Elliott Gue's  Instablog

Sunoco Logistics Partners LP’s (NYSE: SXL) second-quarter results featured several pieces of very good news. Distributable cash flow (DCF) of $106 million rose 92.7 percent from year-earlier levels to a record, covering the quarterly distribution by a robust 2-to-1 margin. That enabled management to boost the payout for the 25th consecutive quarter to $1.215 per unit, a 1.7 percent increase from the prior quarter and 6.6 percent from a year ago.

The oil and gas MLP was able to take advantage of robust throughput at its crude oil and gas liquids infrastructure, as well as a favorable price contango, to boost returns from its existing asset base. Certain customers’ unplanned refinery issues crimped revenue from refined products pipelines. But that was more than offset by robust income from terminal facilities and the crude oil pipeline system, which saw operating income nearly triple on expansion and acquisitions.

Equally encouraging, Sunoco Logistics continues to build its asset base, putting the pieces in place for strong future cash flow and distribution growth. Expansion capital expenditures were ramped up 121 percent to $168 million in the first half of 2011. And the company expects to deploy another $100 to $150 million in the second half.

The biggest move to date is the acquisition of a controlling interest in the Inland Corporation from privately held Texon LP for $205 million plus inventories, announced along with earnings. That deal is expected to be immediately accretive to DCF and will add lease crude business and gathering assets in 16 primarily western states. The merger will immediately boost Sunoco’s lease business by more than 30 percent and gains it entry to several high growth shale energy-rich areas, including the Bakken, Granite Wash and Eagle Ford areas. For more information regarding opportunities in shale oil investing, see Peter Staas’ InvestingDaily.com article, Emerging Shale Oil Plays.

The Inland deal will be initially financed with the MLP’s revolving credit facilities and will eventually require more permanent capital. The company’s credit position, however, is strong, leaving it some flexibility should overall conditions tighten. Credit raters S&P and Fitch still rate the company at BBB with a stable outlook, having recently affirmed their opinions. The company also continues to find opportunities for “tuck in” expansion, i.e. acquiring additional stakes in assets it’s already familiar with.

The New York Times recently sparked a wave of controversy after the news organization published a series of stories that questioned the sustainability of the shale gas revolution. These pieces suggested that shale gas producers have overstated the productivity of their wells and that shale gas fields are unprofitable in the current pricing environment.

These articles undoubtedly had their intended effect, mobilizing both critics and supporters of shale gas development and stimulating a vociferous debate. Although arguments that the emperor has no clothes always attract plenty of eyeballs--the primary motivation of many media outfits--readers must evaluate the logic underpinning these claims and distinguish the rational from the sensational.

The New York Times is correct that some shale gas fields are uneconomic in the current pricing environment, which explains why drilling activity has declined in the natural gas-rich Barnett Shale and Haynesville Shale.

But the articles largely ignore the economics of the Eagle Ford Shale and other unconventional fields that produce large amounts of high-value oil, condensate and natural gas liquids (NGL) such as butane, ethane and propane. In general, exploration and production firms have shifted production from dry-gas fields to liquids-rich plays that offer superior profitability.

As we explain in the March 15, 2011, article, “The Saudi Arabia of Natural Gas Liquids,” available to MLP Profits subscribers, NGLs can dramatically increase the profitability of some of America’s largest shale fields.

Moreover, the shale gas industry has undeniably changed the domestic energy mix in recent years: Natural gas production from US unconventional fields has soared to about one-quarter of total domestic gas output, up from only 4 percent a half-decade ago.

This production boom has enabled the US to overtake Russia as the world’s leading producer of natural gas, while the resulting supply overhang and closed domestic market has ensured that the country enjoys natural gas prices that are far lower than anywhere else in the world. That hardly sounds like a Ponzi scheme in the making.

A subsequent Op-Ed piece published in The New York Times--Clashing Views on the Future of Natural Gas--highlighted some of the inaccuracies, distortions and exaggerations evident in the paper’s late June series on shale gas fields. The article also criticizes the stories for their reliance on anonymous sources and individuals who are known opponents of the shale gas industry.

But mergers and acquisition activity provides the best refutation of The New York Times’ articles on shale gas. From Chevron Corp (NYSE: CVX)  and ExxonMobil Corp (NYSE: XOM) to Total (Paris: FP, NYSE: TOT) and Royal Dutch Shell (NYSE: RDS.A), some of the world’s largest and most-respected energy companies have invested billions of dollars to add exposure to US shale oil and gas fields.

