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1 Company Solving the Permian’s Biggest Problem

By Matthew DiLallo - Sep 5, 2013 at 11:03AM

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The Permian Basin has a big problem, but it’s nothing a few billion dollars won’t fix.

Photo credit: LINN Energy

Oil and gas producers in the Permian Basin have a big complaint. Infrastructure issues are holding back profits. The good news for investors is that where there are problems, it's a prime opportunity to invest in those developing solutions. Let's take a closer look at the situation.

The problem
It has been a rough year for LINN Energy (LINEQ). It has had to battle a number of issues beyond its control including the weather and short-sellers. On top of that LINN also had to battle issues with infrastructure that started cropping up in the first quarter when it noted that, "curtailments in the Permian Basin region resulted in lower than expected production volumes caused by shut-ins and high line pressures." Those issues continued to impact the company's production last quarter as well. Unfortunately for LINN and other producers in the basin, those problems run pretty deep.

Nowhere is this clearer than the following quote from Concho Resources (CXO) CEO Timothy Leach. He said,

...industry activities reached a level that current midstream infrastructure struggles to support. Historically, we've been able to account for things like extended plant turnarounds and high line pressures in our production guidance, but the challenges today are beyond those risk assumptions.

As an example, a 15-mile high pressure gas line operated by Frontier Field Services failed after only a few years of service. That line is in a critical area of our shelf asset and was moving about 25% of our shelf volume. In addition, new plant expansions have been delayed. We estimate that the impact to our production due to midstream challenges was approximately 375,000 barrels of oil equivalent year-to-date. And if these conditions persists, we expect the full year impact of approximately 700,000 equivalent barrels.

Right now, the infrastructure issues are a problem for producers. However, one company's pain is another company's gain. In this case it's the opportunity for midstream providers to step up and build additional infrastructure.

The opportunity
Among the companies looking to capture this opportunity is Magellan Midstream Partners (MMP 1.59%). The company is turning its attention to focus on the Permian. One reason for this is because production in the Permian is expected to grow by another million barrels per day over the next few years. To capture that growth the company is developing crude oil projects in the region. Its projects include the Longhorn Pipeline reversal, which it's spending $375 million to complete as well as the BridgeTex joint venture with top Permian producer Occidental Petroleum (OXY 0.06%). That project will cost Magellan $600 million, while it will help Occidental to maximize the prices it gets for the oil produced out of the Permian.

Both projects come with low single digit EBITDA multiples as well as upside from volume expansions. It's enabling Magellan to play a material role in providing a long-term solution for the Permian, while earning a pretty decent return on the capital it's spending. 

Final Foolish thoughts
Oil and gas companies can be handicapped by infrastructure issues. That can open up a huge opportunity for midstream companies like Magellan, as it can earn a terrific return on the capital it spends to solve those issues. In fact, Magellan's ability to solve problems are what has fueled a 306% increase in it's distribution to investors since its IPO.

Fool contributor Matt DiLallo owns shares of Linn Energy, LLC. Matt DiLallo has the following options: short October 2013 $25 puts on Linn Energy, LLC. The Motley Fool recommends Magellan Midstream Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Linn Energy, LLC Stock Quote
Linn Energy, LLC
Occidental Petroleum Corporation Stock Quote
Occidental Petroleum Corporation
$65.73 (0.06%) $0.04
Magellan Midstream Partners, L.P. Stock Quote
Magellan Midstream Partners, L.P.
$51.64 (1.59%) $0.81
Concho Resources Inc. Stock Quote
Concho Resources Inc.

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