Forget oil. Natural gas liquids (NGL) are a more important growth driver for many of the master limited partnerships (MLP) in our model Portfolios. MLPs involved in natural gas processing and NGL storage, transport and export reported some of the strongest fourth-quarter results in our coverage universe. This outperformance reflects a long-term, secular shift in the global market for NGLs that favors North America.

Civil war in Libya, toppled dictators in Tunisia and Egypt and protests across the Middle East and North Africa have pushed crude oil prices higher this year. West Texas Intermediate (WTI), the most widely watched US oil benchmark, eclipsed the psychologically important $100 level.

But WTI understates the rise in global oil prices, capped by a glut of supply at Oklahoma’s Cushing terminal, the official delivery point for US-traded crude oil futures. This oversupply doesn’t stem from a lack of demand, but a surge in local supplies; a new pipeline that delivers oil from Canada and growing production from US onshore plays such as the Bakken Shale of North Dakota and the Permian Basin of West Texas have conspired to swell inventories at Cushing.

Meanwhile, Brent crude has soared to almost $120 per barrel, reflecting geopolitical risk and a tight supply-demand balance.

But amid all the headlines about crude oil, investors are missing one of the most important trends for our favorite MLPs: Surging demand and supply of NGLs in the US. We’ve written extensively about the NGL market in prior issues, including the April 23, 2010, issue $7 Natural Gas.

By way of review, natural gas is composed primarily of methane, a hydrocarbon consisting of one carbon atom bound to four hydrogen atoms (CH4). But raw natural gas produced from wells isn’t homogenous; methane typically occurs with a variety of heavier hydrocarbons (NGLs) such as ethane (C2H6), propane (C3H8) and butane (C4H10).  Crude oil, water vapor, carbon dioxide, nitrogen and sulfur also mix with raw natural gas.

The components of this mélange vary from field to field. Some regions produce dry natural gas, or gas that consists primarily of methane with little NGL content. In contrast, “wet” fields such as the Eagle Ford of Texas and the Marcellus Shale in Appalachia also contain large quantities of NGLs.

NGLs may not receive as much media attention as crude oil or natural gas, but they’re vital energy commodities. Ethane and propane are commonly employed as petrochemical feedstock. Ethane is used to make ethylene, while propane is used to manufacture propylene–chemicals that form the building blocks of various plastics. Oil refineries also use NGLs to boost the octane rating of gasoline.

When NGL prices are low, producers leave some NGLs in the natural gas stream to be burned with methane–a common practice for ethane the most prevalent and lowest-price NGL. But NGL prices are elevated by historical standards, while natural gas prices remain depressed; in producers maximize returns by removing the NGLs from the raw natural gas and selling each component separately  

The Current Environment for NGLs

Robust demand from the domestic petrochemicals industry has been a big part of this trend. Check out this graph, which tracks US demand for ethane and propane from 2003 onward.

Source: Enterprise Products Partners LP

NGL consumption dipped between 2008 and early 2009, a product of the recession and financial crisis. But this decline has reversed as the economy recovers, reverting to the broader trend of consistently growing demand for NGLs.

In December 2010 US ethane consumption topped 1 million barrels per day, an all-time high. Demand has slackened slightly since then, largely because a handful of processing plants were temporarily closed for maintenance.

A number of new petrochemicals plants have opened over the past year. For example, Eastman Chemical (NYSE: EMN) reopened an ethane cracking facility–a plant that produces ethylene and other chemicals from ethane–that had been mothballed since 2008. Meanwhile, Chevron Phillips Chemicals, a 50-50 venture between oil giants ConocoPhillips (NYSE: COP) and Chevron Corp (NYSE: CVX), recently restarted a cracking facility in Sweeney, Texas.

Dow Chemical (NYSE: DOW), the world’s second-largest chemical outfit, in December 2010 announced plans to increase its ethane cracking capacity on the Gulf Coast over the next two to three years. The firm will also improve its ethane cracking capabilities by 20 to 30 percent to take advantage of the superior economics offered by the NGL.

Industry observers estimate that US chemical producers could consume an additional 100,000 barrels per day of ethane by expanding the capacity of existing plants.

