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

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

An Overview of Nondestructive Testing | BlackArch Partners | 2 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.

An Overview of Nondestructive Testing | BlackArch Partners | 3 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 with high economic and Other 7% reputational costs of 0% 20% 40% 60% 80% Source: Forbes 2012 non-compliance.

An Overview of Nondestructive Testing | BlackArch Partners | 4 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 CHART F: TIC Market Share several mid-sized service providers have remained highly acquisitive in an attempt to

bolster their portfolio of service offerings and 41% gain access to new end markets. One particular 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 the highly fragmented nature of the TIC Large-Cap Providers

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.

An Overview of Nondestructive Testing | BlackArch Partners | 5 CHART G: NDT Requirements of Key Energy Infrastructure

Critical Infrastructure NDT Requirements

Onshore . Evaluation of potential wellhead sites and inspection of fabricated piping . Extensive drill pipe and tool inspection, utilizing Well Completion bottom hole assembly inspection and full length Equipment ultrasonic inspection . Casing and coil tubing inspection using EMI equipment to evaluate well deterioration . Recurring evaluation of equipment and material integrity once well becomes productive due to Onshore Production increasingly harsh operating conditions of new

Facilities drilling techniques m

Offshore . Inspection of fabricated piping and pressure Upstrea vessel welds and valves . Ongoing inspections and maintenance of Offshore Fabrication production platform piping systems and critical Yards infrastructure . Mechanical integrity programs mandated for all production equipment and systems in the GOM . In-line inspection of risers, internal welds and other difficult to access platform infrastructure Oil and Natural Gas . Industry pressure mounting to increase Production Platforms inspection frequency

. Inspections for pipeline internal and external corrosion and cracking Onshore Oil and . Weld integrity testing Natural Gas Pipelines . Point-to-point inspections and assessments of pipe wall thickness to detect leaks and localize deficiencies . Integrity management, fitness-for-purpose

Midstream Offshore Oil and assessment and risk-based assessment required throughout the operating life of the pipeline Natural Gas Pipelines . Certification of distribution pipeline safety, pursuant to regulatory standards

. High-temperature corrosion monitoring of critical plant equipment and piping systems Petrochemical / . Chemical Plants In-line assessments of rotating equipment to minimize downtime and improve utilization . Mechanical integrity and predictive maintenance to prolong the operability of rotating equipment and plant assets . Certification of asset installation, maintenance

Downstream Oil and Natural Gas and repair Refineries . Repetitive service needs driven by perpetual operating schedules

An Overview of Nondestructive Testing | BlackArch Partners | 6 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 Inspection and . Manages Exploratory Drilling Well Completion Well Production Maintenance conservation of . Identification of suitable . Casing and tubingz . Continual follow-on 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

An Overview of Nondestructive Testing | BlackArch Partners | 7 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 47 48 50 45 suggest a first year decline rate in 40 40 34 excess of 60% for natural gas and 30 liquid-rich shale plays. This shift 20 10 is expected to drive shorter U.S. Well Drilled (000s) 0 duration, but more frequent 2009 2010 2011 2012 2013 450 expansionary drilling activity. 346 375 311 335 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 Footage Drilled (mm ft.) 0 proximity to maintain the 2009 2010 2011 2012 2013 Source: Analyst Research production levels of their positions.

An Overview of Nondestructive Testing | BlackArch Partners | 8 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 10,000 2011 Average: 8,333 ft. 35 2011 Average: 25 Stages

8,000 30 25 6,000 20

4,000 15 10 2,000

5

Average Average Frac Stages Per Well Average Average Lateral Length (Feet) 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 10.0x hydrocarbons. Notably, advanced 8.0x gas systems are one of several add-on 8.0x services provided in liquid-focused 6.0x regions. CHART L illustrates the 4.0x compounding service intensity 4.0x

factors by: (i) drilling convention and 2.0x 1.0x ServiceIntensity

(ii) natural resource type. 0.0x Vertical Well Horizontal Horizontal Oil Gas Well Well Source: Baker Hughes, Analyst Research

An Overview of Nondestructive Testing | BlackArch Partners | 9 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.

An Overview of Nondestructive Testing | BlackArch Partners | 10 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 MI as . Testing and inspection Compliance z 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

An Overview of Nondestructive Testing | BlackArch Partners | 11 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 resurgence of GOM production Permits Rig Count 500 75 is permitting activity, which has steadily increased since the 400 60 lifting of the federally imposed, 300 45 six-month deepwater drilling moratorium in 2010. The 200 30 number of offshore drilling 100 15 permits issued to operators in 0 0 the GOM increased by 2008 2009 2010 2011 2012 2013 approximately 31% from 2011 to Deepwater Drilling Permits Shallow Water Drilling Permits 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.

