The 2 Best Ways to Play the Marcellus Gas Bonanza

Of all the impressive energy statistics I've come across, few compare to those describing the behemoth that is the Marcellus shale. The largest shale gas formation in the U.S., the Marcellus shale contains an estimated 410 trillion cubic feet of natural gas and a projected production life of 110 years.

More impressive than its size is the pace at which production is increasing. In 2007 daily production was a mere 1 billion cubic feet/day (Bcf/d); but in 2013 it increased 61% to 10.4 Bcf/d, and it is expected to increase an additional 40% in 2014 to 14 Bcf/d. Production is predicted to continue growing strongly, to 20 Bcf/d by 2017-2018, but Morningstar predicts that level may come as soon as 2015. 

Why such massive growth out of this one (admittedly enormous) formation? The answer is cost. Production costs from this formation are among the cheapest in the world, with gross production costs as low as $1.50/MMbtu (the current price of natural gas is $4.50/MMbtu, but the recent price due to cold winter weather was as high as $8/MMbtu). Thus even when gas prices became massively depressed, reaching a low of $2.25/MMbtu in 2012, Marcellus gas was still profitable. And with LNG (liquefied natural gas) exports coming online in 2015-2017, the demand, and thus price, of natural gas is expected to increase going forward (a gradual uptrend to $7.65/MMbtu is expected by 2040).

This will provide incentives for oil and gas producers such as Cabot Oil & Gas and Chesapeake Energy to continue increasing production from the Marcellus for years to come. This article, however, is not about these exploration and production companies. It's about a better way to cash in on the Marcellus bonanza.

"Pick and shovel" producers, e.g., the service companies providing necessary equipment and support to these companies, will face soaring demand for their products and services, regardless of how any individual company fares. Two of the best investments in this "pick and shovel" space are in midstream services (gas pipelines, storage, processing, and fractionating out natural gas liquids) and fracking sand, for which demand is expected to soar by 30% between 2013-2016.

Pick and shovel providers for the Marcellus gold rush
Increasing gas production (and its associated NGL production) will greatly increase the demand for storage, processing, and transport pipelines. This is where MarkWest Energy Partners (NYSE: MWE  ) shines.

With 2.2 Bcf/d of processing capacity (22% of 2013 Marcellus production), 615 Mcf/d of gathering capacity, and 172,000 barrels a day of fractionating capacity (extracting NGLs from gas), MarkWest is one of the largest midstream operators in the Marcellus; and this MLP is aggressively planning for strong growth. It is investing $2 billion-$2.3 billion in 2014 as part of the following expansion efforts:

  • a 1.9 Bcf/d increase in processing capacity (a 86% increase through 17 new processing and fractionator plants)
  • a 30,000 barrels/day fractionator capacity expansion (17% increase)
  • Major NGL export pipeline partnerships with Targa Resources, Sunoco, and Kinder Morgan
Management is forecasting a fee-based net margin of more than 70% (up from 25% in 2008) and distributable cash flow growth of 30%-plus in 2014 -- and it's guiding for 7% distribution growth in 2015 and 10% in 2016. With analysts at S&P Capital IQ forecasting 62% compound annual growth in earnings per share for the next decade, investors can expect MarkWest to be one of the best performers of the Marcellus boom in the years to come.
 
Hi-Crush Partners (NYSE: HCLP  ) is another terrific way to play the Marcellus gold rush for one simple reason: frack sand. Frack sand is the No. 1 proppant (substance used to "prop" open cracked shale and increase oil and gas production), and Hi-Crush is the No. 1 provider of frack sand in the Marcellus, with exclusive rail access and three times the distribution terminals of its nearest competitor.
 
The MLP recently announced two major contract extensions with large oil services companies: Weatherford US, a subsidiary of Weatherford International, and US Well Services. The new two-year extensions substantially increase the volume of sand to be bought from Hi-Crush and guarantee a minimum monthly quantity and price to be paid to the MLP.
 
Management's latest guidance shows stunning growth ahead:
  • 128% production growth in sales from 2014-2015
  • 92% growth in earnings before interest, taxes, depreciation, and amortization
  • 84% increase in distributable cash flow 
  • distribution guidance of low-double-digit percentage growth
S&P Capital IQ Analysts are projecting a 20% CAGR in EPS and 17% CAGR distribution growth over the next decade. With the production potential of the Marcellus and the above guidance, I feel those projections to be reasonable. 
 
Foolish takeaway
The prolific production boom of the Marcellus shale is one of the strongest megatrends in the energy sector today. In my opinion, there are few better ways for long-term investors to cash in on this bonanza than with MarkWest Energy Partners and Hi-Crush Partners. Both MLPs offer generous and secure yields with strong growth prospects and a capital gains kicker to boot. With decades of strong production expected from the Marcellus shale, both partnerships (and their investors) are likely to prosper for many years to come.

Get a piece of America's energy bonanza with these income plays
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