Oil discoveries hit their lowest level since 1946 last year as energy companies diverted capital spending from new projects and exploration to their proven money makers. It resulted needing to conserve cash after the pandemic drove demand dramatically lower.
It's not that there is no oil left to find, but rather the oil companies weren't willing to risk the capital to find it. That's changing now as oil prices rise and profits soar. ExxonMobil intends to finance between $20 billion and $25 billion worth of new projects this year, up from $16 billion last year, though that's still below the $33 billion it spent before the COVID outbreak.
The world still needs oil and gas to run on as there are not nearly enough alternative energy sources available to power businesses and consumers today. It means the energy sector still has a long runway for growth ahead of it, and investments in fossil fuel stocks remain an attractive target.
While I've previously made bets on integrated giants like Exxon and Chevron when they were battered by falling prices and a belief we were at peak oil, today I'm looking more closely at the midstream space, which transports, processes, stores, and exports oil, natural gas, liquified natural gas (LNG), and other refined petroleum products.
I think they represent a unique opportunity to capitalize on oil's resurgence and thrive in an inflationary environment, and Enterprise Products Partners (EPD 1.29%) may be my favorite energy stock in the space right now.
Playing the middleman
Enterprise Products Partners is one of the largest publicly traded partnerships in the U.S., with 50,000 miles of pipelines, 23 natural gas liquids (NGLs) processing plants, 14 billion cubic feet of storage for natural gas storage, and over 260 million barrels of storage capacity for NGLs, crude oil, refined products, and petrochemicals.
Midstream energy stocks make for great long-term investments because they most often generate steady cash flows from fees, which they return to investors through distributions. Energy Products Partners derives most of its revenue from long-term, fixed-fee, or take-or-pay contracts, so it gets paid regardless of whether its customers accept delivery of the product or not. Its generous 6.9% distribution is especially appealing, particularly as it has increased the payout for 23 consecutive years.
Because that's one of the main reasons investors like partnerships such as Enterprise Products, it's important to consider the safety of the payout, and with this midstream leader, there are no worries.
The distribution coverage ratio, or the amount of cash flow available for distribution compared to what the company disburses to its shareholders, should not fall below 1 because that implies the payout is unsustainable. With Enterprise Products Partners, the ratio grew to 1.8 in the first quarter from the 1.7 it reached at the end of December. Even during the industry's pandemic rout in 2020, though, it never got close, ending the year at 1.6.
Satisfying a long-term need
With exposure to all of the most important shale regions in the country, the midstream energy stock is well positioned to capitalize on production in the various regions. Significant consolidation has occurred in the space, especially in the Permian basin, giving Enterprise Products Partners a competitive advantage because of its scale.
And though demand for alternative energy sources will undoubtedly grow in the future, causing some easing in fossil fuel demand, it's likely not going to be so dramatic as many might assume.
The U.S. Energy Information Administration estimates oil consumption will fall from around 40% of the total of all energy sources to just 37% by 2040, while natural gas will grow from 17% to 18%. And oil for energy use is still going to be growing, increasing from 80 million barrels of oil equivalent per day to 90 million barrels of oil equivalent per day; it's just that the total pie will grow larger, so its percentage of the total is less.
NGLs represented 33% of Enterprise Products in 2021 while crude was just 18%, and it accounted for half of its gross operating margins, or two and a half time more than the next biggest segment, crude. NGLs are also vital to the global economy and are found in everyday consumer products, including clothing, mobile phones, and even diapers.
As the world's largest exporter, Enterprise Products stands to benefit most from increasing demand for these products as economies continue to recover from the pandemic, not just in the U.S. but globally.
With its enterprise value trading at almost 14 times EBITDA, its slightly above the five-year average of around 12, but that includes the pandemic period that depressed valuations. Compared to the prior five-year period where EV/EBITDA averaged 16 times, Enterprise Products Partners looks to be a bargain and is just one of the many reasons it's one of my favorite energy stocks today.