Atlas Pipeline: Call Option on Oil

Nov.26.08 | About: Atlas Pipeline (APL)

Natural gas transport and processing company Atlas Pipeline Partners (NYSE:APL) has been hit hard by falling oil prices. Or at least its stock price has. At the time I write this APL stock is trading at 2 times the annual dividend. It is apparent that there is a strong belief that APL will be unable to continue distributions at the current rate.

Atlas Pipeline Partners is dependent for a majority of its revenues on the processing and sale of natural gas liquids (NGL’s). NGL’s are used in the chemical and petroleum industries and their prices are strongly correlated with the price of oil. Those who provide analysis of APL stock believe that the company needs oil prices to be in the $70 to $80 range to be able to maintain its distribution levels. As oil prices have fallen, the market has hammered the value of APL stock. Last week, Jim Cramer added APL to is “Sell Block” when oil dropped below $50 per barrel.

First, we have to remember that oil prices dropped below $70 all of oh…3 weeks ago. Three months ago oil was in the $115 range. Six months ago everyone thought oil was headed for $200. Who really can forecast where oil prices will be in the next 3 to 6 months. I am not uncomfortable with the idea of oil recovering to over $70 in the very near future.

Last week I wrote an article on how Mexico has hedged its entire 2009 oil production to earn at least $70. How many other state owned or controlled oil agencies “need” oil to sell for more than $70 and have taken hedge positions to insure they get the required revenues? How many traders are out there trying to skin these agencies of the premiums they have paid for their hedges? This is entirely conjecture on my part, but I think a not unlikely scenario.

My point is that if oil does rebound above $70 in the next few months, APL is a $25 stock. Owning the stock gives you an open call option on $70+ oil. In the meantime you may (even probably) collect some level of distribution in February. The last distribution was 96¢. When oil was $70ish in 2006-2007 they were paying 75¢ to 85¢ per share. I think the distribution could be cut to 40¢ for the 4th quarter if oil does not rally rapidly. But 40¢ is 5% of the current share price!

I have written several articles recently about the Atlas family of companies. APL and Atlas Pipeline Holdings (AHD) have become the most speculative of the bunch. If you believe that oil prices will rally above current levels I believe I have made a case for these stocks.

Disclosure: APL is a component of my site’s hypothetical Income Portfolio.