MLPs To Capitalize On Energy Trends

This article is part of our CEO Interview - energy series. It focuses on the industry dynamics of MLPs, which is this weekend's interview with Kinder Morgan President C. Park Shaper.

We believe Master Limited Partnerships (MLPs) are well positioned to capitalize on the growth of the energy infrastructure build out in the United States. The low price of natural gas is having a positive effect on building demand for natural gas products in multiple areas. The extremely warm winter in the Northeast and Midwest as well as continued increases in natural gas supply due to the further development of our country’s unconventional energy resources have driven natural gas prices to 10 year lows.

Many MLP companies are very well insulated from falling gas prices. The cash flows are often predicated on long-term (5 to 10 year) contracts and much of the revenues are secured by capacity commitments regardless of price or even short-term usage. MLPs are also differentiated by geographic market and by type of product, which presents diversification opportunities.

Natural gas is sold into four principal markets: Power generation, home heating, manufacturing and transportation. It competes with coal and nuclear for power generation. Natural gas along with oil and propane are the main energy sources for the home heating market. Natural gas liquids compete with naphtha, a byproduct of crude oil, as a feedstock used in the petrochemical industry for manufacturing. Natural gas is quickly becoming an attractive option to fuel commercial trucks, although today it is only a tiny fraction of the overall market for transportation. With the abundant supply and low prices, we expect demand for natural gas to continue to expand.

Today, natural gas accounts for about 25% of all electricity generated in this country. The U.S. Energy Information Administration (EIA) forecasts that the U.S. will add 222 gigawatts of generating capacity over the next 25 years, which is equivalent to one-fifth of the current U.S. capacity. It is estimated that 58% of the capacity will come from natural gas. Natural gas has significant environmental advantages versus coal and nuclear. However, low price is further accelerating the move by utilities to switch more capacity to natural gas. The current price is one-third of where it was in 2005 and one-seventh from the highs in the summer of 2007.

Abundant, low-cost natural gas supplies are also leading to a manufacturing renaissance in America. A type of natural gas commonly referred to as “wet gas” is processed into various natural gas liquids components which are used as feedstock for the petrochemical industry. We have recently seen major announcements from global manufacturers to open plants inside this country to gain access to low price natural gas liquids. In March, Royal Dutch Shell PLC (RDS.A) selected Pennsylvania as the location for a $2 billion petrochemical plant expected to generate 10,000 permanent jobs. The plant, an ethane cracker, will convert ethane found in natural gas into ethylene, a core component for plastics and fertilizer. Pennsylvania is the home of the Marcellus Shale, one of the more massive areas for unconventional gas deposits in the U.S. We expect many more manufacturing jobs to be created as more plants are built here to take advantage of the huge price differential for natural gas in this country versus the rest of the world. The price for natural gas in Asia is approximately seven times that of the price in the U.S.

We feel our country’s transportation market is also on the cusp of a significant shift toward much greater usage of natural gas. Currently, trucks account for 30% of all gasoline usage in this country. Not only is natural gas much cleaner than crude oil refined base products, it has become much cheaper (the cost is equivalent to $2 per gallon) and is completely domestically sourced. The technology and the cost for the production of natural gas vehicles is not a barrier, however the lack of filling stations is the major challenge. That soon will begin to change with the recent partnership between Navistar (NAV) and T. Boone Pickens’ company Clean Energy Fuels Corp. (CLNE). In February, Clean Energy unveiled plans to open 150 liquefied natural gas stations by 2015, 70 of which are planned to open in 33 states by the end of next year. Navistar will make an extensive range of its trucks available to run on natural gas sold throughout its 800 dealer locations across America. In March, General Motors and Chrysler announced they will both soon be offering customers compressed natural gas (CNG) powered pickup trucks for several of their better-known brands.

Another exciting area is the potential for natural gas exports. Unfortunately, there is no current export capability in the U.S. to take advantage of the wide differential between gas prices between the U.S. and Asia. Soon that may begin to change. Last year, Cheniere Energy (LNG) received permission to retrofit a major import facility off the Gulf of Mexico for exports. Last fall, the British energy firm BG Group (BRGXF.PK) signed a 20-year commitment to purchase $8.2 billion of liquefied natural gas from Cheniere’s Gulf Coast facility for sale to Asia and Europe. The Blackstone Group (BX) recently made a $2 billion equity investment to fund the construction of this project which is scheduled to be completed by 2016. The building of this facility is a major step toward the U.S. becoming a meaningful exporter of LNG.

The two largest holdings in the Rachlin Group Income Plus Portfolio: Energy Transfer Equity (ETE) and Enterprise Products Partners (EPD). Both are well-positioned to capitalize on these positive trends. ETE recently announced plans seeking FERC approval to construct an LNG export terminal in Lake Charles, Louisiana, in order to supply overseas markets with U.S.-produced natural gas. When built, the proposed terminal is projected to provide the equivalent of 2 billion cubic feet per day of natural gas. Additionally, EPD announced plans at its recent investor conference to construct additional NGL fractionators at Mont Belvieu, Texas, to facilitate the continued growth of NGL production in the Eagle Ford shale and Rocky Mountain gas-producing basins.

Over the next several years as momentum for natural gas products further builds, our nation’s energy markets are going to be transformed. We believe that leading MLP companies are poised to substantially benefit as the energy industry significantly expands its infrastructure and logistics footprint in this country. This is a very exciting time to be a company engaged in the building of pipelines, storage and processing facilities in places like the Eagle Ford shale in South Texas, the Bakken in North Dakota, the Marcellus in Pennsylvania and other burgeoning energy basins inside the U.S.

This material is presented solely for informational purposes and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Any views or opinions expressed may not reflect those of the firm as a whole.

Specific securities identified and described do not represent all of the securities purchased, sold or recommended for advisory clients. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable.

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