Higher Gas Prices Are a Natural

11/05/2007 12:00 am EST

Focus: COMMODITIES

Elliott Gue

Editor and Publisher, Energy and Income Advisor and Capitalist Times

Elliott Gue, editor of The Energy Strategist, recommends a tanker company that can profit from growing demand for liquefied natural gas.

Natural gas prices in the US remain well off their 2005 post-hurricane highs. And gas drilling activity in North America has remained subdued because of weak prices, rising drilling costs, and bloated inventories of gas in storage.

But the simple fact is that gas is an important fuel for power plants, as well as a key source of heat used in a variety of industrial activities.

Better still, natural gas is a far more environmentally friendly fuel than crude oil or coal; gas demand has been accelerating in key markets such as Europe and the US.

Unfortunately, production basins near these key markets have been depleted and are seeing declining production. Gas consumers are increasingly forced to source their natural gas from more distant reservoirs. That all adds up to growth for liquefied natural gas (LNG) technology.

Investment in LNG infrastructure globally is accelerating. Global spending on LNG infrastructure is expected to top $250 billion in the next 30 years as LNG capacity rises at a 15 percent annualized pace.

Exporting natural gas was a problem in the past because of the process necessary to transport it. However, new liquefying technologies are making it easier to move this material to and from areas previously unable to do so. This also spells increased returns for tankers, which are responsible for such transportation.

Teekay LNG Partners (NYSE: TGP) is a master limited partnership (MLP) that owns a fleet of LNG tanker ships. All of these ships are leased under long-term arrangements-typically 15 to 20 years-to major LNG projects, including new LNG developments in Qatar and Indonesia. These contracts provide for a fixed rate plus an adjustment to account for cost inflation.

In the second quarter, Teekay LNG hiked its quarterly distribution to 53 cents per unit (MLP lingo for share), equivalent to a yield of about 6.7%. That represents a 15% jump over its prior quarterly payout of 46.25 cents per unit.

The reason that Teekay LNG increased its dividend is that the company accepted delivery of new tanker ships. As soon as the ships were delivered, the company put them out on pre-negotiated long-term contracts.

As the cash from these contracts started to hit the bottom line, Teekay was able to boost its payout. I calculate that the company's second-quarter payout amounted to just 86% of the actual distributable cash flow earned during the quarter. That's healthy coverage for an MLP.

In fact, Teekay LNG should be able to sustain distribution growth in the 10% to 15% annualized range over the next three years. That would put its quarterly payout at about 75 cents in three year's time, [equating] to a yield of 9.5% at current prices. Teekay LNG Partners is a buy under $40. (It closed near $33.50 Friday-Editor.)

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