More Energy Deals Likely In The Pipeline: What This Means For Investors

by: Mike Maher

Deals are heating up in the energy space. Over the weekend, Kinder Morgan (NYSE:KMI) agreed to purchase El Paso Corp (EP) for $38 billion including debt, Statoil (STO) agreed to purchase Brigham Exploration (BEXP) for $4.4 billion, AmeriGas (NYSE:APU) agreed to buy the propane operations of Energy Transfer Partners (NYSE:ETP) for $2.8 billion, and Enterprise Products Partners (NYSE:EPD) agreed to sell 29 billion cubic feet of storage capacity to Boardwalk HP Storage Company, a JV of Boardwalk Pipeline Partners (NYSE:BWP) and Boardwalks's GP, for $550 million.

That's nearly $46 billion in deal activity announced over a single weekend, and is further proof of the shifting landscape of the US energy market. These deals follow the bidding war between Williams Companies (NYSE:WMB) and Energy Transfer Equity (NYSE:ETE) for Southern Union Co (NYSE:SUG), Enterprise Products buying Duncan Energy, and BHP Billiton (NYSE:BHP) buying PetroHawk (NYSE:HK), all of which happened earlier in the year. So what are the underlying themes among these deals, and what should investors take away from the activity?

First and foremost, expect energy production in the US to continue to increase, keeping downward pressure on natural gas prices, and potentially downward pressure on oil prices in the coming years. It takes years to build the plants, refineries, and infrastructure to use the new oil, NGLs, and natural gas that is coming on the US market, and just as long to build out the export infrastructure to move the resources out of the country. That means the glut of natural gas in the US is set to continue, as well as the oversupply of oil in Cushing, OK.

While this is great for consumers, who will benefit from lower energy costs, it will lead to lower margins for producers until the US becomes a more efficient exporter, or domestic consumption increases. However, as long as natural gas futures remain above $3, and Nymex crude above $60, producers will still continue to bring new wells online, and most will continue to be profitable.

Secondly, expect energy infrastructure to continue to be in high demand, as new finds in areas under-served by the current pipeline systems strain the ability to move energy resources around the country. Interstate pipeline networks such as El Paso's and Southern Union's are crown jewels of firms looking to acquire and expand, as these assets would take years to build from scratch.

First movers in new resource plays will have an extra advantage, as producers drilling new wells in the Marcellus, Utica, and Bakken look for takeaway capacity to get their new production to major markets. Large firms will also have an advantage, as they have the financial heft to fund new pipelines more easily than smaller competitors.

Third, the rush to snap up small and mid-sized energy producers in the US will not slow. The US is a first world, capitalist country with the second largest economic area in the world (only behind the EU), a stable government with no threat of nationalizations, no national oil companies to deal with, a highly educated population, and a strong energy industry. These features make the US a much more desirable place to do business than off the coast of Africa, some South American counties, the Middle East, Russia, or China.

Add to that a weak US dollar making US companies more affordable to foreign purchasers, and combing the US oil and gas arena for deals makes a lot of sense. William's E&P business will likely be in play after it is spun out in late 2011 or early 2012, and Kinder Morgan has already said it plans on selling El Paso's E&P business.

I continue to believe that EPD is the best name in the MLP space, given its size, strong management team and track record. However, the KMI/EP tie up is a very interesting move, especially given management raising the dividend guidance to a 12.5% average annual growth rate in the dividend for KMI through 2015. Investors looking for pipeline plays should look for companies with assets close to or already serving new shale plays, or the South Eastern US markets, as these companies are the most likely to receive some takeover interest given the strong growth potential in these areas.

As for the E&P side, it seems that no company is immune to takeover rumors, and that seems to have been true since the Exxon/XTO deal. Given that the El Paso E&P assets will be coming to the market, I expect that will be a further catalyst for continued consolidation in the E&P space, as investment bankers shop that unit and size up potential buyers and sellers. Companies with exposure to oil and NGLs will be in higher demand than dry gas plays due to the better pricing environment, so investors should focus their attention towards the oil and NGL names.

Disclosure: I am long EPD.