As advances in horizontal drilling and hydraulic fracturing have boosted U.S. crude oil and natural gas production to multidecade highs, midstream companies have struggled to keep up with the surge in output. In remote resources plays like North Dakota's Bakken shale, where pipeline capacity is limited, many companies are shipping the majority of their production by rail.
Midstream companies recognize these challenges and are investing heavily in the necessary infrastructure to transport, store, and process the oil, gas, and natural gas liquids being pumped out of U.S. shale plays. But to keep up with the expected growth in domestic hydrocarbon production, they will have to spend a whole lot more over the next several years. Let's take a closer look at exactly how much, as well as one stock to play the trend.
Energy infrastructure spending to rise through 2035
Energy companies will need to invest a whopping $641 billion on U.S. and Canadian midstream oil, gas, and natural gas liquids infrastructure over the next two decades, according to a recent study by consultancy ICF International on behalf of the Interstate Natural Gas Association of America. That equates to annual spending of roughly $29.1 billion through 2035, almost triple the $10 billion companies have shelled out each year over the past decade.
So, where exactly will that money go? According to the study, roughly half, or about $14.2 billion per year, will need to be spent on midstream infrastructure to accommodate the continued growth in U.S. natural gas production. Companies will need to build some 35,000 miles of new transmission pipelines and 303,000 miles of gas gathering lines, says the report, titled "North American Midstream Infrastructure Through 2035: Capitalizing on Our Energy Abundance."
In addition to heavy spending on gas infrastructure, the study estimates that some $12.4 billion per year will have to be directed toward infrastructure designed to handle crude oil, including pipelines, gathering lines, and storage tanks. Lastly, another $2.5 billion in annual spending will be required for infrastructure associated with natural gas liquids such as ethane, butane, and propane, including NGL pipelines, fractionation, and export facilities.
How might investors profit from this expected growth in U.S. hydrocarbon production and the associated increase in midstream infrastructure spending? One way is by investing in the very midstream companies that build and operate the pipelines and other facilities to handle all of that oil and gas.
One stock to play the trend
Most of these companies are structured as master limited partnerships, or MLPs, which allows them to bypass corporate taxes and pass on the lion's share of their cash flows to shareholders, or unitholders, as they are called in MLP parlance.
For investors looking to invest in an MLP for the first time, I'd recommend starting with Enterprise Products Partners (NYSE:EPD), one of the largest publicly traded midstream firms in the country and a true stalwart in the MLP space. The Houston-based partnership boasts one of the strongest credit ratings for any MLP and has consistently raised its distribution for 38 quarters in a row.
In addition to the $4.6 billion of capital projects Enterprise brought online in 2013 and the first quarter of this year, Enterprise plans to complete an additional $5.8 billion of capital projects through 2016. Since the majority of these projects are fee-based projects with long-term commitments, they provide a great deal of visibility into future distribution growth.
For instance, the ATEX Express pipeline is supported by 15-year ship-or-pay commitments, while Seaway is supported by 5-year and 10-year contracts with committed volume requirements. Since revenues from these pipelines depend mainly upon the volume of hydrocarbons transported and the level of fees charged to shippers, growth in volumes translates into growth in revenues and cash flow.
ATEX, Seaway, and other projects slated to come online this year should generate roughly $4 billion of distributable cash flow in 2014, up from $3.8 billion in 2013, which should be more than enough for Enterprise to grow its distribution by around 6% -- the historical rate of growth. Further, the partnership's phenomenal 1.5 times distribution coverage ratio means it has a 50% cash cushion after it pays out its distributions, giving it plenty of room to grow distributions at an even higher rate.
Indeed, Credit Suisse reckons that Enterprise could grow its distribution at an annual rate of 6% for the next seven years with no additional capital investment just by squeezing its coverage. If that doesn't help Enterprise unitholders sleep better at night, I don't know what will.