Monday, September 23, 2013

The Case for Pipelines

The market seems confused lately, and not only by the Fed. After rallying hard last week when the Fed announced it was NOT going to taper its $85-billion-per-month quantitative easing program, the market ended the week by giving it all back.  I still think we could see short-term market weakness due to the looming budget battle in Washington. But longer-term -- say, the next 6 months -- I'm more sanguine. I think the US economy and market could do pretty well over that time frame.

So, what to buy?  I'm bullish on US energy production -- I think we haven't seen the top yet, and won't see it in the next six months, anyway. Therefore, those companies that transport oil and gas through pipelines should see increased business.

We are seeing rising nat-gas production from the Marcellus Shale (Haynesville Shale production has fallen, but not enough to matter yet). Natural gas production from the Marcellus is expected to continue growing as infrastructure constraints in the play ease up. Second-quarter results from Cabot, Range, and other Marcellus producers highlighted the issue of backlogged wells – those that have been drilled but are not currently producing, mainly because they lack pipeline connection.

As backlogged wells are connected to pipelines and brought online over the next several months, production growth this year could top even last year's levels.

Meanwhile, US domestic oil production looks like this ...

Put oil and gas production together, and, according to the US Federal Reserve, US oil and gas extraction increased in August by 11.4% from a year earlier to the highest level since the Federal Reserve began reporting data in January 1972 -- more than 40 years ago!

Sure, some of that product will transport by rail, and some by barge. But a lot will transport by pipeline.

The AMLP is a basket of companies including Enterprise Product Partners (EPD), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), Energy Transfer Partners (ETP) and more. You have one guess as to what business these companies are in, and that guess better start with a "P".
The pipes have a meter and they charge for the amount of oil or gas they pass.  While they are in the energy business, their fortunes do not particularly depend on energy prices, because people need oil and gas delivered whether it is expensive or cheap.  In this respect, pipeline MLPs are like utilities.  

And utilities were one of the beneficiaries when Ben Bernanke shocked Wall Street by NOT cutting quantitative easing at at the most recent Fed meeting. 

Side note -- reports that Chairman Bernanke shouted "Who's Your Daddy? I'M your Daddy!" while keeping QE intact have NOT been substantiated.

Anyway, no QE cut means that bond yields go back down, and utilities, which offer yields that compete with bonds, went up rather nicely last week.

Utilities actually saw a poor end to the week, so their rally potential is still questionable.  Still, there's no doubt that with bond yields falling, stocks and funds that pay nice dividends are looking more attractive than before the Fed's announcement on QE.

And that brings me to my next point, which is that the AMLP sports a 5.82% dividend yield. 

Now, let's look at a weekly chart of the AMLP itself ...

You can see that the AMLP rallied sharply last week, much like utilities, and on strong volume, too. It still has to break through resistance, and nothing is certain.  But I think this is a good bullish bet for the next 6 months.

Not everything is rosy. Fund expenses can eat up some of the dividend yield. And your own tax situation will also affect total return. Let's add in the uncertainty of the oil business, which is a boom-and-bust business. Finally, there's the generally confused mood the market finds itself in. This may lead to more short-term weakness in the AMLP. But that's probably a buying opportunity considering the intermediate forces I've mentioned.

Bottom line, investors would consider the AMLP because it is a play on rising US domestic energy production, and all that oil and gas flowing through pipelines.

This is not an official recommendation. You are in charge of your own investing destiny. Do your own due diligence before buying anything. And before you buy, make sure you know at what price you will sell.

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