Pipes Full of Cash

New pipelines in the heart of the North American continent have begun dissolving the region’s crude bottlenecks. We’re taking the opportunity to survey the nation’s biggest and safest pipeline operators.   

As noted in the Jan. 9 issue of The Energy Strategist, this year we should begin to see significant relief of the buildup of crude at the nation’s most important oil hub in Cushing, Okla., thanks to three new pipeline projects with capacity to move 1.1 million crude barrels per day (bpd) out of Cushing.

The consequences of this were also noted in that issue. They were that the Brent-West Texas Intermediate (WTI) differential that had benefited the mid-continent oil refiners so much would decline, cutting into their profit margins. The railroads that have made so much money hauling crude would also be at some risk because of increased competition from more cost-effective pipeline transportation.  

Brent WTI spread chart

Two of the three major pipeline projects are now complete, providing 400,000 bpd of additional takeaway capacity from Cushing. Since January, the Brent-WTI differential has fallen from $17 to a recent low of $5.50.

The primary reason for the shrinking differential is not, however, higher WTI prices. WTI has risen slightly, but the prime mover behind the shrinking differential has been the downwardly mobile Brent, which has dropped about $10 per barrel since the beginning of the year.   

But the picture in Cushing is so far relatively unchanged. In fact, April’s inventories were only about a million barrels below the all-time high set in January. So while traders may be anticipating that the increased pipeline capacity will alleviate the Cushing glut, so far that is not happening.

One reason for this may be that even as the pipeline capacity increases, the oil production in Petroleum Administrative Defense District (PADD) 2 continues to grow rapidly. PADD 2 is typically thought of as the Midwestern PADD, and it includes North Dakota. That is the source of most of the crude flowing into Cushing, and crude oil production is PADD 2 is up by half a million barrels per day in just the past two years.

Mid-continent refiners, as expected, are seeing their profits fall as a result. Nevertheless, refiners like Valero (NYSE: VLO), Tesoro (NYSE: TSO), and Marathon Petroleum (NYSE: MPC) are all up more than 20 percent year-to-date. The railroads also continue to do well, with major carriers like Canadian Pacific (NYSE: CP), Union Pacific (NYSE: UNP), CSX (NYSE:CSX) and Norfolk Southern (NYSE: NSC) all notching gains of more than 20 percent since January.

Cushing inventories chart

So even though the Brent-WTI differential has narrowed, the Midwest oil glut is still there. The narrowing differential has made rail less competitive, although the railroads will continue to move plenty of crude. But as the differential narrows, the pricing advantage will swing back to the pipeline companies that can transport crude oil at a lower cost than the railroads.

Most of the major pipeline companies in the US are organized as master limited partnerships (MLPs). Many pipeline companies are ideal for income investors, because they generally offer very attractive yields, as high as 7 percent. Unlike royalty trusts, the largest pipeline operators do not have much commodity exposure, and therefore have lower risk and volatility.

The key statistics for most of the major pipeline/infrastructure MLPs are summarized at the end, but here is a more in-depth look at a few.

Kinder Morgan Energy Partners
Kinder Morgan Energy Partners (NYSE: KMP) is one of the largest pipeline transportation and energy storage companies in North America. The partnership owns an interest in or operates approximately 46,000 miles of pipelines and 180 terminals, and receives fees for transporting and

storing energy products such as natural gas, refined petroleum products, crude oil, ethanol, biodiesel, and carbon dioxide. KMP’s customers include producers, shippers, oil companies, and utilities.

KMP has an enterprise value of about $54 billion, and an enterprise value/EBITDA of 14. Since 1997 KMP has invested more than $30 billion in projects, joint ventures and acquisitions, and has delivered an astounding average annual return of 24 percent to unitholders.

Kinder Morgan Partners returns chart

KMP has increased annual distributions every year for more than a decade. In 2012 distributions reached $4.98 per unit, which represented an 8 percent increase over 2011. The 2013 distribution is expected to increase another 6 percent to $5.28 per unit.

KMP is a Buy in our Conservative Portfolio, but after advancing 21 percent in the past 12 months it is currently 7 percent above our recommended purchase price. Buy KMP on dips below $82.