These firms employ veritable armies of geologists, petroleum engineers and experienced oilfield workers to evaluate the productivity of these unconventional fields. I have more faith in the Super Oils’ take on the economics of shale oil and gas fields than I do in the slapdash reporting of a New York-based journalist.

Investors should cheer the entry of major integrated oil companies into US unconventional plays; these deep-pocketed firms have the capital needed to drill aggressively in shale gas fields and can afford to take a long-term view on commodity prices. However, it appears as though investors continue to underestimate the need for pipeline, storage and processing infrastructure to support the growth of North America’s unconventional fields.

In contrast to the experts at The New York Times, ExxonMobil has a bullish outlook for natural gas production and demand. A recent comprehensive report issued by the Interstate Natural Gas Association of America (INGAA), a trade group for the pipeline industry, echoes this sentiment.

Although one should question the independence of the INGAA’s analysis, the trade group’s assumptions for US natural gas consumption aren’t unreasonable; the INGAA assumes US power demand growth of just 1.3 percent annualized through 2035.

The INGAA report also doesn’t make aggressive assumptions about new sources of demand for natural gas. For example, the report assumes that gas doesn’t gain widespread acceptance as a transportation fuel. Although the authors acknowledge that some bus and taxi fleets will run on natural gas in 2035, the white paper doesn’t factor in the use of gas in passenger cars or commercial trucks. Moreover, while the INGAA report assumes that the Kitimat liquefied natural gas (LNG) plant in western Canada will begin operations, the analysis avoids projections about additional LNG export capacity. If either LNG exports or natural gas-powered vehicles gain greater acceptance, the INGAA demand assumptions would be overly conservative.

The INGAA forecasts that natural gas will win market share among electric utilities and that these gains will account for three-quarters of the projected increase in natural gas consumption. This prediction makes sense: Stringent regulations will gradually increase the cost of coal-fired power, prompting US utilities to shift to natural gas, the cleanest-burning fossil fuel. Natural gas-fired plants are also comparatively easy to site and build and tend to engender less public opposition.

At the same time, alternative energy sources such as solar and wind power can’t compete with coal and natural gas on price or practicality. These inherently intermittent sources of power--the sun doesn’t always shine and the wind doesn’t always blow--can’t offset the need for reliable, baseload electricity. In fact, the more solar and wind power farms the world builds, the more thermal or nuclear power plants are required to compensate for any power shortfalls.

According to the INGAA, building the infrastructure to meet production growth will require roughly $8.2 billion (2010 dollars) in investment per year through 2035--a total of more than $200 billion worth of new projects.

Profiting from Master Limited Partnerships (MLP)

As I mentioned in the June 24, 2011, article, MLPs: Another Opportunity to Buy This Summer, processing and transporting NGL sis big business for  oil and gas MLPs, many of which have reported strong NGL demand from US-based petrochemicals producers and are building significant processing and pipeline infrastructure to meet that demand.
These MLPs are gaining attention from astute investors because their unique organizational structure offers a simple value proposition: tax-advantaged high yields, strong recession-resistant growth potential, and limited exposure to commodity prices. (For more on the benefits of MLPs check out my recent free report)

Cars and airplanes don't run on crude oil; crude must be refined into products like gasoline, diesel and jet fuel before use.

The same is true with natural gas: Raw natural gas produced from a well isn’t the same as the natural gas that you burn in your home or the gas that’s used to produce electricity in power plants. And natural gas produced in different regions of the US or different parts of the world can have varying properties, characteristics and economic value.

Natural gas, once processed and shipped to your home for use, primarily consists of methane, a simple hydrocarbon molecule that’s a single atom of carbon bonded to four hydrogen atoms (CH4). But methane doesn’t usually occur in a pure form in the nature; CH4 is normally found with other hydrocarbons and mixed with other gases.

Often, natural gas--known as associated gas--is found dissolved in crude oil. Associated gas remains dissolved as long as the oil is under geologic pressures, but as the oil is produced, it tends to bubble out of the crude. The action of natural gas bubbling out of crude aids in oil production in much the same way that carbon dioxide bubbles in your Coca-Cola or sparkling water can power the liquid out of a bottle. The oil industry refers to this action as bubble drive.

In other parts of the world, natural gas isn't associated with oil but contains significant quantities of impurities such as carbon dioxide, water vapor, nitrogen or hydrogen sulfide that must be removed before the gas is suitable for use. The latter impurity, hydrogen sulfide, is a poisonous and highly corrosive gas; natural gas that contains a large amount of hydrogen sulfide is known as sour gas, and the removal process is known as sweetening.

 Source: NaturalGas.org