overtaken onshore conventional and offshore supply sources
as the leading natural gas production source.

An Overview of Nondestructive Testing | BlackArch Partners | 19

 In the last three years alone, the Department of Energy has approved four LNG
terminals to export to countries without free trade agreements with the United
States. The four facilities including the Lake Charles, Louisiana terminal (2013), the
Cove Point, Maryland facility (2013), the Sabine Pass, Louisiana terminal (2011) and
the Freeport, TX facility (2013), highlight the speed with which the U.S. is accepting
its role as a prominent LNG exporter.

Conclusion NDT providers offer a critical service to asset owners and operators in the energy
sector. As activity in the oil and gas industry has rebounded dramatically from its
low point during the recent recession, firms have needed to invest in equipment
and infrastructure to meet the rising demand for energy. NDT services improve the
profitability of oil and gas operators by improving facility operation efficiency and
reducing the incidence of machine failure and malfunction, while ensuring that
equipment complies with the increasingly stringent environmental regulations in
place. BlackArch Partners believes the value-add services of NDT providers will
continue to serve an important role in the oil and gas sector. Our Energy team has
recent transaction experience with companies that are active in the NDT space and
we are happy to share our thoughts on the industry.

An Overview of Nondestructive Testing | BlackArch Partners | 20

Energy Sector Contact
Team

Will Cooper, Managing Director

(704) 414-6305
cooper@blackarchpartners.com

Drew Quartapella, Managing Director

(704) 414-6301
drew@blackarchpartners.com

An Overview of Nondestructive Testing | BlackArch Partners | 21

Visit and Connect: BlackArch Partners is a leading middle-market investment bank offering a full spectrum of
BlackArch advisory services to financial sponsors, private companies and diversified
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An Overview of Nondestructive Testing | BlackArch Partners | 22

 BlackArch ‘s “We have chosen to work with BlackArch on multiple occasions due to their
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balanced approach of not only maximizing shareholder value but also addressing
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Their deep executive team was a real asset to our management team and the
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Explore the We invite you to explore the many BlackArch Reports available for immediate
BlackArch Library download on our website:

Achieving Superior Outcomes Introduction to Private Company Valuation

Alternative Private Capital Solutions M&A Market Overview

BlackArch’s Roadmap for ActionTM Rise of the Strategic Acquiror

Communication & Confidentiality: Strategic Alternatives for Liquidity

Strategies for a Smooth Transition
The Why’s and How’s of Creating an Equity
Economics of Equity Rollover Incentive Plan for Senior Management

Globalization of the Middle Market Transitional Capital Solutions

An Overview of Nondestructive Testing | BlackArch Partners | 23

The information, opinions and views contained in this white paper were prepared by BlackArch Partners LP
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