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Midstream Master Limited Partnerships

Business Model

Midstream limited partnerships are involved in the gathering of gas from different gas production fields, and processing it at their gas processing plant before distributing it to different consumers. At the gas processing plant, Natural gas, and natural gas Liquids (NGL), are separated from each other before being distributed to different consumers of the products produced.

(click to enlarge)

Source: 1Q2012 presentation (pdf) Targa Resources Partners LP (NGLS)

Outlook

We believe that growth will continue in the sector due to the high production of natural gas and oil in the U.S.

The sector is offering very high dividend yields, while there is ample opportunity to experience growth due to a consistent CAPEX.

However, there is a risk posed by the recent increase in natural gas prices, and the decreasing prices of oil and NGLs - due to high supply. Therefore, we are of the opinion that the sector may experience some pressure in the near term, as most producers in the U.S. have been shifting from gas to liquid-and-oil plays due to higher prices. This shift to liquid plays is expected to create an oversupply of NGL, and producers may choose not to extract the energy source if prices offered are lower than natural gas prices.

Introduction

The Gas Industry is divided into two segments being Upstream (Exploration and Production), Midstream (Processing and distribution) and Downstream (Refining and Marketing).

The Upstream Segment is involved in the exploration and production of natural gas. However, gas is extracted from the ground, as methane with different amounts of other constituents like ethane, butanes, iso-butanes, propane and pentanes, which are commonly known as liquids or Natural Gas Liquids.

The midstream segment is involved in the gathering of gas from different fields, and processing it at their gas processing plant, before distributing it to different consumers. It is at the gas processing plant that the liquids are separated from methane.

The downstream segment is involved in the refining of oil, and the marketing and distribution of different products to a diverse client base.

Midstream Master Liability Partnerships (MLPs)

According to the regulations of the Securities and Exchange Commission, Master Liability Partnerships are given tax benefits in the pipeline (midstream) and Real Estate Investment Trust (REIT) businesses, through the exemption of Income tax, while granting them permission to list on the exchanges.

Therefore, many large companies (as well as new entrants) in the Oil and Gas Industry have separated their midstream operations and formed Midstream Master Liability Companies (MLCs).

Factors Affecting The Business and Profitability

The midstream segment is affected by the prices of oil, natural gas and NGLs, and the volumes that move through the gathering, processing and logistic assets of midstream businesses.

If the prices of Oil and NGL decline, it will be detrimental to the business of the midstream segment, due to the lower revenue and decreased profitability for the NGL business.

An increase in the price of natural gas is also detrimental to the MLP business.

Separation of Gas

When the liquids content of natural gas is high, it must be extracted out of the gas stream in order for the remaining gas to meet pipeline quality requirements. The raw NGLs are then fractionated, which separates the raw NGL mix into different components. The individual components are approximately Ethane (40%), Propane (30%), Butane (9%), Isobutane (9%) and Natural Gasoline (12%).

If liquid (especially ethane) prices fall below the price of the natural gas, it will be financially viable for the gas processor to leave ethane in the valuable gas stream, which is known as ethane rejection. Since 40% of the NGL returns to gas form, it increases gas supply.

Natural Gas liquids

NGL products have a variety of applications, including usage as heating fuels, petrochemical feedstock and refining blend stocks.

Ethane

Ethane is mostly used in the Petrochemical Industry as feedstock for ethylene, which is one of the basic building blocks for a wide range of plastics and other chemical products.

Propane

Propane is used as a petrochemical feedstock in the production of ethylene and propylene, as a heating, engine and industrial fuel, and in agricultural applications such as crop drying.

Butane

Normal butane is used in the production of isobutane as a fuel gas, either alone or in a mixture with propane, as a refined petroleum product blending component, and in the production of ethylene and propylene.

Isobutane

Isobutane is mainly used in refineries to produce alkylates to enhance octane levels.

Natural Gasoline

Natural gasoline is used as a blending component for certain refined petroleum products and as a feedstock used in the production of ethylene and propylene.

Recent Trend

Over the last one year, natural gas prices have witnessed a significant decline as compared with price levels witnessed in the previous year. The prices of natural gas dipped to their 10-year low in March, after trading below $2/mmbtu. However, natural gas prices have seen some recovery in the month of June, and Henry Hub futures prices at the end of the month were trading at $2.8/mmbtu, up 20% since the beginning of the month.

Oil and natural gas liquids prices on the other hand, have witnessed a decline in 2Q2012, while the West Texas Intermediate Oil (WTI) is trading at $84.96/bbl, down 17.5% as compared to $103.02/bbl at the end of the previous quarter. The prices of NGLs have also been on the decline, since their prices are highly correlated with oil prices.

