Benefit from Oil and Gas Shale Boom through High-Yield Pipeline MLPs

Published Mon, 17 Dec 2012 19:30 CET by

The oil and gas shale boom in North America has caused a surge in the supply of hydrocarbons, shifting the balance in the energy markets and attracting substantial investments in the sector. Dubbed the new “revolution” of the 21st century, the oil and natural gas shale developments have substantially boosted energy output, created new jobs, invigorated auxiliary industries, and given the needed impetus to the local and national economies. Moreover, these developments, due to price declines, are in the process of shifting consumption trends toward environmentally clean natural gas. All this is creating opportunities to invest in energy companies that, in the years to come, are likely to grow significantly faster than the U.S. or even global economies. Investors can take advantage of this trend by investing in high-yielding master limited partnerships (MLPs) in the oil and gas (pipeline) transportation segment.

Given the ongoing explosive growth in oil and natural gas outputs, investments in the transportation infrastructure to expand the use of excess supplies by commercial customers is considered the next big thing in the noted shale oil and gas “revolution.” Investments to expand North America’s transportation infrastructure –the vast pipeline networks– are expected to average $40 billion per year, according to Bloomberg’s citing of private-equity firm EnCap Flatrock. (As an indicator of how robust the demand will be in the future, especially for natural gas, Financial Times reports that manufacturing companies are planning to allocate $90 billion in investments to benefit from the higher natural gas use).

According to PIMCO, the pipelines segment of the energy sector is attractive because of “strong asset quality, long-term contracts, noncyclical cash flows and significant growth in pipeline capacity.” Indeed, pipeline owners have stable business models that depend more on the volume of transported products than on product prices. That is exactly why, despite the plunge in natural gas prices caused by the surge in the supply, pipeline operators have continued to grow their top and bottom lines. Moreover, margins are not under pressure, as the competitive pressures are almost absent because pipeline operators usually service different geographical areas. (Still, it should be noted that some pipeline operators may include the gathering and processing operations, which do expose them to short-term fluctuations in commodity prices).

Investors pursuing both robust growth and high income can find many opportunities for investing in the oil and gas pipelines segment of the energy sector. Although more complicated from a tax standpoint than regular equity investments, pipeline MLPs offer both strong growth potential and attractive high income from distributions. Most MLPs have solid asset quality and are generating stable cash flows that assure the stability of their distributions. In fact, many MLPs have increased distributions over the past several years and are likely to continue doing so in the future.

Below is a list of pure-play pipeline operators incorporated as MLPs. All MLPs featured in the table are profitable (boasting returns on equity of at least 5%), are forecast to achieve positive EPS growth for the next five years, and pay high distribution yields in excess of 6%. The featured MLPs also have institutional ownership of at least 30% and all trade below their respective industry’s average price-earnings ratio of 27.5. It should be noted that, as a group, MLPs are undervalued relative to other yield-oriented securities, including the U.S. 10-year Treasury and corporate bonds.

Pipeline Operators Dividend Table
There are several other pipeline-market players that investors should consider. Three examples are Plains All American Pipeline LP (NYSE: PAA), Kinder Morgan Energy Partners LP (NYSE: KMP) and Williams Partners LP (NYSE: WPZ). Plains All American Pipeline LP is yielding 4.8% and its distributions expanded, on average, by 5.2% per year over the past five years. The MLP is expanding its oil assets in Eagle Ford shale formation and is increasing the rail terminals capacity for future growth. Kinder Morgan Energy Partners LP is the largest independent owner and operator of petroleum product pipelines in the U.S. It is yielding 6.4%, and its distributions grew, on average, by 7.4% annually over the past five years. Williams Partners LP, which owns and operates an extensive network of pipelines that stretch over nearly 14,000 miles, also includes midstream operations. Over the past five years, its distributions, which are currently yielding 7.0%, grew, on average, by 9.0% per year.

Now, with all that is stated about the appeal of the pipeline MLPs, in the current market, these securities should provide an additional incentive for investors. Unlike corporations, MLPs do not pay taxes on distributions, so they avoid double taxation. MLPs’ distributions are treated as partnership income (regular income), and thus, are taxed at the individual’s marginal tax rate. Hence, they are not subject to the fiscal-cliff tax effect. All these factors should be considered when structuring a portfolio of investments that maximize returns to shareholders.

Stock name Dividend Yield
Enbridge Energy Partners Lp 13.35
Buckeye Partners Lp 7.29
Tc Pipelines Lp 6.79
Plains All Am. Pipeline 6.75
Williams Partners Lp 5.41
Boardwalk Pipeline 3.45

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