Domestic midstream companies include (but aren’t limited to) names such as Kinder Morgan Energy Partners (KMP), Plains All American Pipeline (PAA), Enterprise Products Partners (EPD), Enbridge Inc. (ENB), Spectra Energy (SE), Energy Transfer Partners (ETP), Targa Resources (NGLS), and Williams Partners (WPZ).
(Read more: Why MLPs provide excellent risk-reward for investors)
The midstream segment of the broader energy sector represents activities between the production of oil and gas (under the purview of the upstream segment) and end users. Midstream companies are involved in oil and gas transportation through means such as pipelines, rail, trucks, and barges. Midstream names are also involved in processing, fractionating, and storing hydrocarbons.
Factors to watch
One feature of master limited partnerships (MLPs, the structure of most midstream companies) is that they pay much of their excess cash flow out in the form of distributions (fundamentally the same as dividends). Because of this feature, one of the most important features in evaluating midstream MLPs is distribution. Analysts look at the distribution yield, which is the annualized quarterly distribution divided by the unit price (fundamentally the same as the stock price). Additionally, growth in future distributions is an important factor to consider. A company’s current distribution could be low, but if it expects future distributions to increase rapidly, it could build this expectation into the company’s valuation.
(Read more: Why fractionation spreads affect some MLP stocks)
2. Oil and gas infrastructure demand or drilling activity
For midstream companies, the demand for oil and gas infrastructure is one of the major drivers of growth. For example, the Marcellus Shale in Appalachia has been one of the fastest-growing oil and gas plays in the United States. The Marcellus is a major source of natural gas—especially wet gas (gas with a high natural gas liquids component) in its most highly sought-after areas. Drilling and production in this region have increased rapidly, and this has prompted the development of infrastructure there. Natural gas gathering networks, gas processing facilities, fractionation plants (see Why fractionation spreads help some MLP stocks), and pipelines for natural gas and natural gas liquids have all been necessary for the development of the shale play.
Companies with strategically located midstream assets in the Marcellus have seen outperformance. For example, MarkWest Energy is a midstream MLP (master limited partnership) that has seen its share price climb from ~$34 per unit in August 2010 to ~$70 per unit currently. The total return for the name if distributions have been reinvested in the security is roughly 140%. In comparison, the Alerian MLP ETF, an ETF (exchange-traded fund) designed to track an index of energy-related MLPs, experienced a ~40% total return (assuming distributions reinvested into the ETF) from August 2010 to present.
The popularity of new unconventional plays such as the Marcellus, the Permian in West Texas, and the Bakken in North Dakota has driven the growth of many midstream companies. Generally speaking, increased drilling and resource development benefit the midstream sector.
Where growth in activity can help midstream names, decline in activity can hurt midstream names. One example is midstream names with natural gas gathering assets in the Barnett Shale or Haynesville Shale, where gas drilling has been slowing. Regency Energy Partners (RGP) operates a joint venture in the Haynesville Shale for which 2Q13 throughput was 657,950 million British thermal units per day (MMBtu) of natural gas, compared to 903,344 MMBtu per day in 2Q12.
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