Midstream Opportunities in the Marcellus

I’ve been warning readers about 1st quarter energy results in the Exploration and Production companies – believing that the results would be overhyped and lead to disappointments.  But nothing like that has happened.  

In fact, the E+P’s have been killing it, if not from increased realizations, then by the strong prices in natural gas during the winter of 2013.  And, if that weren’t enough, the wide differentials in domestic crude benchmarks led to some incredible results from the refiners and in the downstream results of the big integrated stocks.  Exxon-Mobil (XOM), my long time ‘go to’ integrated behemoth, just posted incredible downstream numbers, in time to see those shares rise well over $100.  Jim Cramer, who I spoke with yesterday, sees $120 as a reasonable Exxon target.   Wow.

But one area of energy is being overlooked in this incredible renaissance of US production:  Midstream assets.  In the massive ramping of production here in the US, what has been left behind so far has been the infrastructure to carry it where it needs to go.  Despite the thousands of miles of pipelines that currently criss-cross our nation, there’s much, much more that needs to be built in order to catch up to the potential resources E+P companies are targeting.  

Two obvious areas for midstream growth present themselves as worthy of investment, the Marcellus and the Bakken – but let’s look at the Marcellus for this column.  The Cabot (COG) conference call showed just how restraining midstream bottlenecks can be, as the Marcellus-area natural gas basis discount reached beyond $0.30/mcf, killing profits.  

For investors that have been following the midstream space in the Marcellus, much of the easy money has already been made:  Pipeline behemoth Enterprise Product Partners (EPD) has long been the leader in Marcellus midstream assets and is continually increasing its mileage – it’s latest project being a 1230 mile pipeline that will bring Marcellus NGL’s to Texas.  But shares in EPD have already increased close to 10% in the last year, knocking the distribution under 4%. A similar scenario can be seen in EQT Corp. and their midstream partner EQM, in old fave MarkWest Partners (MWE) and Natural Fuel Gas (NFG).    Gone are the days when midstream companies will pay a juicy 6-8% in distributions, but that doesn’t mean that there aren’t still pockets of quality to be found.

One I would suggest is Spectra Energy (SE) and its midstream partner SEP.  Spectra is a very diversified midstream company, with assets devoted to processing and storage of nat gas, as well as transport.  Their pipes run through Canada and parts of the Northeast as well as into the Gulf Coast.  But it is in the Marcellus that I believe the growth is going to come in the next 3 years and drive Spectra’s share price forward.  They’ve just completed one Marcellus pipeline project and have another 5 that they are pursuing, including seeking approval for a major upgrade of their pipeline in the New York area.   While Enterprise might be the strongest bet in the Marcellus region, share price seems at the upper end of their likely range.  With Spectra, I believe there is still appreciation to be had as well as a 4% dividend, both from the energy company as well as the MLP.  

If you can invest in a tax-advantaged way using MLP distributions without penalty, I’d recommend Spectra Energy partners (SEP) as a nice addition to your midstream portfolio.  If you can only tolerate regular dividends, Spectra energy (SE) is the way to go.

Midstream assets in the Marcellus are going to have to explode alongside the production there – and there is still plenty of upside yet to be seen.