2 Top Domestic Pipeline Companies

11/28/2011 9:00 am EST


Jim Trippon

Editor-in-Chief, China Stock Digest

One of the biggest trends to hit the energy markets—especially in the US—is going to be consolidation and expansion in the pipeline industry, so it’s time to get a piece of the growth and income, writes Jim Trippon of Dividend Genius.

Merger and acquisition activity is on center stage in the oil and gas industry. Investors took notice when Energy Transfer (ETP) acquired Southern Union (SUG) for $5.1 billion. Houston based Energy Transfer beat out Williams (WMB) for Southern Union’s pipeline access to the Midwest and Florida.

This deal was followed by Kinder Morgan’s (KMI) $2.1 billion deal for El Paso (EP) .The trend of oil and gas pipeline players is clearly moving toward consolidation, a trend which should continue rather than abate.

The price of oil has seen West Texas Intermediate climb over $110 a barrel back in the spring, with recent prices trading in the low $90s. The spike in oil prices—which also saw light sweet Brent crude reach the $120s earlier in the year—has retreated, although consumer gasoline prices haven’t reacted to that extent.

But this has all been something of a mixed bag for the majors. Exploration and production costs also saw increases, and with consumers balking at higher gasoline prices, and the US and other economies pulling back, demand—though still historically high on a secular basis—softened somewhat.

So you have some majors, Chevron (CVX) for instance, trading higher than ExxonMobil (XOM) or ConocoPhillips (COP), as each of the integrated oil giants has a slightly business different mix and its results differ somewhat.

The pipeline companies, however, show a more consistent reaction. Kinder Morgan and one of its subsidiaries, Kinder Morgan Energy Partners, LP (KMP), an oil and gas pipeline master limited partnership, shows no such ambivalence to the price of oil. The pipeline businesses are living in the sweet spot.

KMP has seen its unit prices, equivalent to share prices, power up from $63.42 to a recent close at $78 in the last 52 weeks. Unit prices have risen for many of the energy MLPs.

Indeed, the Alerian MLP Index (AMZ), which is an index that tracks MLPs, within its 52-week range of $310.81 to $391.85, recently closed at $374.78.

NEXT: Advantages of the Pipeline MLPs


Advantages of the Pipeline MLPs
Investors should remember that the important difference for pipeline companies compared to other energy companies, including the major oil companies, is that the pipelines are largely buffeted from swings in the commodity price of oil.

As storage and transport companies, the pipeline companies receive their money from the tolls, fees for storing and shipping, sending the oil and gas through the pipes which transport the energy products all over the continent. Furthermore, the unique structure of MLPs provides opportunities to investors to collect sizable dividends.

Those of you who’ve read our other columns on MLPs know we are strong proponents of investing in them for income. Many of these MLPs yield from 6% to 10% or more.

The unique tax structure requires the companies to pass through roughly 90% of their income to holders of partnership units, which function much like shares. Dividend investors in the know also are keenly aware that many pipeline MLPs pay a rich distribution or dividend, which makes these companies ideal holdings as the cornerstone of high-yield dividend income portfolios.

The Kinder Morgan-El Paso deal positions Kinder Morgan to become a mega pipeline and storage company. Nearly 2 billion barrels of fuels of all kinds—not just crude oil and liquid natural gas, but jet fuel, diesel, and of course gasoline, will flow through Kinder Morgan’s pipeline network.

The natural-gas pipelines will now be even more extensive, with connections in all the major shale plays, including Marcellus, Barnett, Eagle Ford, Haynesville, Utica, and Fayetteville.

Another deal, this one with Plains All American Pipeline LP (PAA) attempting a hostile takeover of SemGroup (SEMG), reflects more of the M&A fever in the pipeline space. If the deal eventually goes through, Plains will become the dominant storage and transmission company at the Cushing, Oklahoma terminal.

The battle in this merger rages over whether Plains’ $1 billion offer undervalues SemGroup, and there are issues with SemGroup’s management of its assets as well. Regardless of the outcome, there are attractive assets which are being pursued in the pipeline sector.

Although natural-gas prices have lagged oil prices, the long-term usage of natural gas is on the increase, with greater usage expected on the horizon. Currently there is more production than demand, yet demand should grow even faster, as natural gas is expected to become preferable in many places to coal and oil.

There will be a need for more transport capacity, so the pipeline and storage businesses should grow. There is also the increasing development of the shale-gas plays through hydrofracking, so again, more pipeline will be needed to transport that increased production.

The Kinder Morgan deal, as well as most of the prospective M&A activity in the pipeline sector, will have natural gas as a component of most deals. These companies, many distribution- or dividend-paying stocks—though many are currently high yielders already—should derive increased cash flow and growth from the additional natural-gas emphasis, not just oil.

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