Global warming is a real thing, and it is good that the world is trying to address it. However, energy transitions aren't as easy as flipping a light switch, which is why Enterprise Products Partners (EPD 0.45%) thinks it has a very long and profitable future ahead. If management is correct, unitholders collecting the fat 7.3% distribution yield will have a profitable future, too.
The carbon problem
Burning oil and natural gas produces carbon dioxide. This gas helps to heat up the planet. It's a well-documented and long-known relationship. It is the reason why governments around the world are pushing so hard to reduce the amount of carbon-based fuels being used. In fact, this effort is a big piece of the E (environmental) in the ESG investing approach. That's all well and good.
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The problem is that carbon fuels are so entwined with the global economy that it is very difficult to curtail their use. And because energy is so important for economic growth, emerging market nations have been highly reluctant to pull back in any fashion. Doing so would effectively limit, if not squash, the growth prospects of some countries. That would mean leaving large portions of their populations from moving up the socioeconomic ladder.
These two broad issues back up Enterprise Products Partners' expectation that demand for oil and natural gas will continue to grow until at least 2040. The actual figure is 18% growth, and it comes from the International Energy Agency (IEA), a global industry watch group.
Enterprise takes this a step further, given its North American focus, to explain that it expects strong U.S. production numbers over the long term. For example, in the Permian Basin, a key U.S. energy region, wellhead gas production is expected to increase nearly 50% by 2027 in the master limited partnership's (MLP's) base case scenario. That could be as high as 80% if things go particularly well. Crude and condensate production in the region increases by 50% in the base case, with a high end of nearly 90%. While that's just one region, it highlights the growth potential that Enterprise sees.
A good model
The thing about Enterprise is that it is a midstream company operating the energy infrastructure that helps to move oil and natural gas from where they are drilled to where they get processed and used. It gets paid fees for the use of its vital North American-based assets, which help to move energy globally. Thus, demand for energy, globally speaking, is far more important than the price of the commodities it moves.
And that's where things start to get really interesting for income-focused investors. Enterprise's distribution yield is a huge 7.3%. Better yet, the MLP's distributable cash flow covered that payment by a very impressive 1.8 times in the third quarter of 2022. That suggests that there's very little reason to worry about a distribution cut and, far more likely, ample room for more increases over time.
On the distribution increase front, Enterprise has hiked the payment annually for 24 consecutive years. That's impressive, given the highly cyclical nature of the energy sector. It makes this an interesting way to bet on the future of energy without having to take on as much commodity risk as would be involved with an oil driller. And Enterprise has $5.5 billion worth of capital investment projects to keep its business growing over time.
To be fair, that $5.5 billion of spending is modest by historical standards. Thus, the MLP's growth is likely to be modest even though it expects the industry it serves to remain important and energy production to continue to expand. The juxtaposition here is that the longer-term trend is toward clean energy alternatives with moderating demand for carbon fuels as the world defaults to an "all of the above strategy." Given that the types of energy infrastructure Enterprise owns tend to have decades long useful lifespans, it does need to be extra cautious about building new assets given the long-term changes taking shape in the energy space.
The distribution is the key
Enterprise is not a growth stock, and investors need to accept that most of the return here will come from the huge distribution yield. But if you are looking to maximize the income you generate today, that probably won't bother you. Now add in the potential growth that's still ahead, despite the negative view of carbon fuels, and you can see why Enterprise is such an interesting income investment even as the world looks to shift toward cleaner energy options.
