Profit From The U.S. Energy Boom's Most Critical Need

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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 in production.

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 pipeline.

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 Lac-Megantic, Quebec.

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 Intermediate ( WTI ). 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 growth.

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 years.

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 partnerships (MLPs).

Enbridge Energy Partners (NYSE: EEP ) 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: EPD ) 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 flow.

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.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Stocks

Referenced Stocks: WTI

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