Current Income Sweet Spot For MLPs: Natural Gas Liquids

by: The Wall Street Transcript

It sounds like an oxymoron, but Gas Liquids is a valuable component derived from the production of natural gas. Increasing demand for gas liquids is moving a select group of MLPs -- the "Midstream"-- to higher valuations and more secure current yield prospects.

The first indicator that natural gas liquids were going to drive increased profitability for mid stream MLPs began to appear last spring. In an April 18th 2011 interview, Ethan Bellamy of Robert W. Baird & Company saw the evidence show up on his radar:

We're seeing pretty elevated levels of effective rig utilization. Now most of that is being steered toward liquid plays, oil and natural gas liquids, but most areas that you drill for liquids you are also going to get gas as a by-product... In many places operators could sell the natural gas for zero and still have very positive returns on just selling the liquids that they produce.

These greater volumes of natural gas liquids moved into the supply chain, pushing the demand for mid-stream processing and transportation by steadily increasing volumes. The value of MLPs that control these assets began to grow.

By January 23rd of this new year, 26-year investing veteran Jerry Swank of Swank Capital stated that for

...18 months now we have wanted to be involved in the midstream companies, the pipelines, the companies with pipelines and terminals and storage facilities that are engaged primarily in the oil business, not the natural gas business, and also in the natural gas liquids business.

Mr. Swank pointed out that

...the oil and natural gas liquids are growing dramatically in United States, and we don't have enough infrastructure in the correct places.

Swank goes on to identify the three best MLP plays that will benefit:

The holy trinity of the natural gas - of the liquids business, we call it - and that's Enterprise Products (NYSE:EPD); ONEOK, and there are two companies, OKE (NYSE:OKE), and OKS (OKS) ; and then Targa; and again, there are two entities there, one is Targa Resources Partners (NYSE:NGLS) and the other is Targa Resources (NYSE:TRGP).

Company Ticker Price P/E Yield EV
Enterprise Products Partners EPD $48 25 5.2% $57 bln.
ONEOK Partners OKS $56 21 4.3% $11.4 bln.
ONEOK OKE $83 27 2.9% $8.6 bln.
Regency Energy Partners RGP $26 175 7.1% $4.1 bln.
Targa Resources Partners NGLS $39 24 6.1% $3.3 bln.
Targa Resources TRGP $41 105 3.3% $1.8 bln.

Since the MLP corporate structure requires that 90% of all cash flow pays out in current income on the security, the research experts that specialize in these publicly traded vehicles are by definition conservative cash flow investors.

Brian Watson of SteelPath Fund Advisors is looking to hedge downside commodity pricing risk so that an economic downturn doesn't tank his returns. In a recent interview he detailed his specific downside metric:

Right now, our bear case is $60 oil for two years with a very weak ratio of natural gas liquids to oil. That is obviously not many people's expectations.

One of the biggest investments in that fund is Regency Energy Partners (NYSE:RGP), an MLP which is aggressively moving into the natural gas liquids space:

They are spending a pretty good amount of money right now on a natural gas liquids private company, and they are expanding natural gas liquid services to West Texas.

Clearly some of the smartest money in Oil & Gas MLPs has been zeroing in on the midstream Gas Liquids partnerships. As the demand for domestically produced energy increases over the long term, this will in turn drive a long term valuation chain. The effects can now be seen in increasing opportunities for investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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