Oil giant ExxonMobil (NYSE: XOM ) is being sued for $5 million after one of its pipelines burst which led to a small oil spill in an Arkansas town.The Exxon pipeline, Pegasus, was carrying Canadian crude oil from Illinois to the refinery hub of the Gulf of Mexico. While the cause of the spill is still under investigation, it's not believed to have had any major impact on the drinking water supply, though it still caused damage to a handful of houses. Two of those homeowners are now filing suit saying that the rupture has caused permanent damage to area property values.
While the lawsuit represents just pocket change for Exxon, the incident is a reminder of the risks faced by pipeline operators. An incident like this can come with a high price tag. Whether its cleanup, lawsuits, or lost revenue, these costs have the potential to have a negative effect on the operator's bottom line. Investors in major pipeline operators like Kinder Morgan Pipeline Partners (NYSE: KMP ) and Enterprise Products Partners (NYSE: EPD ) are much better insulated against these risks because of the diversity of their operations as well as their balance sheet strength. However, if you're considering swapping out for a smaller operator with a higher yield, you might want to think twice before you make that move.
Given that one invests in a pipeline company with one goal in mind – income – you want that income to be as secure as possible. Those distributions could be at risk, if you're invested in the wrong operator. If a larger portion of the company's income flows from one asset, you could be exposing yourself to more risk than you realize.
If that pipeline has a major rupture that causes great environmental and property damage, then it's impact on operations would be substantial and could be compounded if the company's business is saddled with a lot of debt. To avoid this risk, invest in a company with a diversified asset base and solid balance sheet. Further, look to see if the company's largest asset is partnered with another company with an even stronger risk profile.
For example, Enterprise's major oil pipeline to the Gulf Coast, Seaway, is partnered with Enbridge (NYSE: ENB ) . The 500-mile pipeline was recently reversed and is undergoing a major capacity expansion program. This partnership helps both companies mitigate some of the risk should the pipeline ever have a major, long-term disruption.
Enbridge and its affiliates have had its share of pipeline problems over the past couple of years. One of the worst was a 2010 spill in the Kalamazoo River system. In that spill the EPA says more than 1.1 million gallons of oil and 200,000 cubic yards of oil-contaminated sediment and debris were removed. That spill is believed to have cost the company more than a billion dollars to clean up. Given Enbridge's size and scale, it was able to absorb those costs. The question you need to ask yourself is if the company you're considering could do the same.
The key takeaway here is to be aware that a pipeline rupture is a real risk. As an investor, you can mitigate this risk by not over allocating your portfolio to pipelines, no matter how tempting the distribution. Further, take a deeper look to see where the company derives its income. If a large portion of your distributions are coming from one major asset that's not partnered with another operator, it might be wise to swap out that company for a more diversified operator.
One of these operators investors should commit to memory due to its sheer size – it's the third-largest energy company in the U.S. – not to mention its enormous potential for profits. In The Motley Fool's premium research report on Kinder Morgan, we break down the company's growing opportunity – as well as the risks to watch out for – in order to uncover whether it's a buy or a sell. To determine whether this dividend giant is right for your portfolio, simply click here now to claim your copy of this invaluable investor's resource.