Source: Marketwatch, December 5, 2011
Posted on: http://envfpn.advisen.com
Finding ways into the industry that avoid energy price volatility
SAN FRANCISCO (MarketWatch) – The latest technology for producing natural gas from shale rock is not only altering the American energy landscape its also opening a host of entry points for investors eager to profit from this booming new industry.
But rather than simply snapping up shares of the biggest producers or drilling companies, many favor investments that are not directly tied to the price of the underlying commodity, especially as growing supply pushes natural gas prices to near-historic lows.
These investors are turning instead to companies providing midstream services, which include processing, storing and transporting natural gas.
Pipeline companies are a frequent choice, given their reputation for steady revenue streams and high dividends. Many pipeline operators are master limited partnerships, also called MLPs, or publicly traded limited partnerships, which do not pay federal income tax and can confer these tax benefits on shareholders in the form of dividends.
MLPs and pipeline companies are basically charging a toll for every molecule that runs through the pipeline, said Geoff Jay, energy analyst at Janus Capital Group. These companies are standing in front of a tsunami of investment.
Investors are especially keen on midstream services provider Enterprise Product Partners LP EPD, the largest publicly traded energy partnership. Enterprise charges customers a volume-based fee, which reduces its exposure to natural gas price swings, said Steve Howard, a portfolio manager at Morgan Stanley Smith Barney. Howard also cited Enterprises strong free cash flow and transparent business model.
Enterprise shares are up 11% so far this year, most recently closing at $46.28 a share. Howard, whose portfolio owns the stock, said he expects it to trade toward $50 a share over the next year.
Other options include Schlumberger Ltd. SLBand Halliburton Co. HAL, a couple of giants among international oil field service providers who are also leaders in hydraulic fracturing. Fracking, as its also known, injects water under enormous pressure into a well, shattering the underground shale formation and freeing the gas trapped within.
Schlumberger and Halliburton are both down about 10% this year but have rebounded over the past month, with Halliburton shares trading recently at $36.58 and Schlumberg shares at $75.01. These companies valuation reflect the belief that production is ramping up significantly for both companies, said Januss Jay.
Analysts polled by FactSet have a consensus 12-month price target of $54.75 a share for Halliburton and $91.80 a share for Schlumberger.
There is especially high demand for companies that process natural gas, which strips the raw gas of corrosive materials to make it safe for pipeline transport. Natural gas is also separated into other hydrocarbons, such as ethane or propane, which are widely used in other industries.
One such processor is Pembina Pipeline Corp. PPL. The Canada-based company expanded its business to include natural gas processing in 2009. Pembina has exclusive transport agreements with energy giant Canadian Natural Resources Ltd. CNQ, which will translate to stronger cash flow and higher dividends as production ramps up, said Roger Conrad, editor of Utility Forecaster.
These processing companies can decide on a project, line up customers and have sales locked in before they even begin work on the project, Conrad said. That provides a lot of visibility on future earnings and dividend growth.
Pembina shares have soared 37% so far this year, closing at $29.50 a share on Friday. Conrad is looking for the stock to approach $32 a share in the next 12 months.
Water suppliers are also appealing because they help reduce environmental impact and associated costs, according to Malcolm Gissen, co-portfolio manager of the Encompass Fund.
Drilling and fracking require huge volumes of water. Companies that can provide clean water supplies and dispose of wastewater with minimal environmental impact can also be instrumental in easing local opposition to drilling operations, he added.
For instance, Canadas Poseidon Concepts Corp. PSN builds storage tanks that hold up to 40,000 barrels of fracturing fluids, making sure they dont escape into local creeks, ponds or wells.
Dundee Securities analysts initiated their stock coverage of Poseidon, which began publicly trading on Nov. 4, with a buy rating, citing the companys unique fluid storage system and attractive and sustainable dividend. Dundee has a 12-month price target of $13.25 on the stock.
Poseidon stock is currently at $11.16 a share, down slightly from its first trade at $11.20 last month.
Other beneficiaries of low gas prices are power providers that supply other utilities with gas storage or transport services, said Utility Forecasters Conrad.
Among the most attractive, according to Conrad, is Dominion Resources Inc. D, which operates the largest natural gas storage system in the U.S. In early October, Dominion received government authorization to export natural gas from its Cove Point LNG Terminal near Maryland.
Dominion shares have jumped 18% so far this year, trading at $50.56 each. Conrad, who owns Dominion stock, said he expects it to rise to $60 a share in the next year.
Others include San Diego-based Sempra Energy SRE, which has aggressively weaned itself from oil and coal-fired power generation to natural gas-fired plants. The company announced in early November that it plans to request building approval from the Department of Energy for a natural gas export terminal in the Gulf of Mexico, an energy export business that falls outside of its regulated utility operations.
Sempra shares are trading around $52.92, up 0.8% so far this year. Conrads 12-month price target for Sempra is $60 a share.