Sunday evening investors were hit with news that Kinder Morgan and El Paso would be merging their pipelines and assets for future development. The combined company will have the largest pipeline network in the country. Also note that the announcement made clear that the combined company would be selling off exploration assets and use the proceeds to reduce debt. What is to be made of this merger and if you own pipeline assets via MLP's how does effect your investment.
I believe this merger makes clear one thing, natural gas is here to stay as a viable energy source. It also makes clear that the use of fracking is here to stay too. Most states that possess natural gas assets that can be got at via fracking have either approved or in process to approve this technique. Pennsylvania is the latest to approve and is diving in full bore, Arkansas, Texas, Louisiana, Oklahoma and many others have already done so. I expect Ohio, where the most recent finds have been discovered, to do likewise. New York is holding back due to extremist environmental concerns, but once New York start seeing the tax flow I would expect New York democrats will want to get in on the bonanza too. When you are dealing with tax revenue such as is starting to flow now most government interests find a way to get at it. Other states, like North Carolina, where the gas pools are less, might allow these extremists environmental interests to prevail. Such is the way of politics.
KMI and EP are combining pipeline assets to get at these natural gas sources. You can expect other pipelines have taken notice and can expect additional mergers forthcoming if the companies can find ways to make assets work for delivery from the new natural gas fields. Bigger means cheaper and that is where this is going. Now one thing is left out here and that is if we in the US are going to either use these new energy resources and pipe them to terminals in Texas and Louisiana to have them shipped to Asia where the countries there are willing to pay higher prices to use the energy.
Either way the new combined company of KMI will be able to take advantage, either flowing to utilities and industry here or offshore. The opportunity to use our own natural gas here in long haul trucking is also there as well. It would reduce costs of hauling, reduce costs at the consumer level, and also raise even more tax revenue. Here IS where the federal government has a role to play. Obama is currently allowing extreme environmental interests to prevail in the use argument, but he also is being pushed hard by union interests who want the jobs and dues from the use of natural gas onshore. Only time will decide if we use our own energy or sent it in ships to Asia. Note Obama is ramping down on coal use in the US, but the same coal is being shipped to China for use there, so what is the difference environmentally?
The new natural gas fields offer an investor so serious long term plays. You can invest in the actual drillers in the field or you can invest in the pipelines who take the energy to the user. I personally do not see any advantage in investing in the end user, since the only difference here is the switch from oil or coal to natural gas. If, and this is a big if, Obama relents and allows trucks and others end users to use the new fuel then that is a game changer and the consumer suppliers become serious investment opportunities.
Investing in the drillers is a good opportunity in getting a solid source of long term income. Many of these new finds will be turned into royalty trusts where the wildcatter sets up the new find as a trust and moves on to new drilling opportunities. Some of these trusts exists now. SJT, HGT, LINE, and MTR or some of them. They are set up as trusts that essentially pay out monthly to holders. The "distributions" as they are called essentially are cash flow after costs and depend strongly on the current price of natural gas. Currently natural gas is selling very cheaply. If you do not believe so check the new competition in propane gas delivery and the much lower pricing structures. Buying into these trusts is a bet on the price of natural gas and with natural gas per BTU is about one third the cost of oil the bet there is quite good as gas usage worldwide ramps up. But note, as with oil, there is lots and lots of natural gas out there. Also note that royalty trusts distributions can sometimes be a tax favored event since the trusts are partnerships and with the depletion allowance most of the distribution is considered nothing more than returning your money to you since the gas field is a finite resource. Payout's average 6% plus.
Investing in the pipelines offers different investing opportunities. As with the trusts the pipelines are generally partnerships and distributions can be tax favored as well since you are participating in the write down of pipeline assets. The difference with pipelines is that you become an owner in delivery of the natural gas to the end user and charge a fee for that delivery via your pipeline. Most partnerships increase their fees regularly and increase the distribution to partners as well. The recent announced merger noted above pre-announced an increased distribution and a 7% annual increase for four years up front. Since payout's for pipelines average around 6% plus and most are increasing their annual payout's you stand to get regular growth in your capital investment as well.
The big difference here is that royalty trusts offer significant upside capital gain and distributions if natural gas takes off and Obama allows the resource to be fully used here in the US. Pipelines offer steady increasing payout's with smaller capital gains potential. Either way you an investor will do well I believe.
Note that both of these investments have K-1's to deal with a tax time, so have a good CPA. I do not own either as a option or long investments in either of these areas. I am considering buying into the pipeline sector.
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