Oil prices have roared higher in 2018 thanks to both traditional and non-traditional factors. The former includes a more balanced market, dwindling national inventories, and decisions from OPEC (the Organization of the Petroleum Exporting Countries). The latter includes pipeline bottlenecks in America's Permian Basin, global trade wars, and presidential tweets forcing OPEC's hand. Oil traders sure have their hands full.
Of course, individual investors have the luxury of thinking long term. Zooming out reveals several megatrends that will have a bigger effect on energy markets over time than often-contradictory statements from the White House will. Perhaps the most important trend is rising oil and gas production and exports from the United States (and North America more broadly). The country became a net exporter of natural gas in 2017, is on pace to become a net exporter of energy sometime in the next several years, and is expected to become a net exporter of crude oil sometime in the next decade.
The most important energy play in the mix will be the Permian Basin in West Texas and southeast New Mexico, which, if the area were a stand-alone country, would be among the top 10 global petroleum liquids producers. However, exploiting its full potential will require nearly doubling pipeline capacity in the region by the end of 2023. Few companies are tapping into that opportunity quite like Plains All American Pipeline LP (NYSE:PAA). Impressive near- and long-term growth strategies, a healthy 5% dividend yield, and a new joint venture with ExxonMobil (NYSE:XOM) make it my top stock to buy this July.
De-bottlenecking the Permian Basin to unleash growth
According to the U.S. Energy Information Administration, the United States is expected to produce an average of 10.72 million barrels per day of crude oil in 2018. The Permian Basin is expected to exit the year with output of 3.5 million bpd, or about 33% of the total. More impressive is the expectation for the region to continue driving American oil production growth, with up to 6.4 million bpd of crude production possible by the end of 2023.
The problem is that oil production in the Permian Basin has grown so quickly that there's barely enough pipeline capacity to handle it. In order to keep pace with production growth in the next five years, the region will need to double pipeline and refining capacity from 3.5 million bpd today to about 7 million bpd in 2023.
Plains All American Pipeline is doing its part to relieve the bottleneck by focusing on three types of infrastructure:
- Gathering pipelines: for shuttling raw crude away from production sources. The company's current capacity is 2 million bpd.
- Intra-basin pipelines: for delivering products to refineries or hubs within the region. The company's current capacity is 2 million bpd.
- Long-haul pipelines: for moving product out of the region, such as to refineries or export facilities on the Gulf Coast. The company's current capacity is 1 million bpd.
Long-haul pipelines will be the most important of the three. That's because moving product out of the Permian Basin is key to eventually removing the bottleneck altogether, not just kicking it downstream within the neighborhood of West Texas (from intra-basin pipeline capacity to intra-basin storage capacity, for instance). That explains why Plains All American is focusing most of its efforts on expanding its existing long-haul lines -- and building an enormous new network with ExxonMobil.
- Toward Cushing: By the first quarter of 2019, the company will add about 220,000 bpd of new takeaway capacity to its Sunrise network, which heads toward storage depots in Cushing, Oklahoma. It could be expanded by an additional 500,000 bpd in the future.
- Toward Corpus Christi: The company is adding 670,000 bpd of takeaway capacity to its Cactus network, which heads toward important refinery and export infrastructure in Corpus Christi, Texas. The city was responsible for nearly half of all petroleum exports for the United States last year. Cactus could be expanded by an additional 200,000 bpd to 400,000 bpd in the future.
- Toward Beaumont: The recently announced joint venture with ExxonMobil will plan to build a new 1 million bpd pipeline from the Permian Basin to Beaumont, Texas. That will allow the energy multinational to transport its crude oil to its refinery infrastructure just northeast of Houston. The pipeline will likely travel the same route as the existing BridgeTex pipeline, which is owned by Plains All American Pipeline and Magellan Midstream Partners.
In 2018 and 2019 the company will also bring online about 600,000 bpd of new gathering pipelines and close to 900,000 bpd of intra-basin pipelines. Add up all the near-term projects, and Plains All American is growing total Permian Basin pipeline capacity by 2.3 million bpd, or 45%, by the end of next year. The region will receive $1.6 billion of capital investment from the business in that span, or over 80% of total growth capital spending.
That will allow the business to post record fee-based adjusted EBITDA in 2018 of about $2.2 billion, which is then expected to grow 14% to 15% in 2019. Combine the growth in earnings from increased pipeline volumes transported with an expected $700 million in non-core asset sales by the end of this year, and Plains All American Pipeline will boast a considerable amount of financial flexibility next year and beyond.
Consider that the company is expecting to exit the year with 170% distribution coverage. That opens up a huge opportunity for distribution growth as soon as 2019. For instance, if management's guidance plays out, the company would have the ability to grow its distribution 50% while still maintaining 112% coverage. And that's just from near-term growth projects. Long-term projects on the table could see the company add another 2 million bpd of pipeline capacity beyond 2020.
This pipeline stock is a buy for long-term investors
Plains All American Pipeline is my top stock to buy in July because it's uniquely positioned to provide value to the world's most important oil-producing region, both in the near and long term. The company is already the leading pipeline operator in the region, which allows it to expand existing lines and court major customers such as ExxonMobil. The expansion projects coming on line in the next year will provide ample earnings and cash flow growth, which is nearly guaranteed considering the Permian Basin's production growth. And considering the region is expected to drive American production growth for at least the next five years, investors shouldn't make the mistake of thinking this $17 billion oil stock can't go higher.