Economic principles tell us much about the effects of supply and demand on prices of goods and services. Simple economics shows us that if the supply of a particular good or service remains constant while demand for that good increases, the price for the good will also increase. Likewise, if demand falls, so does price. But what is the end result when demand and supply rise in tandem? That answer is not so simple. It depends on which is rising faster and by how much. If they rise at exactly the same rate, prices should remain constant. However, there is one particular sector that currently stands to benefit from the simultaneous rising supply and rising demand of natural gas. Companies involved in natural gas gathering, pipeline supply, and transport will benefit from the increasing supply of natural gas in the short term and will continue to benefit in the long run as demand grows.
There is a new theme at play on financial message boards, newsletters and blogs across the internet. There has been a significant amount of news and coverage surrounding the use of fracking in shale formations around the country, and for good reason. Fracking is a fairly new process of drilling through rock formations to extract natural gases and oil, and so far, the process has been extremely successful. The early release of the Annual Energy Outlook 2013 put out by the U.S. Energy Information Administration shows that natural gas production increased from roughly 17 trillion cubic feet in 1990 to nearly 25 trillion in 2011. The report estimates this number to grow to 33 trillion cubic feet by 2040 from shale gas production alone. While the many articles covering this phenomenon today are timely and relevant, few are focusing on the most likely benefactors of this supply increase. As the available supply of natural gases and oils grows as a result of continued improvements in extraction methods, pipeline supply companies will continue to be a necessary component of the gas gathering and transport process.
Williams Partners, LP (WPZ) is one of the largest publicly traded master limited partnerships in the world. It is also one of the largest gas gatherers, processors, and transporters in the natural gas market. The partnership owns and operates pipelines across the U.S. and is in the process of developing a major natural gas supply hub in the Marcellus Shale formation in Pennsylvania. This hub is connected to major interstate gas pipelines and has a capacity to gather 1 billion cubic feet per day. By 2015, the company expects to be gathering 5 billion cubic feet per day, making the Marcellus Shale area its largest single site producer of natural gas. There are certainly a number of great natural gas pipeline supply and processing companies providing services in this sector, but Williams Partners is positioning itself for continued growth as it expands operations in major gas supply regions.
Williams Partners is currently paying a hefty dividend yield of 6.5% and has consistently increased its dividend since the Company was formed in 2005. The partnership paid a dividend of $1.605 per unit in 2005, and by 2012 that number had grown 96% to $3.14 per unit. While many companies were forced to reduce dividends during the recession of '08-'09, Williams Partners increased the dividend payout 4.5% from '08-'09 and 4.3% from '09-'10 as a result of its expanding and profitable operations. As the partnership continues to benefit from the demand increase in natural gas and it's foothold in major gas production areas, it will continue to grow in value. If Williams Partners can continue to grow its dividend at the current rate, it should already be valued 10% higher than it is today based on a constant growth dividend discount valuation. This would put the company at a P/E of 18, where it would be more fairly valued given its history of dividend growth and current position in the market. In addition, the company is well positioned to capture increased revenues from the ongoing expansion of the Marcellus Shale area, increased demand for natural gas, and higher natural gas prices.
While it may just seem like another short-lived theme gathering attention from analysts, the hype about fracking and extracting natural gas and oil from shale formations isn't just a passing craze. This is the future of drilling and extraction that will benefit U.S. pipeline supply and other companies in the natural gas space for years to come.