Companies

Targa Resources Partners LP (TRGP)

Overview

NGLS is a master limited partnership involved in the gathering, processing, fractionation, storage and transportation of natural gas and natural gas liquids , and the storage of refined products and crude oil in the United States. The general partner of NGLS is Targa Resources Corp, which owns a 13.7% interest in NGLS' limited partner units, and 100% of NGLS' incentive distribution rights (IDRs).

Financial Performance

NGLS reported an EPS of $0.64 for 1Q2012, witnessing a growth of 70% compared with the same period last year. Revenue increased due to higher commodity sales volumes, higher fee-based and other revenue, and the higher impact of realized prices on condensate, which was partially offset by the impact of lower realized prices on natural gas and NGLs.

The cash flow from operating activities has increased to $146.7 million for 1Q2012, an increase of 48% compared with $98.6 million for the same period last year. CAPEX for 1Q2012 of $102.7 increased 86%, as compared with 55.5 million for 1Q2011.

Source: 1Q2012 Presentation (pdf)

The company announced a dividend of $.6225/share for 1Q2012, which translates into an annualized dividend payout of $2.29/share, showing an increase of 3% from the previous quarter (4Q2011) and an annualized increase of 12% compared with 2011. The total distribution paid out to shareholders was $69.6 million for the 1Q2012.

Earning Expectations

The consensus earnings expectations for NGLS for 2012 are $1.93/share, which is relatively flat as compared with the previous year's EPS. This is due to the declining prices of NGL and the increasing prices of natural gas in the U.S.

ONEOK Partners, L.P (OKS)

Company Overview

OKS is one of the largest publicly traded master limited partnerships, and is a leader in the gathering, processing, storage and transportation of natural gas and natural gas liquids in the U.S. The general partner of OKS is ONEOK Partners GP, L.L.C., which is a subsidiary of ONEOK, Inc. (OKE). OKE is a diversified energy company and owns 43.4% of the partnership.

Financial Performance

OKS announced an EPS of $0.91/share for 1Q2012, an increase of 57% compared with EPS of $0.58/share for 1Q2011. The natural gas gathering and processing segment showed an improvement due to higher natural gas volumes gathered and processed, offset partially by lower natural gas and NGL product prices. The increase in 1Q2012 operating income was due to increased NGL fractionation, favorable natural gas liquids price differentials and transportation capacity availability.

Cash flow from operating activities has decreased to $219 million for 1Q2012, a decrease of 21% compared with $278 million for the same period last year. CAPEX for 1Q2012 of $281 million increased 94%, compared with $148 million for 1Q2011. The cash flow from operating activities decreased due to increasing accounts payable and commodity imbalances.

The company announced a dividend of $0.635/share for 1Q2012, which translates into an annualized dividend payout of $2.54/share, meaning an increase of 4% from $0.61/share. The total distribution paid out to the shareholders was $164 million for 1Q2012.

Future Growth

OKS has announced projects of $2.0b-$2.3b after the announcement of 4Q2011 results. These include:

  • Investment of $1.5-$1.8 billion in the 1,300-mile Bakken Crude Express Pipeline to transport 200,000 barrels of oil to Cushing Oklahoma, which is expected to be in service by 2015.
  • Investment of $140-160 million in the 270-mile natural gas gathering and related infrastructure in Divide County, which links wells in the Bakken shale to OKS's planned processing facility in Williams County, North Dakota, and expected to complete by 2H2013.
  • Investing $340-$360 million for gas gathering and related infrastructure in the Cana-Woodford shale in Oklahoma, expected to be online by 1Q2014.

Earning Expectations

The consensus earnings expectation for NGLS for 2012 is $2.95/share, which is 12% lower compared with the previous year's EPS. This is due to declining prices of NGL and increasing prices of natural gas in the U.S. and the high CAPEX.

Kinder Morgan Energy Partners, LP (KMP)

Company Overview

Kinder Morgan is the largest midstream company in North America. KMP pipelines transport crude oil, natural gas, carbon dioxide, refined petroleum products and other products, and its terminals store chemicals and petroleum products, and handle products like ethanol, petroleum, coke, coal and steel.

Earning Expectation

The consensus earnings expectation for NGLS for 2012 is $2.31/share, which is 300% higher compared with the previous year's EPS. This is due to expected organic growth and the drop down of assets from its parent, while it completes is transaction of El Paso Corporation (EP).

NGLS

KMP

OKS

P/E

16.06

31.56

19.33

P/B

2.30

3.84

2.68

P/S

0.45

3.28

1.02

Dividend Yield

7.00%

6.10%

4.90%

Net Margin

3.37%

13.83%

8.04%

Total Debt/Equity

88.82

192.85

87.82

Source: Buy High-Dividend-Yielding MLPs