Enterprise Products Partners
Enterprise Products Partners
(NYSE: EPD) is the largest publicly traded master limited partnership (MLP) in the US. EPD has an asset base of $34 billion, and its businesses are more diversified than those of KMP. EPD’s asset base includes:
  • Over 50,000 miles of natural gas, NGL crude oil, refined products and petrochemical pipelines

  • 190 million barrels of NGL, refined products and crude oil storage capacity

  • 14 billion cubic feet of natural gas storage capacity

  • 25 natural gas processing plants

  • 20 NGL and propylene fractionators

  • 6 offshore hub platforms

EPD has an enterprise value of about $56 billion, and an enterprise value/EBITDA of 16. The units presently yield 4.4 percent, and management has raised the distribution rate for 34 consecutive quarters. The partnership has significant insider ownership, with management and affiliates owning approximately 38 percent.

In the past few years EPD has invested in excess of $7 billion in future growth and plans to invest more than $10 billion in projects through 2015. Two of the three major projects meant to alleviate the glut of crude oil at Cushing involve EPD. Seaway Crude Pipeline Company is a 50/50 joint venture between EPD and Enbridge (NYSE: ENB). In 2012 the partners reversed the flow direction of the Seaway This initially allowed the transport of 150,000 bpd of crude oil from Cushing to Gulf Coast refineries near Houston, and in January the capacity was increased to 400,000 barrels a day.

EPD has been a strong performer in our Conservative Portfolio, appreciating by a third over the past 12 months. It is currently 23 percent above our recommended purchase price, so we would suggest waiting for any weakness to buy this outstanding company. Buy EPD on dips below $50. The units were last at this level on Dec. 31, so prospective buyers will need to exercise patience.

Plains All American Pipeline
Plains All American Pipeline
(NYSE: PAA) has a diversified portfolio of assets that covers most of the important energy-producing areas of the US and Canada. The company has 18,000 miles of crude oil, NGL and refined products pipelines and moves approximately 3.5 million barrels of liquid product per day. The primary focus is on crude oil, but assets include:
  • 74 million barrels of crude oil and refined products capacity

  • 22 million barrels of NGL/LPG storage capacity

  • 93 billion cubic feet of natural gas storage working capacity

  • 7 fractionation plants

  • 11 processing plants

  • 1 isomerization unit

  • 23 crude oil and NGL rail terminals

PAA has an enterprise value of $27 billion and an enterprise value/EBITDA of 11.7. The units presently yield 4 percent, and the distributions have increased in 33 of the past 35 quarters. The company has met or exceeded earnings guidance for 44 consecutive quarters.

The most attractive feature of PAA may be its low debt. At 38.5 percent of debt to assets, PAA has one of the least leveraged balance sheets among the pipeline MLPs. This minimizes the still hypothetical risk of rising interest rates cutting into future distributions.

PAA is not currently in any of our portfolios, but it may offer a lower-risk option than KMP or EPD because of its lower debt. Like its peers, PAA has also had a strong run over the past year, rising 53 percent. So investors interested in taking a position should probably wait for a pullback before jumping in.

Williams Partners
Williams Partners
(NYSE: WPZ) is focused primarily on natural gas infrastructure and the gathering, treating, processing, transportation, and storage of natural gas. The company also owns natural gas liquids (NGL) fractionation facilities. These facilities include the Geismar, Louisiana olefins production facility, which upgrades NGLs into approximately 1.3 billion pounds of ethylene and 90 million pounds of polymer-grade propylene each year. WPZ has an enterprise value of about $30 billion, and is slightly cheaper than KPM or EPD with an enterprise value/EBITDA of 13.4. The units presently yield 6.5 percent, with the most recent quarterly distribution up 9 percent from a year ago.

WPZ has been hurt by poor ethane and NGL pricing. As a result, the unit price is up only 1 percent over the past year, in stark contrast to the performance of KPM and EPD. However, the company is projecting growth in fee-based revenue to $4 billion by 2014, which would represent a 50 percent increase over 2011 levels. Williams is trying to shift more revenue to fee-based businesses to insulate itself from the commodity exposure that’s hurt recent performance.   

WPZ is not currently in any of our portfolios, and it would be a speculative pick. However, if management delivers on its targets the unit price should see a strong move upward over the next year or two.

Key Peformance Indicators for Select Pipeline MLPs

Key stats for top pipeline MLPs

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