The other major shift underway in the US NGL industry is the source of the supply. Historically, petroleum refineries have accounted for as much as half of domestic NGL production, but that’s changed: In January 2011, gas processing plants supplied 860,000 barrels per day of ethane to customers.

US demand for NGLs continues to boom, thanks to the country’s newfound abundance of these hydrocarbons in a number of prolific onshore shale gas plays.

Hydrocarbons don’t occur in giant underground pools; they’re trapped in the pores and cracks of a reservoir rock. Conventional reservoir rocks such as sandstone feature high porosity and permeability. That is, they have many pores capable of holding hydrocarbons as well as fissures and interconnections trough which the oil or gas can travel. When a producer drills a well in a conventional field, oil and gas flow through the reservoir rock and into the well, powered by geologic pressure.

Shale fields and other unconventional plays aren’t particularly permeable. In other words, these deposits contain plenty of hydrocarbons but lack channels through which the oil or gas can travel. Even in shale fields where there’s plenty of geologic pressure, the hydrocarbons are essentially locked in place.

Producers have developed and refined two major technologies in recent years to unlock the natural gas and oil trapped in shale deposits–horizontal drilling and fracturing.

Horizontal wells are drilled down and sideways to expose more of the well to productive reservoir layers. Fracturing is a process whereby producers pump a liquid into a shale reservoir under such tremendous pressure that it cracks the reservoir rock. This creates channels through which hydrocarbons can travel, improving permeability. Over the past several years, US producers have perfected these techniques in a number of prolific shale gas and shale oil plays.

The evolution of these two technologies has completely revolutionized gas production in the US. It’s also completely changed the outlook for US electricity prices and a host of manufacturing industries that use natural gas for energy.

But all this drilling activity in US unconventional fields also increases the supply of NGLs; many of the most promising US gas shale fields are rich-gas fields that also contain large quantities of NGLs.

An example is the Eagle Ford shale of southern Texas. Here’s a map showing the geographic bounds of this play.

Source: EOG Resources

The Eagle Ford contains three distinct windows: an oil window, a wet-gas window and a dry-gas window. As companies ramp up drilling in the Eagle Ford, they produce more NGLs–a key contributor to profit margins. Natural gas currently goes for $4 per million British thermal units (BTU) in the US, near a multiyear low. Meanwhile, crude oil prices have shuffled between $100 and $115 per barrel this year. A mixed barrel of ethane, propane, butane and isobutene costs roughly $56 per barrel. Better prices for oil and NGLs has prompted producer to focus on liquids-rich plays. Check out this graph of US NGL production.

Source: Energy Information Administration

In November 2010, US NGL output reached a record high and has continued to climb. The US now produces more than 2 million barrels per day of NGLs from natural gas processing alone. This rapid growth is impressive when you consider that in 2005 most analysts called for NGL production to decline because output from nation’s mature conventional fields was on the wane. The shale gas revolution has changed the landscape of the petrochemicals industry.

The increased availability of NGLs enables US petrochemical producer to better compete with foreign companies on price. During Enterprise Products Partners LP’s (NYSE: EPD) conference call, the MLP’s Chief Operating Officer quoted a passage from a recent sell-side analyst report on Dow Chemical’s new joint-venture chemicals production facility in Kuwait, EQUATE:

We visited EQUATE as a part of our Middle Eastern field trip in June 2010 and it was clear that lack of cheap ethane feedstock in Kuwait would mean future capacity expansions would use naphtha as a feedstock, which would likely position the new capacity above the US Gulf Coast on the cost curve. Similar issues appear to be present in Saudi Arabia.

Not too long ago, industry observers would have scoffed at the suggestion that US petrochemical firms would enjoy a cost advantage over facilities in Kuwait and Saudi Arabia. But the shale gas revolution has ensured that the US chemical producers have access to an abundance of NGLs at reasonable prices, a huge advantage over areas where NGL prices are higher or naphtha–which is derived from crude oil and therefore costlier–serves as the primary feedstock.

And the market for US NGLs isn’t restricted to domestic customers; US exports of NGLs and related products have soared in recent quarters.

Source: Energy Information Administration

Exports of NGLs and related products such as ethylene and propylene are approaching 200,000 barrels per day, near an all-time record. The real export boom began in 2005-06 when US production from unconventional natural gas fields began to take off.

The MLP Connection

MLPs are involved at many levels of the NGL supply chain. Here’s a look at some of the key businesses in the industry.

• Natural Gas Gathering: Gathering lines are small-diameter pipelines that collect individual gas wells to processing facilities and, ultimately, the interstate pipeline network. The key to the gathering business is location: MLPs with gathering systems located in NGL-rich plays such as the Eagle Ford continue to thrive from accelerating drilling activity.

• Gas Processing:  Natural gas processing involves removing NGLs from the raw natural gas stream. Once again, location is everything. Plants near wet-gas fields are running near full capacity.

• Fractionation: Fractionation is the process of breaking a mixed barrel of NGLs down into its constituent components. In other words, fractionation facilities separate ethane, propane, butane and isobutene into individual streams.

• Export terminals: Liquefying natural gas for shipment is a complex process, but propane and other NGLs can be liquefied with relative ease and far less compression. The US currently boasts only one export terminal for liquefied natural gas, but the country has considerable capacity to exports NGLs, primarily from the Gulf Coast.

• NGL Marketing: A handful of MLPs sell NGLs processed at their facilities to petrochemicals plants and other buyers. For many MLPs, this is a safe, fee-based business. Strong demand for NGLs can provide additional opportunities for profit.

• NGLs Storage and Pipelines: MLPs own dedicated pipelines and terminals to move and store NGLs.

One major fundamental that drives processing, fractionation and drilling activity is the spread between gas and oil prices. Crude oil is priced in terms of US dollars per barrel, while gas is quoted in terms of dollars per million BTUs (roughly 1,000 cubic feet). To measure the relative cost, convert the price of a barrel of crude oil into dollars per million BTUs. A barrel of WTI crude contains roughly 6 million BTUs. The following graph compares the price of a BTU’s worth of natural gas to a BTU of crude oil.

Source: Bloomberg

From 1995 to 2006, a BTU of natural gas cost an average of 85 percent of what a BTU of crude oil cost. The relationship between oil and gas prices often departed from that level; however, the long-term average remained fairly consistent.

This relationship broke down around 2006 because of drilling activity in shale gas plays. The glut of natural gas depressed US prices at a time when oil prices generally have remained elevated because of strong global demand and limited supply growth. This gap is unlikely to close in the foreseeable future, as the fuels are used in different markets: natural gas is primarily used in heating and power production, while oil is a key transportation fuel.

Recently, a BTU’s worth of natural gas commanded just 25 percent of the price of an energy-equivalent amount of oil, an all-time low. If the long-term average price relationship between gas and oil held today, $100 oil would imply gas prices of $14 per million BTUs. Today, natural gas trades at less than $4 per million BTU in the US.

This pricing environment is great news for any MLPs that operate natural gas processing and fractionation plants, as these facilities are in high demand when producers accelerate drilling activity in liquids-rich plays. MLPs with gathering systems and pipelines that serve these fields also benefit.

NGL prices broadly follow oil rather than natural gas. By far, one of the most common questions we receive from subscribers concerns whether the traditional relationship between crude oil and NGL prices has broken down because of surging NGL supplies. This graph, which compares the prices of several different NGLs to the price of a barrel of crude oil, holds the answer to this query.

Source: Bloomberg

As you can see, NGL prices generally track oil prices. For example, the price of both commodities collapsed in late 2008 and early 2009, before rebounding in the second half of 2009 and into early 2010. NGLs also followed crude oil prices in summer 2010, when the EU credit crunch and fears of a double-dip recession roiled markets.

Generally speaking, NGL prices have followed the price of oil more closely than the price of natural gas, which has declined steadily since 2009. Apart from the occasional spike, gas prices have hovered near multiyear lows.

But the relationship between NGL and oil prices has deteriorated to an extent. The current price of a mixed barrel of NGLs is about 54 percent of the price of a barrel of crude–compared to a longer-term average closer of 60 to 65 percent. Surging oil prices, a product of geopolitical events in the Middle East and North Africa, are behind this decline. Whereas events the fighting in Libya and civil unrest throughout the Middle East have driven oil prices higher, these developments don’t affect US NGL supply.

Investors should also note that the ratio to oil prices varies for each NGL. The spread between ethane and oil prices, for example, is far wider than the difference between butane and oil prices. Although ethane prices tend to track oil prices, the correlation between the two commodities is far looser than the relationship between other NGLs and oil.

That being said, ethane prices have rallied since mid-2010 and currently hover around their two-year high. Meanwhile, propane, butane and oil prices are at their highest levels since 2008. In short, the basic relationship between oil and NGLs remains intact; these commodities continue to follow oil prices more closely than gas prices.

The ratio of natural gas to oil prices is also useful for gauging demand for natural gas processing. When natural gas prices are low relative to oil, companies seek to maximize the amount of NGLs extracted.

All of these factors add up to strong business environment for MLPs involved in all aspects of the NGLs supply chain. Booming North American NGL production has transformed the economics of the petrochemical industry, giving US chemical producers a sizable cost advantage. Here’s a look at the fourth-quarter results from five Portfolio holdings that have exposure to NGL-related businesses.

A Word of Caution

Investors shouldn’t rely on traditional earnings figures to gauge the performance of MLPs and their ability to pay distributions.  The majority of MLPs are midstream players that own and operate pipelines and storage facilities. These assets generate significant depreciation charges over time–charges that don’t represent an actual outlay of cash and don’t affect the firm’s ability to pay out distributions. In fact, MLPs are able to pass through depreciation charges to investors, the reason why a large portion of the income investors receive from MLPs isn’t immediately taxable. 

Instead, investors should evaluate an MLP’s performance on its distributable cash flow (DCF), an adjusted earnings figure that adds noncash charges such as depreciation back to earnings. In addition, DCF includes a charge known as maintenance capital spending, which measures the amount of capital an MLP must spend to keep its assets in working order.

Enterprise Products Partners LP

Conservative Portfolio holding Enterprise Products Partners LP, the largest publicly traded MLP in the US, boasts a diversified business mix that includes natural gas pipelines, offshore production platforms, crude oil pipelines and even tank barges. Roughly 70 percent of Enterprise’s revenue comes from pipelines and other assets that generate fees regardless of whether they operate at full capacity.

These fee-based businesses limit sensitivity to commodity prices and broader economic conditions. That conservative business position is why Enterprise earns our highest possible safety rating of “4.”

In 2010 Enterprise generated DCF of $2.256 billion, up from $1.643 billion in 2009 and an increase of more than 37 percent. That was enough to cover the company’s full-year 2010 distribution of $2.315 per unit by 1.3 times, a high level of coverage for an MLP that operates primarily fee-based businesses. In the fourth quarter, the partnership generated DCF of $571 million, up slightly from a year ago and enough to cover its quarterly payout by 1.2 times.

Thanks to this strong DCF growth and high distribution coverage, Enterprise boosted its quarterly payout for the 26th consecutive quarter, to $0.59 per unit.

Don’t assume that Enterprise’s conservative, fee-based business model means limits its growth prospects. In fact, during its conference call to discuss fourth quarter results, Enterprise’s management team reiterated its long-held view that the potential returns from organic growth projects such as constructing new pipelines and processing facilities exceed returns available from acquisitions in the markets it serves. The company is putting money behind this strategy, investing $3.1 billion in growth capital projects in 2010. Management plans to plow $3.4 billion into organic growth initiatives in 2011.

Enterprise has a tremendous advantage over all but a handful of MLPs when it comes to spending on growth initiatives: The MLP enjoys one of the lowest costs of capital of any partnership. Despite boosting its distribution in all four quarters last year, Enterprise’s healthy cash coverage means the MLP retained about $480 million in DCF.

The firm also raised slightly less than $1.4 billion through three secondary unit offerings. In each case, the MLP sold units when the stock was near a 52-week high and enjoyed strong demand from institutional buyers.

Finally, Enterprise issued $2 billion worth of bonds. One of these issues was $600 million worth of 30-year bonds rated “BBB-” by Standard & Poor’s. Issued with a coupon of 6.45 percent, these bonds now yield just over 6.1 percent; Enterprise is paying about 1.5 percent more than the US government to borrow money for 30 years.

Enterprise won’t have trouble raising the capital needed to fund this year’s growth program; the MLP already raised $1.5 billion in two separate bond issues in mid-January. These included five- year bonds yielding a paltry 3.3 percent and another 30-year issue that yields about 6.2 percent.

Although the MLP boasts operates in several different business segments, just over half of the firm’s gross operating margin–a measure of core profits Enterprise uses that excludes noncash charges–comes from its NGL pipeline and services division. This business unit includes 25 natural gas processing plants, 21 NGL fractionators, extensive NGL pipelines and storage capacity and NGL import-export terminals along the Gulf Coast. This segment is not only the company’s most important source of cash flow but also–for the reasons outlined in our overview of the NGL industry–its most compelling growth opportunity.

One of the company’s key organic expansion projects involves the construction of NGL infrastructure in the Eagle Ford Shale, including 300 miles of natural gas pipelines, a 600 million cubic foot per day processing plant, two major NGL pipelines, a new crude oil terminal in Houston and a fractionation facility in Mont Belvieu, a key hub for NGLs.

Although producers have fought tooth and nail to obtain the best acreage in the Eagle Ford shale, Enterprise has become the region’s dominant provider of midstream infrastructure with relative ease. Enterprise has signed long-term agreements with all of the major producers operating in the region, including Chesapeake Energy Corp (NYSE: CHK), EOG Resources (NYSE: EOG), Pioneer Natural Resources (NYSE: PXD), Anadarko Petroleum Corp (NYSE: APC) and Petrohawk Energy Corp (NYSE: HK). These contract guarantee the profitability of its midstream assets before construction gets underway.

In addition to its expansion projects in the Eagle Ford, Enterprise has also invested about $1.6 billion in the Haynesville Extension Pipeline to carry gas from the Haynesville Shale in Texas and Louisiana to the Gulf Coast. This pipeline is 270 miles long and can transport 1.8 billion cubic feet per day. Enterprise isn’t taking any chances in the Haynesville; long-term contracts cover about 1.6 billion cubic feet per day of the pipe’s total capacity.

During its conference call to discuss fourth-quarter earnings management, noted that the MLP has booked all of its capacity at its import-export facility on the Gulf Coast for the entirety of 2011 and virtually all of that capacity for 2012. Strong demand for capacity at the firm’s import-export terminal–one of the largest such operations in the US–underscores how robust the overseas market is for US NGLs. Management expects this trend to pick up steam; the firm is weighing an expansion to the facility that would add 1.5 million barrels per month of capacity.

Management also noted that long-term growth plans will continue to focus on US shale plays, acknowledging that it’s monitoring 20 up-and-coming fields that are in the early stages of exploration. These plans will come to light sooner rather than later. Producers usually accumulate as much acreage as possible before announcing they’ve discovered a new field. From that point on, development proceeds rapidly; three years ago, few had heard of the Eagle Ford, which is now one of the hottest shale plays in the US.

Management believes that it can serve all 20 of these emerging onshore fields by extending and adding capacity to its existing asset base. The MLP followed a similar game plan to ramp up its presence in the Eagle Ford. With several assets already in the region, Enterprise was able to establish a foothold in the play more quickly than firms that needed to build from scratch.

One play in Enterprise’s sights is the Permian Basin in west Texas, a mature oil-producing region where horizontal drilling and hydraulic fracturing have reinvigorated activity. Although the MLP traditionally has focused on natural gas- and NGL-related infrastructure, its acquisition of Teppco a few years ago beefed up its exposure to crude oil.

Management also mentioned that the MLP was building a pipeline and other assets to transport oil from the Eagle Ford and hinted that it was looking to expand its presence in the Permian. A few days later, Enterprise announced the purchase of a 39-mile long carbon dioxide pipeline that serves the Bone Springs region of the Permian. The MLP will convert this pipeline to transport crude oil.

Finally, Enterprise on Feb. 8 reported a fire at one of its storage facilities at Mont Belvieu, Texas. Although the media published a number of sensationalist stories about the incident, the fire shouldn’t have a meaningful impact on the company’s results. The fires were contained Enterprise’s primary operations and didn’t damage its main fractionators. Management also indicated operations had returned to normal in late February, and the company did not anticipate being able to file a business interruption claim on its insurance policy because the deductible on that policy is $5 million. For a firm that generates close to $600 million in quarterly distributable cash flow, that’s a negligible amount.

Growth Portfolio holding Targa Resource Partners LP (NYSE: NGLS) has more exposure to commodity prices and the broader health of the NGLs business than Enterprise. But this risk is balanced by a higher yield and more upside in strong markets from gathering, procession and fractionation economics.

The company posted solid fourth-quarter and full-year 2010 results and increased its distribution to $0.5475, up 5.8 percent from the $0.5175 it paid one year ago. In the fourth quarter, the partnership generated $76 million in DCF, enough to cover that payout by an impressive 1.4 times. Investors should seek commodity-sensitive MLPs with above-average distribution coverage during strong years; this is a sign management isn’t paying out too much or risking a distribution cut if business conditions moderate somewhat.

Targa operates three business lines: field gathering and processing (G&P), coastal G&P and downstream.

The field G&P unit consists of three gathering systems and processing capacity within each of those systems. Targa’s field G&P business is attractive because the firm’s major systems are all located near key oil- or liquids-rich plays where drilling and production activity continues to ramp up.

For example, the firm’s North Texas system is well-placed to serve the Barnett Shale play. Traditionally regarded as a natural gas play, the Barnett also contains several oil- and liquids-rich windows. Targa reported that volumes of gas passing through this system jumped 15 percent in 2010, driven primarily by drilling in the liquids-rich Barnett segments.

The San Angelo Operating Unit (SAOU) and the Permian system are both located in the Permian Basin, where producers tend to drill wells targeting a mix of oil, NGLs and some natural gas. The firm reported 20 percent and 12 percent growth in volumes for 2010, driven primarily by the hot Wolfberry and Bone Springs plays. Producers in both of these fields are leveraging horizontal drilling and hydraulic fracturing techniques to increase output from a region that was long considered past its prime.

In 2010 volumes declined at the company’s Versado gas processing and gathering system in Texas and New Mexico. This weakness stemmed not from diminished drilling activity in the region, but from the temporary closure of its Eunice processing plant for maintenance and repairs. This service interruption held restricted full-year growth in field G&P volumes to 6 percent despite the robust demand at Targa’s three other systems.

With the Versado system up and running again, all four of Targa’s major gathering and processing systems posted a sequential increase in volumes during the fourth quarter.

Although Targa profits from an uptick in volumes processed, its G&P contracts with producers are structures so that the firm also benefits from rising NGL prices. Not only did the company process higher volumes of NGLs, but the MLP also earned higher margins on this business.

Targa’s coastal G&P unit comprises pipelines and processing capacity along the costs of Texas and Louisiana that handle natural gas and NGLs produced from the deepwater and shallow-water Gulf of Mexico. In 2010 processing volumes declined by 7 percent from year-ago levels because of lower offshore production, a natural gas stream that contained lower quantities of NGLs and maintenance at one of the firm’s main processing plants.

Volumes processed at Targa’s Coastal G&P facilities will likely remain weak because of the lingering effects of the Obama administration’s moratorium on drilling in the deepwater Gulf and inferior production economics in the shallow-water Gulf (relative to onshore shale plays).

Two factors offset these headwinds. First, although volumes may decline, higher NGLs prices and stronger processing economics mean that the coastal G&P unit remains extremely profitable. Second, the fourth-quarter throughput to Targa’s VESCO system increased 13 percent from a year ago, reflecting additional production from new fields in the Gulf. Better still, the VESCO system operates under a hybrid contract that offers the MLP additional upside in processing fees when economics are favorable.

Finally, the downstream business, which includes fractionation, storage, terminal and marketing assets, also performed well. Volumes fractionated increased 9 percent from the fourth quarter of 2009, driven by strong demand for NGLs among petrochemicals processors. Operating margins jumped by 15 percent, bolstered by an uptick in volumes. 

For 2011, management forecasts that volumes will increase to 10 percent in its field G&P unit, driven by strong drilling activity around its North Texas and SAOU systems. In contrast, the firm anticipates flat volumes in its coastal G&P system, with growth in VESCO offsetting declines in its other coastal assets.

But weakness in Targa’s coastal G&P segment isn’t a major headwind. On average, the MLP extracts about 5.1 gallons of NGLs per thousand cubic feet of gas processed from its field G&P unit and only 1.3 gallons per thousand cubic feet in the coastal assets. Onshore volume growth contributes a lot more to profit margins and processing activity than it does offshore.

Targa continues to grow its asset base, expanding the capacity of one of its fractionation facilities by 78,000 barrels per day and adding capacity to its top-performing North Texas and SAOU systems. With more than $900 million in unused liquidity and only $200 million in planned capital spending, Targa could be on the cusp of announcing some bigger deals.

The MLP is known to be working on an expansion that would take it into the Eagle Ford, and management hinted that it has a long list of projects and acquisition opportunities about which it has yet to comment publicly. This is all good news for future distribution growth.

With high cash coverage of its distribution, strong exposure to attractive NGL prices and the dry powder to add new assets, Targa Resource Partners LP rates a buy under 33.

Liquefied natural gas (LNG) tanker operator Teekay LNG Partners LP (NYSE: TGP) reported fourth-quarter distributable cash flow of $39.3 million, up 17 percent from a year ago. The firm also increased its quarterly cash distribution from $0.60 to $0.63 per unit. On average, Teekay LNG has increased its payout at an annualized rate of about 6 percent over the past three years.

Some investors are scared of the word “tanker” because of volatile day rates in the spot market, which can vary wildly based on near-term supply and demand conditions. But Teekay LNG’s fleet is booked under long-term contracts at fixed rates that guarantee the firm’s cash flows over time.

Teekay LNG is the world’s third-largest independent operator of these tankers. Although LNG prices are low, Teekay’s business remains steady. The partnership leases carriers to producers on 15- to 20-year deals that serve specific LNG projects. These massive, multibillion dollar LNG projects continue to go ahead despite low current gas prices; the major integrated producers and national oil companies (NOC) that fund such deals are willing to look beyond short-term weakness to the long-term likely growth in demand for the fuel. Regardless of those business dynamics, Teekay LNG collects a fixed fee for leasing the ships it owns.

The MLP also owns a fleet of conventional tankers and liquefied petroleum gas (LPG) carriers that transport propane and other NGLs. As we noted earlier in today’s issue, demand for US NGL exports remains robust.

In 2010 Teekay LNG’s DCF covered its distribution a mere 1.03 times, among the lowest coverage ratio of any Portfolio holding. Although we prefer a higher margin of distribution coverage, this ratio should improve as new projects come online. Meanwhile, stability of its cash flows makes it unlikely that the firm’s payout is at risk.

Teekay LNG historically has growth through acquisitions. Last year the MLP purchased three vessels from its parent and general partner, Teekay Corp (NYSE: TK), for $160 million. The firm’s most recent acquisition was a 50 percent interest in two LNG carriers that are booked under long-term charter contracts. One of these tankers also has the ability to re-gasify liquefied natural gas. This vessel would allow a country without fixed LNG import capacity to import gas for injection into its pipeline network.

In 2011 Teekay LNG will receive an additional LPG carrier and two carriers capable of carrying both LNG and LPG. All of these ships are currently contracted under 15-year agreements that begin once they arrive from the shipyard.

In February, the company was offered a deal to buy a one-third interest in four LNG carriers that would be delivered to Teekay Corp in late 2011 and early 2012. These carriers are all scheduled to be leased under a long-term charter to serve an LNG project in Angola. The MLP is expected to announce more details in its first-quarter conference call.

With its existing fleet booked under long-term contracts and the delivery of new vessels likely to support distribution growth, Teekay LNG Partners LP rates a buy under 36.

Regency Energy Partners LP (NSDQ: RGNC) reported solid year-over-year growth, with adjusted earnings before interest, taxation, depreciation and amortization (EBITDA) soaring by 92 percent in the fourth quarter of 2010. Much of that growth stemmed from the start-up of major pipeline projects, including the company’s joint venture in the Haynesville Shale.

Despite a strong 2010, Regency has maintained its distribution at $0.445 for the past 11 quarters, equivalent to a yield of roughly 7 percent. In the fourth quarter, the MLP covered that payout 1.08 times, a comfortable level and an improvement after a few weak quarters. We look for Regency to increase its distribution in either the first or second quarter of 2011, a move that will act as a significant upside catalyst for the stock.

The firm was active in 2010, acquiring a 49.9 percent interest in the Midcontinent Express Pipeline, a 500-mile long natural gas pipeline that transports stretches from Oklahoma to Alabama where the gas can be shipped to the East Coast. The pipeline is supported by longer- term contracts and operated by Conservative Portfolio holding Kinder Morgan Energy Partners LP (NYSE: KMP).

Regency also acquired Zephyr Gas Services last August for $193 million. That deal includes gas treating assets in the Haynesville and Eagle Ford. Gas treating services include the removal of water, sulfur and carbon dioxide from the natural gas stream. As Regency already has considerable exposure to both of these plays, this was a solid tuck-in deal that’s supported primarily by fee-based contracts. Operationally, the company’s gathering and processing business starred during the fourth quarter, with its South Texas system reporting 45 percent year-over-year volume growth.

The company plans to spend at least $250 million on growth projects in 2011 and remains on the prowl for acquisitions. Regency should have no problems financing any deals it chooses to pursue; in 2010 Regency raised more than $400 million in an equity offering and issued $600 million worth of eight-year bonds that currently yield less than 6 percent.

The MLP’s general partner is controlled by Energy Transfer Equity LP (NYSE: ETE), the GP for Energy Transfer Partners LP (NYSE: ETP). Not only does Energy Transfer Equity have every incentive to position Regency for growth, but this experienced management team also has what it takes to steer the limited partner toward the best opportunities.

 Energy Transfer Equity could also work out some sort of a joint venture between the two MLPs it manages, Energy Transfer Partners and Regency.

We expect to hear more about future growth plans when the MLP hosts its annual investor day on April 6. Regency Energy Partners LP rates a buy under 29.

Finally, Energy Transfer Partners LP reported fourth-quarter DCF of $284.4 million, up about 10 percent from year-ago levels. That covered its $0.89375 per unit distribution roughly 1.05 times, up from less than 1 times in the fourth quarter of 2009.

Like its sister Regency Energy Partners, Energy Transfer Partners hasn’t increased its distributions for the past 11 quarters, though we expect this dry spell to end at some point in 2011, likely in the first half of the year. That’s after management reassured investors that the MLP will hike its distribution growth “sooner versus later” during its conference call to discuss fourth-quarter earnings.

Two major projects, the Fayetteville Express (FEP) and Tiger pipelines, will support this growth. The Fayetteville Express is a 185 mile long pipeline designed to take gas out of the Fayetteville Shale field located in Arkansas. It’s operated as a joint venture between Energy Transfer Partners and Kinder Morgan Energy Partners and is backed by a solid base of reliable fee-based revenues.

The Tiger Pipeline is a 175-mile long system that can collect gas from a number of fields, including the Barnett and Haynesville. The pipe terminates in Louisiana, where it interconnects with seven different interstate gas pipelines. The pipe has a current capacity of 2 billion cubic feet per day, but that will expand by 400 million cubic feet per day in late 2011.

The MLP also announced a deal in late February to build a new pipeline–the Rich Eagle Ford Mainline–that will gather gas from the Eagle Ford and transport it to the partnership’s existing plants as well as a new facility. The initial capacity is 400 million cubic feet per day, but management stated that could be expanded to 800 million if the demand is there. The $300 million price tag will be supported by long-term agreements with local producers. The line is expected to be in operation by the end of the year.

Energy Transfer Partners continues to benefit from strong growth in volumes through its existing gathering and processing assets, thanks to their proximity to new unconventional gas plays.

Buying an MLP ahead of a new burst of distribution growth is a profitable strategy. Buy Energy Transfer Partners LP under 55.