How 1 Utility Uses Exploration to Grow Earnings

One utility took advantage of its knowledge of its own franchise as the region began to boom. Exposing itself, and its investors, to extracting oil and gas, this utility has learned to grow profit and reap value.

Mar 4, 2014 at 6:08PM

There's been much in the news about the U.S. becoming less dependent on foreign oil. One reason is the discovery of large oil reserves in the Bakken shale formation in Montana and North Dakota. MDU Resources Group (NYSE:MDU) does not do much prospecting in the Bakken, but it does benefit from this play by offering electric and natural gas as well as construction services to the largest Bakken producer, Continental Resources (NYSE:CLR), and to railroads like Union Pacific (NYSE:UNP) that ship Bakken crude oil to the rest of the U.S. and Canada.

MDU spans the electric and natural gas value chain from well-head to meter across Idaho, Montana, North Dakota, and even Minnesota, Oregon, and Washington State. Its geographical footprint includes the Bakken shale oil fields. The company even has a website devoted to Bakken with the tag line "built for the Bakken."

In spite of MDU's exposure to the boom that is the Bakken crude oil play, the company's performance was weak overall in 2012, due mainly to writedowns of natural gas and other properties. But all of this has changed in 2013. MDU reported higher and healthier operational income and promises more for 2014.

The company has made its utility operations more cost-efficient and growth-oriented, while gaining from higher than expected yields in non-utility sources of income in construction and oil and gas exploration. In short, the Bakken boom is helping MDU become a more full-service energy company.

Will MDU's Bakken franchise and cross-energy value chain strategy be enough to grow this utility into an integrated energy player?

First the utility
MDU only generates nearly a third of its income from its natural gas and electric distribution, pipeline, and energy services businesses. The rest of MDU's income derives from construction services and oil and gas exploration.

About a quarter of the utility segment's 2014 investment of $300 million is slated for the Bakken region. This investment will help improve service reliability for the company's 6% electric and 4% natural gas customer base growth in 2013 in the Bakken region. In this way MDU continues to protect its solid utility earnings and gain customer satisfaction. This factor alone is critical to convert a utility ratepayer into a construction services customer. 

MDU's Pronghorn natural gas and oil midstream pipeline, gathering, and storage assets grew higher volumes. These volumes took advantage of scalable operations that kept expenses at bay. Storage and pipeline improvements will increase service reliability, lower cost of service, increase the return on rate base, and help turn ratepayers into non-utility customers. 

A growing customer base, lower operating expenses, and an integrated plan for increased customer relationship investment seem to be the key not only to manage regulated rate base earnings, but grow a non-regulated franchise.

Now for the rest of the company
As good a utility story as MDU has posted, it is topped by MDU's growth strategy to explore for shale oil and build services to feed this boom. MDU's Fidelity Exploration & Production Company's oil exploration unit met 2013 targets with over 2.8 million net barrels from acreage in the Bakken field and nearly 2 million in Utah's Paradox Basin. This unit contributed over a third of MDU's in 2013.

Fidelity also just acquired an additional producing acreage in Paradox. This basin stretches across four states and contains over a million barrels of recoverable oil and a billions of cubic feet of natural gas along in formations where Fidelity is drilling. Growth for MDU will be determined by drilling success and higher gas and oil prices.

The Bakken and other shale oil fields are growing at break-neck rates. What keeps up with their pace is construction and other ancillary services. MDU seemed to realize this opportunity in its backyard. MDU's construction services and materials segment earned 35% of total 2013 adjusted earnings from this source alone.

Is there a growth story here?
MDU has been growing equity at about 5% with an over 2% dividend yield promised to shareholders. Is a 7% return enough? S&P seems to think so, as it rated MDU BBB+ for having enough capacity to meet commitments, and is strong enough to withstand the risks of the Bakken and Paradox exploration market, on which most of MDU's earnings depend. With international tensions driving oil prices ever higher, Bakken and Paradox production will only become more valuable. I believe MDU is well positioned to maintain and grow its 7% return.

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Bill Foote has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Jun 12, 2015 at 5:01PM

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