Fracking in combination with horizontal drilling has made once inaccessible gas and oil profitable to drill. This, in turn, has changed the country's energy future and opened up big opportunities for investors.
The safe approach
A relatively safe way to generate income from domestic oil and gas drilling is to buy midstream companies like Kinder Morgan Energy Partners (NYSE: KMP) and Enterprise Products Partners (EPD -0.35%) that provide services to the oil and gas industries, among others. This includes, but is hardly limited to, owning the pipelines that move products from the well to processing facilities and storage facilities. These are largely fixed fee-based businesses that will see increased demand as drilling continues to expand. These fixed-fee contracts help Kinder Morgan Energy Partners and Enterprise as they are paid a predetermined amount for access to their infrastructure, reducing commodity price risk and offering unitholders steady distributions.
These two giants are diversified across multiple commodities. And, they offer notable yields supported by long histories of regular distribution hikes and business expansion. Enterprise has actually increased its distribution for 36 consecutive quarters. Kinder Morgan Energy Partners' distribution, meanwhile, has seen a double-digit compound annual growth rate over the past decade, powered by consistent distribution increases.
Kinder Morgan Energy Partners' yield is around 6.6% versus Enterprise's 4.4%. Enterprise has grown its business much more quickly, leading to a premium valuation. Revenues, for example, have grown from nearly $22 billion in 2003 to $42.5 billion last year. Kinder Morgan Energy Partners' top line fell over the same span. Note, too, that Enterprise bought its general partner in 2010, so it avoids the general partner incentive payments that Kinder Morgan Energy Partners has to make.
Kinder Morgan Energy Partners and Enterprise are very similar entities. Investors should feel comfortable with either, though it's worth highlighting that Kinder Morgan Energy Partners' accounting methods have been questioned by a niche research shop, which is likely presenting a short-term buying opportunity .
The supplier
Another way to play the trend is Hi-Crush Partners (HCRS.Q), a pure-play frac sand miner. This material is vital to the fracking drilling method. Hi-Crush's premium white sand is a high-quality offering that is gaining share within the proppant market. And the company benefits from on site distribution capabilities at its two mines, helping to keep its costs low.
The units yield around 8.8%, which is pretty high and speaks to a lack of diversification. Where Kinder has oil and gas pipelines, shipping terminals, and storage facilities, Hi-Crush just has sand.
That said, Hi-Crush recently grew its business via an acquisition and intends to increase its distribution in the fourth quarter. That would be the first hike for this young partnership but is a statement to its underlying strengths. And management is projecting increased pricing and demand for frac sand through the end of the decade.
The drillers
If you are looking specifically for a driller, however, Vanguard Natural Resources (NASDAQ: VNR) is a good option. About 60% of the company's production is natural gas, with the rest coming from oil and NGLs. Its goal is to further diversify its portfolio, bringing natural gas down below 50%.
Still, it will be a direct beneficiary of increased natural gas use and foreign oil displacement, and it offers an around 8.8% yield. The distribution has been increased each year since 2007 as Vanguard has expanded its business via acquisition.
If you are more aggressive, Linn Energy (LINEQ) might be of interest. The units yield over 11% and trade under the cloud of an informal SEC inquiry into its accounting practices that could have an impact on its acquisition of Berry Petroleum. That said, the company is working on the issue with the government and the outlook isn't as negative as it once was, though there is still little available information.
And despite the problems, Linn has built itself into the 11th largest independent oil and gas driller in the country. The partnership's has focused on buying mature properties and running them well. And it locks in prices for its output via an active, and so far largely successful, hedging program. Both of these attributes provide notable clarity to the company's ability to pay distributions.
About half of Linn's reserves are natural gas. Although there's clearly more business risk here right now, the additional yield might be worth it for aggressive types.
Oil, gas, and yield
If you are watching the energy revolution taking place in the United States and want to participate, but also want to "get paid," these five partnerships are good options. Their risk profiles and direct exposure to gas and oil differ, so they aren't right for every investor. But each one of these high yielders is positioned to continue exploiting the fracking boom.
