With all the recent buzz surrounding the energy sector, I thought I'd define a common piece of industry jargon: Midstream.
Your average investor probably knows that midstream is a place where you're not supposed to change horses. Beyond that, it's a mystifying term to many. The midstream is one of the least-discussed segments of the oil and gas value chain. However, as the least cyclical part of the business, it's proven an attractive investment area, particularly for investors seeking dividend growth.
The midstream commonly refers to the processing, storage, and transmission of oil and gas. Pipeline transmission is the heart of midstream operations, and the steady, predictable cash flows it provides are the key to understanding this subsector's attractiveness. Compared to producers like ConocoPhillips (NYSE: COP ) and refiners like Valero (NYSE: VLO ) , pipeline operators like Enron-fleecer Kinder Morgan Energy Partners (NYSE: KMP ) and two-time Income Investor pick Enterprise Products Partners (NYSE: EPD ) are hardly levered to the commodity price. The trade-off, of course, is that operational upside potential is somewhat limited.
That's not to say you can't make a killing investing in these operators, which are usually structured as master limited partnerships, or MLPs. In a nutshell, MLPs resemble REITs: They're structured in a tax-advantaged manner, and they pay out high distributions, typically in the 6%-9% range. The low cost of capital available to an MLP makes it an ideal acquirer, and successful dealmaking provides the fuel for dramatic increases in payouts to shareholders -- or limited partners, to be exact.
Before you dash off to pick up units of the nearest MLP, make sure you brush up on the taxation issues. Things can get a little more complicated come tax season, but you may find that it's worth the trouble to introduce this emerging asset class into your portfolio mix.
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