Why Pipelines Are the Next Phase of the Energy Revolution

A crude oil pipeline in Panama. Source: Gunvorgroup

In the 1930s, JP Morgan once quipped that he knew a stock market disaster was imminent when his shoe-shiner was bullish on the market and was giving Morgan advice. I feel a tinge of the same thing every time I surf the web, go to a website unrelated to finance, and an ad like this pops up: 

"The oil and gas boom is on! Click here to get in on the action before it's too late!"

It's true that there is an oil and gas boom going on, but it's been going on for five years now, and I've only started seeing these ads recently.

In some ways, these ads are at least a year too late. The strategies that worked well just a couple years ago will not work as well going forward. For example, in both the Eagle Ford and the Bakken, which are easily the two best shale plays, the parabolic growth is already over. While there are probably still a couple good, new shales yet to be developed, the North American energy revolution is moving decisively into a new phase.

Over the last few years, investment capital for exploration and production flooded into North America; spending rose 46% from $243 billion in 2009 to $354.4 billion in 2012. In 2013, however, spending flattened out at just $354.8 billion. In other words, producers are no longer expanding their land and drilling budgets in North America. This means that the fantastic growth in oil and gas production over the past few years will continue, but at a decelerating pace. 

Look beyond the drill bit
Midstream spending has gone from just $12.8 billion in 2012 to $46.4 billion in 2013, a stupendous 263% increase in just one year. Basically, the spending spree has moved from the drill bit to the pipeline: It's now the midstream sector's turn to grow. 

The best prospects for midstream growth will likely be in those pipelines which transport natural gas. After all, demand for natural gas in the US is steadily increasing, while demand for oil is flat at best. 

The most well-known choice is Kinder Morgan Energy Partners (NYSE: KMP  ) , which is the second largest pipeline company by market cap and the biggest transporter of natural gas in the country. However, Kinder Morgan will not likely offer leading returns, simply because the company is already so big: The combined market cap from Kinder Morgan Energy Partners and its general partner, Kinder Morgan Inc, is over $70 billion already. 

Instead, look to smaller partnerships that are growing distributable cash flow at a faster clip. Consider first Spectra Energy Partners (NYSE: SEP  ) . This partnership is one of the stakeholders in the Express-Platte pipeline, a 'backbone' system that transports oil sands and Bakken oil into the Wood River refinery complex. Spectra is also building a bi-directional natural gas pipeline between the Marcellus and the Gulf Coast, where supply will flow from the former to the latter. Management expects 11% distributable cash flow growth, or DCF growth, in 2014, and 8%-9% DCF growth through 2016. After that, when its new Marcellus-Gulf Coast pipeline system is ready, I believe that growth will accelerate. 

Williams Partners (NYSE: WPZ  ) is another strong candidate. This $25 billion pipeline expects 14.6% DCF growth between 2014 and 2016, thanks largely to its strong pipeline network in the Marcellus Shale, where cost of dry gas production is among the lowest in the country. Just recently Williams announced it would acquire Access Midstream Partners, another Marcellus pipeline operator. This acquisition should, if anything, accelerate DCF growth for Williams Partners.

Bottom line
The flattening of exploration and production spending in 2013, coupled with a sharp increase in midstream spending, signifies a big shift from the drillbit to the pipeline. Adhering to the strategy of looking for the biggest production growers may not be the best way to approach today's situation. Instead, look for pipelines exposed to transportation of natural gas. Williams and Spectra are two great places to start. 

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.


Read/Post Comments (1) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 02, 2014, at 11:11 AM, Smokeless wrote:

    Did Motley Fool sell all of its shares in Kinder Morgan yesterday? If not, the disclosure is wrong, and needs to be updated.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 3011378, ~/Articles/ArticleHandler.aspx, 10/31/2014 9:48:02 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement