In a previous series of energy-related articles, I discussed how the resurgence of natural gas would give us solid alternative to oil for transportation energy needs. In addition, natural gas will also provide us with additional supplies of petrochemicals to offset the world’s insatiable demand for them and their end products, which includes just about everything you might currently purchase at Walmart.
The gas shale boom has come along just in time to offset declining cheap oil supplies and offer the US, in particular, the enviable position of net energy exporter of the future. Those who have excess energy tend to have stronger and more resilient long-term economies.
In addition to boosting our prospects of economic stability based upon a solid foundation of domestic energy supplies, the boom in natural gas and oil production in the United States provides investors with many potential choices for stock appreciation and dividend plays.
In this series of articles, I will present some companies across the natural gas sector that may profit investors handsomely for several years. I’ll begin by discussing a midstream energy company, Plains All American Pipeline, LP (PAA), and will weigh benefits versus the risks.
Plains is a vertically integrated oil and gas midstream company providing facilities, supplies and logistics, and transportation.
The company sports over $5 billion in portfolio across a range of assets. The company has over 19,000 miles of pipeline in North America as its largest transportation asset, and is beefing up rail transportation to address short term shortages with $1 billion in rail depot projects in the last several months. The segment also includes trucks, trailers, and barges.
Facilities provide storage, terminals, and throughput services for oil, natural gas, LPG, and refined products. The segment also offers LPG fractionation and processing of natural gas.
Supply and Logistics purchases product and resells it at the other end of their transportation networks.
Plains dropped down their natural gas storage into a separate LP, PAA Natural Gas Storage (PNG), which I will discuss in a future article.
The recent purchase of BP’s Canadian NGL assets provides Plains with an opportunity to process and transport those products in Canadian to US markets, as well as using the infrastructure for moving other refined products that capture higher premiums on the market. Plains management expects their retail approach to raise margins on these former assets which BP used primarily for internal purposes.
Outside of the BP purchase, Plains has concentrated on expanding pipelines, storage, and rail at existing sites to take advantage of local market knowledge while reducing the risk of asset under-utilization. Plains management has positioned assets in active and sizeable oil and gas plays that should allow smooth monetization and provide solid returns for investors.
The approach to Plains’ expansion is a solid one with real gains seen in each business segment. I believe that Plains business model closely aligns with growth in the oil and gas segments, specifically in pipelines and rail to markets and in fractionation of natural gas liquids. The company has a forward-thinking market approach and has appeared to spend their money wisely given current market trends.
In keeping with my risk-based approach to investing, the following is my analysis of the risks that Plains All American Pipleline faces in the market.
First, the recent expenditures in rail appear to alleviate the near-term shortage of transportation needs to various markets. However, pipelines have a higher return over time and the industry is expected to invest very heavily in pipelines that will compete in some areas directly with Plains rail expansion.
Determining what competition will arise is difficult as future demand volumes are in many cases difficult to predict accurately. Some of Plains’ rail may compete with pipelines and receive lower margins while some of it may sell at a premium due to lack of alternatives in the area. This is a chance that investors must take in assessing any of the midstream energy companies. Generally Plains has added rail where large pipeline alternatives do not exist to mitigate this risk, but it should not be expected that this scenario will hold true for all Plains future projects.
One mitigating factor for the rail projects is that pipelines face political and environmental challenges that rail has tended to avoid thus far. Another is that pipelines are very costly, and rail can more quickly be implemented to support current market demand waiting on pipeline build out.
Because US natural gas infrastructure is woefully behind, my instinct is that Plains will be fine. The rail expansion serves critical market needs and is profitable now. Likely it will be years before pipelines catch up to market demands and they may never meet all localized requirements for oil and gas products by themselves.
Another risk for companies structured as MLPs are that most profits are distributed to the investors. As such, most expansion projects, being CAPEX intensive, are financed by share dilution and debt. Therefore, debt grades for PAA are one step above speculative. But I feel this rating is a bit misleading for those who understand how the sector operates in the long run.
Normally I would warn away from companies that have relatively low operating margins and high debt levels, but in the case of energy MLPs I make an exception. I do not see many scenarios in a normal market hungry for grid power, transportation alternatives to rising oil costs, and cheap petrochemicals where income drops significantly for Plains and similar MLPs. Natural gas serves as a hedge for the trend of expensive oil and its byproducts and both products will experience strong demand.
This article is for information and discussion purposes only and does not form a recommendation
to invest or otherwise. The value of an investment may fall. The investments referred to in this
article may not be suitable for all investors, and if in doubt, an investor should seek advice from
a qualified investment adviser. More