Roger Conrad’s Utility Forecaster is one of only nine newsletters on the Hulbert Financial Digest’s 2011 Honor Roll, which recognizes newsletters that outperform in both up and down markets. Below, he analyzes some of the best income investments in the natural gas sector.
“It’s a bull market for natural gas, really. No, I’m not talking about the fuel itself, which has plunged 71% from its July 2008 high and is barely $1 per million British thermal units above its September 2009 low.
“Rather, the juice is in companies that build, own and operate the gathering systems, pipelines, storage and distribution networks that bring gas from wellhead to burner tip, power plant and fueling station. [Low gas prices] are fueling demand, and infrastructure is needed to bring the fuel from shale-rich areas. Then there’s needed upgrades to the 50% or so of the nation’s pipeline network built in the 1950s and ’60s. PG&E’s (PCG) pipeline explosion last year is now expected to cost the company between $200 million and $480 million, a stark reminder of the steep price of maintenance errors. Building and maintaining gas infrastructure requires huge amounts of capital. That limits the field to a handful of dominant companies that can afford it and earn a decent return on their investment.
“Three UF Portfolio master limited partnerships (MLP) have emerged as major energy infrastructure players in North America: Energy Transfer Partners LP (ETP – yield 6.60%), Enterprise Products Partners LP (EPD – yield 5.60%) and Kinder Morgan Energy Partners LP (KMP – yield 6.20%). All three have utilized low-cost equity and debt capital to grow assets rapidly in recent years. Last month Energy Transfer announced it will build a natural gas pipeline, processing plant and additional facilities in the Eagle Ford Shale region of South Texas, with a target completion date of second quarter 2011. Fourth- quarter distributable cash flow rose 10.4%, thanks to similar organic expansion. Enterprise Products reported record natural gas and NGL pipeline volumes in the fourth quarter, investing $3.1 billion to acquire midstream energy infrastructure. It also completed three major construction projects, including storage facilities and pipelines, and will invest a further $3.4 billion in 2011, focused on the Eagle Ford and Haynesville Shale regions. Kinder Morgan is also active in the Eagle Ford Shale area, venturing with Copano Energy LLC (CPNO) to build infrastructure and provide gas gathering, transportation, processing and fractionating services to Anadarko Petroleum Corp (APC).
“As master limited partnerships, the three pay no corporate tax and instead drop down virtually all cash flow directly to investors as distributions. A large percentage of these are return of capital (ROC), so no tax is due when they’re paid. Instead, the ROC is subtracted from your cost basis and taxed as a capital gain when you sell. MLPs’ favorable tax status maximizes yield. Investors receive a Form K-1 rather than a 1099 at tax time, a slightly more complicated filing that any accountant should be able to handle. Contrary to popular belief, they’re suitable for IRAs, though investors will lose the benefit of ROC. Buy Energy Transfer Partners (up to 55), Enterprise Products Partners (45) and Kinder Morgan Energy Partners (75).
“First-rate Portfolio corporations highly leveraged to the gas infrastructure boom include Dominion Resources, Inc. (D – yield 4.30%), NiSource, Inc. (NI – yield 4.80%), ONEOK, Inc. (OKE – yield 3.20%), Sempra Energy (SRE – yield 3.60%) and Spectra Energy Corp. (SE – yield 3.80%). Dominion has now sold the natural gas and oil production operations it acquired with Consolidated Natural Gas in the ’90s. The company, however, is launching a major build-out of gas gathering, pipeline and storage infrastructure in the Marcellus Shale as well as a liquefied natural gas export facility in Maryland. That’s in addition to the $900 million Appalachian Gateway and Gathering Expansion proj- ects slated to come on line over the next two years. NiSource also has a series of Marcellus projects, as it expands the Columbia Gas System it purchased a decade ago and rolls out an ‘investment opportunity’ in infrastructure it sees ‘approaching $4.5 billion over the next 20 to 25 years.’
“ONEOK lifted its dividend 8.3% last month and targeted 8%-10% annual earnings growth for 2011- 13, as its ONEOK Partners LP (OKS) unit invests $1.5 to $1.8 billion the next three years. Sempra runs the nation’s largest gas distribution system, as well as one of the Americas’ biggest storage (12 billion cubic feet capacity) and pipeline networks and an LNG facility in Mexico. And it expects to spend at least $3 billion a year on expansion at least to mid- decade. Finally, Spectra plans to spend $1 billion a year on gas infrastructure in the U.S. and Canada over the next five years. And it’s targeted eight gigawatts of coal and oil-fired plants ripe for conversion to gas.
“We’ll know the North American energy infrastructure building boom is near a peak when companies like these don’t pre-contract facilities before they build. In contrast, almost everything is pre-sold now, providing instant cash flow when projects are completed. That’s a powerful argument for these companies to keep growing rapidly in the years ahead. Buy Dominion Resources (up to 45), NiSource (19), ONEOK (60), Sempra Energy (55) and Spectra Energy (27).”
Roger S. Conrad, Utility Forecaster, 3/11