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North American Oil-And-Gas Boom: Stock To Watch

Suzanne McGee

When a freight train carrying crude oil from North Dakota’s Bakken formation across Canada to a New Brunswick refinery derailed in Quebec, triggering an explosion that leveled half of the downtown area of the town of Lac Megantic and killing dozens of its citizens, the disaster prompted renewed debate over the safest way to transport new reserves of crude oil and natural gas to market.

To the dismay of those who argue against both pipelines and railway transport, simply not extracting the newly-discovered reserves of crude oil and natural gas probably isn’t a viable option, either politically or economically. To date, renewable energy sources aren’t available in the right quantities or locations to offer a serious alternative to fossil fuels. That, in turn, means that demand will need to plummet, or that the United States will need to return to being reliant on imported crude oil, or that some kind of solution will be found to the current oil and gas transportation bottlenecks.

None of these options are particularly appealing to the politicians who will ultimately have to choose one or the other. But the odds are heavily in favor of new pipeline construction emerging as a major part of the solution, including, quite possibly, the controversial Keystone XL pipeline. The latter has been made more appealing since its sponsor, TransCanada Corp. (TRP) proposed a new route that would bypass the Ogallala Aquifer, a key source of fresh water in Nebraska, addressing a key concern raised by President Barack Obama when he blocked the project last year. Environmentalists’ other objection to the deal – that development of Canada’s oil sands would fuel further climate change – may end up being moot, if Canada’s Natural Resources Minister Joe Oliver is accurate in stating that if Keystone isn’t built, an east/west pipeline within Canada will be: either way, the oil sands reserves are coming out of the ground, Oliver said in April. Meanwhile, the Obama decision not to approve the Keystone project has become a big political bone of contention between the United States and Canada.

TRP Chart

While the uncertain fate of the Keystone venture has weighed on TransCanada’s outlook, there are plenty of other reasons for investors who don’t have built-in objections to owning pipeline stocks for environmental reasons to add this infrastructure play to their portfolios.

First and foremost, the company is in expansion mode, even without the benefit of the Keystone pipeline. It announced at the end of July that it will forge ahead with a $12 billion project, the Energy East crude oil pipelines, a move that will help boost prices for Western Canadian producers struggling with the transportation bottleneck. That pipeline, when completed, will transport more than a million barrels of oil daily to refiners in eastern Canada, eliminating the need for Canada to purchase foreign crude oil. Other projects in the queue include a natural gas pipeline in British Columbia that will enable Canada to export gas to Asia; together with Exxon Mobil (XOM), TransCanada has been working since 2009 on another gas pipeline to transport North Slope gas reserves to market.

TransCanada, a veteran pipeline company, knows how to balance the hefty costs of such ambitious projects, and over the years, its assets have expanded at a more rapid clip than have its liabilities, even though its debt-to-equity ratio remains higher than that of the industry. It’s also a savvy and profitable manager of those assets, having just reported a 34% jump in net income on the back of a 9% gain in revenue.

TRP Liabilities to Assets Chart

At present, TransCanada either owns outright or has a stake in assets worth some $48 billion, most of which are pipelines but that also include power generation facilities, including Bruce Power, a nuclear generating complex in Ontario, whose sales volumes surged 42% during the most recent quarter thanks to the return to service of part of the facility. These are assets on which it earns a steady and relatively predictable rate of return. Adding the Keystone Pipeline expansion to the list, perhaps as early as 2015 if there is a positive decision by the White House this year to greenlight the permits, could generate an additional $1 billion of earnings before interest, depreciation, taxes and amortization (EBITDA). The longer the delay, however, the higher the cost of the project, the company has cautioned. That shouldn’t be a major issue for long-term investors, since TransCanada will be able to pass those higher costs on to pipeline users through higher tolls.

An additional inducement? TransCanada’s dividend payment. After hitting some bumps in the 1990s when analysts questioned whether its payout was sustainable, TransCanada has steadily boosted its quarterly dividend, to the point where its dividend yield now stands at 3.84%. That may not be as alluring as it might have seemed a few months ago, before monetary policymakers in the United States triggered a bond market selloff by hinting that they’d soon be tapering off their monthly purchases of mortgage securities, but it’s nothing to sniff about, either.

TRP Dividend Chart

The political risk associated with the expansion of the Keystone Pipeline has been priced into TransCanada’s stock for more than a year now. A favorable ruling from the White House could ignite a big rally in the stock; even without that, it’s hard to imagine a solution to the transportation bottlenecks plaguing North America’s energy industry that doesn’t involve TransCanada. One way or another, this is a long-term growth story, albeit of the modest and unspectacular kind that is characteristic of all such utility companies.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com. You can also request a demonstration of YCharts Platinum.

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