Energy Transportation: Growth, Yield, and Value
11/20/2013 10:00 am EST
An upsurge in domestic energy production is a boon to transportation and storage firms in the energy sector, suggests Elliott Gue, editor of Energy and Income Advisor. Here are his picks among growth, yield, and value situations.
Steve Halpern: Joining us today is energy sector expert, Elliott Gue, editor of Energy and Income Advisor. How are you doing Elliott?
Elliott Gue: Good, good. Thanks for having me on.
Steve Halpern: The price of West Texas Intermediate Crude has fallen from over $110 per barrel to now under $95, and you note, in your latest research, that the media in general is viewing this as a negative for oil stocks, but you see some positives in this situation. Could you explain?
Elliott Gue: Absolutely. Well, first of all, I think one thing you have to keep in mind is that, while the price of West Texas Intermediate Crude Oil (or WTI), which is a US oil benchmark, has declined pretty precipitously since the middle of September, that's not been the case with oil more broadly around the world.
If you look at Brent Crude Oil, which is the key international oil benchmark, it's still trading up around $108 or $109 a barrel. Yeah, that's down from $115 to $118 back in September, but still, it's at pretty elevated levels relative to the last few years and down only about half as much, in percentage terms, as WTI.
I think that if you look around the world, a lot of people are looking at energy and saying, “Well, energy must be doing poorly, because the price of WTI has come down.”
You have to remember that not all oil companies are exposed to WTI. For example, we've seen really good results out of a lot of the oil services companies, because they are benefiting from strong growth and demand for drilling outside the US, in places like Saudi Arabia, and the Middle East, and Africa.
Even with looking within the US, not all sectors of the energy market are negatively exposed to oil prices. One example is the refining sector. Companies like Valero Energy (VLO); they actually benefit from really low US oil prices, because they are able to buy their feedstock—Oil is a feedstock for the refining operations—at cut-rate or reduced prices, and then sell gasoline and diesel fuel on the global markets at much higher prices that are leveraged to Brent, so their so-called crack spreads are actually expanding a lot right now.
Then, also, within the US, another area, which I'm focusing quite a bit on, is the transportation and storage segment.
In other words, if all the growth and world production we're seeing in the US—which is really what's been depressing WTI and other US oil prices—just simply, that a strong growth in production, from areas like the Bakken Shale, necessitates greater midstream capacity, the ability to transport and store oil and refined products, and that's really benefiting companies involved in that group.
Steve Halpern: Among your favorites in the transportation and storage area, you've cited Plains All American Pipeline L.P. (PAA), which is a limited partnership, as well as Plains GP Holdings (PAGP), which is the general partner. Could you talk about these two and explain what type of investor should look at each?
Elliott Gue: Yeah, absolutely. Well, like many midstream energy companies in the US—those are companies that own things like pipelines, oil, and natural gas storage taverns—both of those companies that you mentioned—Plains All American and their general partner—are organized as master limited partnerships, or MLPs.
Basically, what that means is that they are taxed on the corporate level, individuals are taxed on the distributions you receive, which are quite tax-advantaged.
Plains All American is offering a yield up around 4.5% or 5% right now. Their general partner probably, it just went public a few weeks ago, but will probably offer a yield more on the order of 2% to 3% over the coming year.
Basically, what Plains All American owns is a large network of crude oil and refined product pipelines. It's about 18,000 miles of crude oil and refined product pipelines around the US.
They also own oil storage terminals used for temporarily storing oil, as well as blending things like gasoline with Ethanol, to make it compliant with government regulations. These assets are really benefiting enormously from the growth in US oil production over the last few years.
If you think about it, all this new oil coming from places like the Bakken Shale, which is in North Dakota, an area that hasn't had a lot of oil production in the past, it would have to go somewhere.
A lot of it's ended up in Cushing, Oklahoma, that's a major oil terminal there, and further down lately, with the new pipeline capacity opening up in the gulf coast, a lot of that oil has ended up migrating to the gulf coast.
Well, all that oil has to be stored somewhere, and that benefits companies, like Plains All American, that are involved in transporting and storing.
The other advantage that you are seeing with these companies is what we called bases differentials. For example, oil trading in West Texas can trade as a large discount to oil in Cushing, Oklahoma, simply because there's not enough pipeline capacity to move it from Midland, Texas and West, Texas to say, Cushing, Oklahoma.
A company like Plains, with access to pipeline capacity and storage, can take advantage of their bases differentials. Companies can move oil from point A to point B and realize those differential advantages.
Steve Halpern: Now, another company in the sector is Enbridge Energy Partners (EEP), and you specifically recommend that as a value play. Could you tell us a little about that company?
Elliott Gue: That company had what it calls a transitional year in 2013, in the sense that they were unable to cover their distribution, so they actually paid out more money in distributions than they generated in distributable cash flow, which, of course, in the long-term, is unsustainable.
The main culprit for that was that they do have exposure through some of their processing assets to natural gas liquids prices.
Natural gas liquids are hydrocarbons like ethane, propane, and butane, which are found naturally occurring with natural gas in many plays, and also mixed with oil and natural gas in other plays around the US.
With the boom in gas production that we've seen, we've also seen a boom in natural gas liquid production, and what that's meant is that the prices of these hydrocarbons have been very low, especially for ethane, which is the most common natural gas liquid, and as a result, this has affected their processing margins.
Their margins for taking raw natural gas and removing these natural gas liquids. They are compensated partly based on the price of natural gas liquids, which, again, has been in free fall.
However, over the next couple of years, really starting in 2014 in earnest, they have a large number of new, highly-attractive growth projects underway, and these would be new pipelines, new storage terminals, that are due to come on stream over the next couple of years.
For the most part, those assets are fee-based, meaning that they are not paid based on the value of commodities, that they move through those assets, but rather on just the volume, as well as getting minimum commitments from their customers.
Enbridge is a company that, I think, over the next couple of years, not only is their distribution growth going to return to well above one-to-one, in other words, they'll be fully covering the distributions, but I think, in the next year to 18 months, they'll actually be in a position to increase their payout.
Right now, that particular MLP is trading with a much higher-than-average distribution yield, it's trading with a yield, sort of up around 7%, which is much higher than the average MLP.
So, I think it's an opportunity to buy a MLP that's seen a good turnaround—as a result of all their growth projects coming on stream—at a very attractive price and offering a very attractive yield.
Steve Halpern: Well, we really appreciate your insights today. Thank you for joining us.
Elliott Gue: Thanks for having me.