An Overview of Nondestructive Testing | BlackArch Partners | 12 CHART O illustrates the CHART O: GOM Offshore Capital Spending ($ in Billions) historical capital spending levels $30 across the shallow water and $22.5 deepwater regions of the GOM. $25 Billion

$20 In conjunction with heightened Average: levels of offshore spending, the $15 $10.5 Billion movement of producers into $10 deeper, more demanding regions of the GOM has driven $5 significant growth in fabrication $0 yard activity as increasing 2008 2009 2010 2011 2012 2013 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 deepwater production. The Metric Tonnes 800,000 growing complexity of 700,000 deepwater infrastructure assets 600,000 has contributed to the 500,000 substantial increase in the GOM 400,000 offshore fabrication backlog. 300,000 200,000 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

An Overview of Nondestructive Testing | BlackArch Partners | 13 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 $18.1 $17.4 $17.9 $17.9 $17.8 requirements, production platforms $16.8 $10.5 throughout the GOM require a high $11.2 $11.3 $10.8 $10.6 $15 $11.1 degree of inspection, maintenance and mechanical integrity support. $10 According to Quest Offshore $7.3 $7.6 Resources, annual operating ex- $5 $6.7 $7.1 $5.7 $6.2 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

An Overview of Nondestructive Testing | BlackArch Partners | 14 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 NG/NGL/Oil NG/NGL/Refined Gas Crude Oil Pipeline Pipeline Products Pipelines Processing and 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.

An Overview of Nondestructive Testing | BlackArch Partners | 15 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% 56.0% 32% 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.

An Overview of Nondestructive Testing | BlackArch Partners | 16 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  Increases the maximum fines for safety violations to $250,000/day for a single violation, and to Certainty and Job Creation $2.5 million for a series of violations  Act (2012) 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 $6.6 $6.0 $6.3 $6.5 $6.0 $6.0 $5.7 $5.4 $5.4 $5.4 $5.4 $5.1 $5.1 $5.3 $4.7 $4.0 $4.0 $4.4 $4.2 $4.2 $4.2 $4.3 $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 [email protected]

Drew Quartapella, Managing Director (704) 414-6301 [email protected]

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 Website corporations. BlackArch addresses the needs of entrepreneurs, founders and shareholders of private companies with specialized services that include M&A advisory, strategic advisory and private capital solutions. Based in Charlotte, N.C., with offices in Houston, T.X., BlackArch features a total of 12 industry-focused practices that covers all sectors of interest to middle-market investors, and its professionals have closed over 300 transactions in 16 countries on four continents.

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CHARLOTTE NC HOUSTON TX 227 West Trade Street 4400 Post Oak Parkway Suite 2200 Suite 2370 Charlotte, NC 28202 Houston, TX 77027 704.414.6300 713.380.4300

An Overview of Nondestructive Testing | BlackArch Partners | 22 BlackArch ‘s “We have chosen to work with BlackArch on multiple occasions due to their Clients Share balanced approach of not only maximizing shareholder value but also addressing Their Experiences Working With Us the various objectives of management teams as well as buyers. As a result, we have developed enormous trust in the BlackArch team to get all parties focused on agreeing to the key terms necessary to get a transaction closed. We value the personal connection we have developed with their team and look forward to working with them again.” - Bob Horne and Nick Burger, Partners ZS Fund L.P.

“If you want to have the best group represent you and your company, BlackArch is that group. During our process, they were consummately professional and extremely knowledgeable on all the details that you need experts to be focused on. Their hard work helped us exceed the results we expected when we initiated a transaction. It’s a no-brainer; hire these guys and they’ll take good care of you!” -Mike Sechrist; CEO, ProTransport-1

“The entire team at BlackArch Partners worked literally day and night to meet an aggressive schedule and pull the many diverse players in this transaction together. Their deep executive team was a real asset to our management team and the process for all parties. I gained the utmost confidence in their advice and trusted their judgment as they managed the process to a successful close. I wouldn’t hesitate to work with them again in the future.” -Sterling Baker; CEO, Jones & Frank

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 (“BlackArch Partners”), and as such constitute BlackArch Partners’ judgment, and are subject to change without notice. The information presented in this white paper is provided for informational purposes by BlackArch Partners, and as such, is not a research report, as such term is defined by applicable law and regulations, nor is it intended to be a solicitation regarding any securities transaction and or investment relationship.

While the information contained herein is believed by BlackArch Partners to be reliable, BlackArch Partners makes no representation or warranties as to the accuracy, reliability or completeness of such information. The information, products and services discussed in this white paper are provided on an "AS IS," "WHERE IS" and "WHERE AVAILABLE" basis. BlackArch Partners does not warrant the information or services provided herein or your use of the information contained herein generally, either expressly or impliedly, for any particular purpose and expressly disclaims any implied warranties, including but not limited to, warranties of title, non-infringement, merchantability or fitness for a particular purpose. BlackArch Partners will not be responsible for any loss or damage that could result from the utilization of any information or services made available to you via this white paper. Testimonials may not be representative of the experience of all clients. Testimonials are not a guarantee of future performance or success

The financial instruments discussed in this white paper may not be suitable for all investors, and investors must make their own investment decisions using their own independent advisers as they believe necessary and based upon their specific financial situations and investment objectives. Past performance is not necessarily indicative of future results. No part of this material may be copied or duplicated in any form or by any means, or redistributed, without BlackArch Partners’ prior written consent. BlackArch Partners and/or its affiliates may seek to provide investment banking services for companies mentioned in this white paper.

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CHARLOTTE NC HOUSTON TX WEB, EMAIL AND SOCIAL 227 West Trade Street 4400 Post Oak Parkway www.BlackArchPartners.com Suite 2200 Suite 2370 [email protected] Charlotte, NC 28202 Houston, TX 77027 704.414.6300 713.380.4300