There is little doubt that the energy revolution is one of the
most powerful themes in investing today. The United States has
surpassed Saudi Arabia as the world's top producer and production
is set to surge to 13.1 million barrels a day by 2019.
While the whole country has benefited from lower oil imports,
two regions are disproportionately benefiting from the increase
There's Texas, of course, with the Permian, Barnett and Eagle
Ford formations -- and industry infrastructure that dates back
more than a century.
But the other region, the Williston Basin in North Dakota,
might be even more attractive for investors. Until the past
decade, the region had never been a significant producer, so the
need for infrastructure was minimal.
The need for that infrastructure is changing faster than
anyone imagined and could mean strong cash flows for several
midstream giants in the area.
A Troubling Trend
The number of railcars shipping petroleum products has surged to
more than 15,000 carloads a week, more than double the
7,000-carload average through 2010. Crude shipments by rail set a
record of 110,000 carloads in the first quarter of this year.
While transportation by rail involves lower upfront costs, it
is more expensive than pipeline transportation. According to the
Congressional Research Service, transporting crude by rail costs
between $10 and $15 per barrel, up to three times as much as by
In addition to being more expensive, transportation by rail
may be more dangerous and the use of older cars is leading to
more spills. Last year, more crude oil was spilled in U.S. rail
incidents -- nearly 1.5 million gallons -- than in the previous
three decades. And this doesn't include the 1.5 million gallons
of crude spilled in a single disastrous day last year in
Production in the Williston Basin has jumped nearly 280% over
the past half-decade, to just over 1 million barrels a day.
Correspondingly, rail capacity has increased from just 30,000
barrels a day in 2008 to 965,000 in 2013. More than 60% of the
region's total production is now shipped by rail.
One factor for higher volumes of rail transportation is the
difference between prices for Brent crude and West Texas
). Since 2011, WTI has traded at a discount to the price of Brent
crude because of increased domestic production and transportation
bottlenecks. (In fact, my colleague David Sterman
took a closer look at how this spread might have
factored into an interesting move by Carl Icahn
late last year.)
The difference is important because oil transported to coastal
refineries, many of which run off of imported Brent prices, can
fetch a premium compared with that transported to Cushing,
Oklahoma, and priced on WTI.
Since pipelines generally run north to south, rail has taken
share of transportation to move production eastward to the coast.
The spread between WTI and Brent crude spiked to nearly $30 a
barrel in 2011 but has come down over the past year.
The spread has narrowed to just $3 a barrel recently, and rail
transportation is looking less attractive.
But there is another factor beyond the WTI-Brent spread:
Pipeline capacity has just not kept up with production
A Spending Boom -- With Cash Flows To Follow
Total pipeline and refinery capacity in the Williston was 583,000
barrels a day last year. That is well under the region's
production, which is expected to continue surging to nearly 1.6
million barrels a day by 2019.
A shrinking price spread has already seen some demand flow back
to pipelines, and midstream partnerships in the area are likely
to see higher volumes. Two partnerships in particular are getting
in front of the story to increase capacity over the next several
Even if the price spread remains positive for rail
transportation, massive production growth in the region could
means years of strong cash flows for these two master limited
Enbridge Energy Partners (NYSE:
already has significant assets in the Bakken with pipeline
capacity of 355,000 barrels a day. The partnership's
Sandpiper pipeline project
could add as much as 225,000 barrels of daily capacity by the
first quarter of 2016.
While the distribution coverage ratio of 0.73 times is
relatively low, sales are expected to rise 17% this year and 9%
in 2015 and should help to increase distributable cash flow. The
incentive distribution rights to the general partner are capped
at 25%, so
unitholders are protected from a conflict of
interest with the rising distribution
Enterprise Products Partners (NYSE:
is building a 1,200-mile pipeline from the Bakken to Cushing to
add 344,000 barrels of daily capacity by the fourth quarter of
2016. Distributable cash flow covers the distribution by 1.6
times, and revenue is expected to rise 13% this year.
Distributions are made only the unitholders, so there is no
potential conflict with incentive distribution rights.
The partnership's massive size -- it has a market cap of $72
billion -- means it must constantly add assets to increase the
distribution significantly. While this may slow distribution
growth in the future, valuation on the units is attractive, and
the partnership's projects secure growth in near-term cash
Risks to Consider:
Building out pipeline infrastructure is expensive and takes
years to complete. Besides growth projects, investors need to
keep an eye on maintenance expenditures and near-term cash flow
to avoid partnerships with unsustainable distributions.
Action to Take -->
Demand for pipeline capacity is only getting stronger as the U.S.
energy revolution develops. Take advantage of a dearth of
capacity in certain regions to invest in partnerships with large
growth projects that will support future cash flow.
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