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Why Is Buffett Bullish on Pipelines?

By Reuben Gregg Brewer – Jan 20, 2014 at 10:02AM

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Warren Buffett is buying a business that helps pipelines increase their throughput to reduce capacity constraints—if he sees this as an opportunity, pipeline owners have more growth ahead.

Warren Buffett's Berkshire Hathaway is buying Phillips 66's (PSX 4.28%) pipeline-services business. It's a bet on both growth within the industry and on the capacity constraints currently limiting it. More importantly for income investors, it suggests that the Oracle of Omaha sees a bright future for midstream players like Kinder Morgan Energy Partners (NYSE: KMP), Enterprise Products Partners (EPD 0.08%), and Energy Transfer Partners (ETP).

Re-shaping itself
Phillips 66 was spun off from ConcocoPhillips in early 2012. In mid-2013 it spun off some midstream operations into Phillips 66 Partners. And now it's selling its pipeline-services business to Berkshire in what is essentially a $1.4 billion stock swap, with Berkshire returning Phillips 66 shares as payment for the acquisition.

The move allows Phillips 66 to refine its operations and focus on its core businesses. That should help spur growth of the still young company. And, at the same time, it looks like a typical opportunistic Berkshire Hathaway venture: buy a boring business with good demand prospects and build it up. The deal compliments and is informed by the Buffett's other operations.

For example, Berkshire owns pipelines via its MidAmerican Energy business. And, perhaps more importantly, the company's Burlington Northern Santa Fe railroad has been increasingly hauling oil. Clearly, Berkshire is well aware of the constraints facing pipelines and how far companies are willing to go to get oil to market.

The long-term story
Essentially, Berkshire is buying a business that sells an additive that allows more fluid to flow through a pipeline. That increases the capacity of existing infrastructure at a time when new pipelines are facing increasing opposition. And even when approved, pipelines take time to build. But both of these issues speak to the long-term opportunity this deal highlights.

For example, Kinder Morgan Energy Partners, Energy Transfer Partners, and Enterprise own around 140,000 miles of pipelines between them, moving oil, natural gas, and other liquids across the country. They are toll takers that grow their business by building and buying more pipelines and energy handling facilities. The more they send through their pipes, the more money they make.

Without demand for more capacity, this trio's prospects would dim considerably. However, Berkshire's investment is a clear indication that Buffett doesn't see things slowing down. And that spells continued growth for the industry. And while Enterprise, Kinder Morgan Energy Partners, and Energy Transfer Partners are all big players, they still have plenty of opportunity.

For example, Kinder Morgan Energy Partners is buying its way into the Jones Act shipping business because of the need for alternative methods of transporting oil and other products. That's roughly similar to Berkshire's train operations hauling oil. Enterprise has been focusing on internal growth projects to increase capacity, but its acquisition history shows it's not afraid of a merger, either.

And Energy Transfer Partners' 2012 move to gain control of Sunoco Logistics Partners shows that there are still some decent acquisition opportunities to support growth at already big players. Note, too, that small fries like American Midstream Partners have been working hard and fast to grow their scale—which could easily catch the eye of an acquisitive "big fish."

Follow Buffett's lead...sort of
Income investors should see Buffett's Phillips 66 buy as a vote of confidence in the long-term potential of the midstream business. Some of the biggest players here include Kinder Morgan Energy Partners, Enterprise Products Partners, and Energy Transfer Partners. They are a great way to get some income while following the Oracle's lead.

That said, smaller players like American Midstream may be worth a look, too, for both growth potential and because they are the very types of minnows that the bigger players swallow to grow. And, for Berkshire investors, it will be interesting to see just how much mileage Buffett can get out of this opportunistic buy.  

Reuben Brewer has positions in Kinder Morgan Energy Partners, Enterprise Products Partners, and American Midstream Partners. The Motley Fool recommends Berkshire Hathaway and Enterprise Products Partners L.P.. The Motley Fool owns shares of Berkshire Hathaway. 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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