Fossil fuels have to be transported and stored. This
is the classic midstream industry that resides between the producers and the
marketers and that generally makes money regardless of the price of oil,
natural gas or natural gas liquids (NGLs). Now, with the boom in production
coming from unconventional oil and gas shales and
the enhanced technologies that produce fuels in areas where it was once
impossible, the demand for midstream oil and gas infrastructure is growing.
In this exclusive interview with The Energy Report,
Morgan Stanley Managing Director and Master Limited Partnership (MLP) Analyst
Stephen Marsesca makes his case for a handful of
MLP and common stocks that will generate increasing cash flow and dividend
Report: In your last interview,
you told The Energy Report it was a good time to be involved in
midstream plays. What about now?
Stephen Maresca: It's still a good time to be
involved in midstream stocks. A lot of unconventional oil and gas shale plays
are increasing production and require new infrastructure to bring their
supply to market. The growth outlook is still as strong as it was a year ago,
even though recent commodity price weakness has created some investor
We are now
adding duration to this growth story: Midstream companies are adding projects
not for just this year, but as far as three years out. When those projects
are completed, they will add incremental cash flows for these companies. Over
the next few years, we estimate about $60 billion ($60B) in growth capital is
going to be spent among our companies under coverage, and we believe a lot of
that has been derisked. Many new projects are
coming on line with volume commitments from producers and many of these
long-term contracts are not tied to commodity prices. It is becoming a more
The midstream industry seems very unusual given current market conditions.
That is largely because the energy landscape has improved so much over the
past five years, with advancements in oil and gas technology, horizontal
drilling and lower drilling costs. The technological improvements have really
been a game changer for the energy industry, and that is why this story is so
visible. There have been remarkable supply shifts and production growth from
areas that did not previously have infrastructure or end-demand markets. For
example, the oil being found up in North Dakota needs to be moved out into
end markets where it can be used by refiners (like the Gulf Coast or
Northeast). This is where the midstream companies play a critical role in building
the interconnects to bring the new oil supply to
"It's still a good time to be involved in
we think the midstream group of MLPs is attractive on a value basis with
yields where they are now. The median yield in our coverage universe is
currently 6.5%, and we think distribution growth over the next couple of
years is likely to be 7% on average. Year-to-date MLP stocks have experienced
modest share appreciation, about 1%, but with where things stand right now we
see average potential total stock returns at 13–14% for the group.
you could put your theme in a nutshell, how would you describe it?
Building critical North American energy highways. This is an organic building
story. This type of opportunity did not exist before because we did not have
this type of supply shift and production growth, and now we do. These are
still-in-the-ground, non-discretionary, essential energy assets that are
helping to advance energy independence for the U.S. We now have increasing
oil production in addition to the increasing gas production that we have had
for several years. The gas derivatives, the NGLs—ethane, propane and
butane—are also increasing in volume and need to be handled. End users
like utility companies, petrochemical companies and refiners are going to
benefit from this new and increasingly abundant supply of oil and gas.
What does this increasing production portend for capacity? Can fees rise?
believe revenues are going to rise handsomely over the next three or four
years because of the $60B in spending that I mentioned. We see cash flows for
these companies, in many cases, rising 11–12% per year over this time
period because of the buildout.
There are many
asset locations where we are constrained in capacity, so we need to build
more. We are constrained in areas like the Eagle Ford shale in South Texas,
North Dakota and the Marcellus and Utica shales.
Increasing volumes in these areas are creating the need for new building.
Are you seeing net inflows of funds into these instruments?
are seeing money flow into the sector. I think the MLPs have become more of a
mainstream sector with more investors participating. Larger companies, market
caps and daily trading volumes are attracting broader participation across
all types of funds—institutional funds, mutual funds, closed-end funds
and hedge funds. This is an important and growing part of the energy industry
and it is likely to stay that way.
the midstream industry healthy today, and does it represent value for
Balance sheets are, for the most part, quite healthy given lower levels of
debt to cash flow and recent equity raises.
Distribution payout coverage is higher today than it was four years ago. The
amount of commodity sensitivity, in general, is declining for the industry as
more fees and volumes come on line that are not directly tied to commodity
prices. So, bottom line, I would say the sector is healthy in terms of the
financial structure and fundamentals.
"The energy landscape has improved so much over
the past five years, with advancements in oil and gas technology, horizontal
drilling and lower drilling costs."
trade wider on a spread to 10-year bonds than they have in the past, which is
one metric we review. They are about 70 basis points wider than historical
norms. With interest rates overall looking to stay low and growth rates sustainable
for the next year or two, the risk-reward opportunity for the long term is
Some of the MLPs in your coverage universe are up double digits over the past
month. Is a good earnings season upon us?
Not necessarily. I think some of the stock rebound recently was reflective of
an oversold sector and an increase in recent fund flows. Investors have
concerns about commodities pulling back and some of those concerns are valid,
as it can impact a portion of cash flows and longer term could impact
volumes. Now, we have recently gotten some support in commodity prices. West
Texas Intermediate (WTI) oil price has moved back up from below $80/barrel to
nearly $90/barrel. NGL prices have gone from $0.80/gallon up to $0.90/gallon.
Things have calmed with support for the commodity.
I think second
quarter earnings will be weak in certain spots. You have some companies that
will see subdued results because of the lower commodities during the quarter.
I do not think this changes the forward forecast for volumes and project
growth, hence our positive longer-term view.
What MLPs and C-corps do you recommend for your clients?
One of the names that we've been recommending is Kinder Morgan Inc. (KMI:NYSE). We think this is one of the
lower-risk growth names in our coverage universe. It's trading at a 4%
current yield, and we think you'll see 16% dividend growth in the next 12
"The sector is healthy in terms of the financial
structure and fundamentals."
recently purchased El Paso Corp., and that closed about six weeks ago. We
think this was a very good purchase, and it helps to lower Kinder's risk profile because the assets are essentially
long-haul, eight-year weighted average contracted natural gas pipelines with
93% of the capacity under contract. There's not a lot of variability
associated with the assets purchased.
poised to expand on what we think is one of the better footprints in North
America in terms of expansion of pipelines because of a growing volume story.
It's working on a large oil pipeline up in western Canada called Trans
Mountain that could be more than a $4B investment. And it clearly has a lot
of opportunities now with the El Paso assets that it can drop down into its
MLPs, both Kinder Morgan Energy Partners L.P.
(KMP:NYSE) and El Paso Pipeline Partners L.P.
(EPB:NYSE), which will help funnel cash back up to Kinder
Morgan Energy Inc. to help grow its dividend. It's a well-run company with
one of the better management teams in the space, and there are a lot of
synergies from buying El Paso. Kinder Morgan originally talked about $350M in
synergies, and now it's gone up to $400M.
Kinder Morgan Energy is a C-corp, not an MLP. Is
there any advantage to the C-corp?
Not particularly. They own a lot of similar assets compared to MLPs, such as pipelines,
terminals, gathering and processing plants. The big difference about a C-corp common stock is that it is a taxable entity, and
it's a common stock, so you get qualified dividend tax treatment. Being a C-corp doesn't really offer many advantages other than
possibly more trading liquidity, depending on the size of the company.
What's your next promising name?
like Williams Companies Inc. (WMB:NYSE). The current dividend yield is
over 4%. We expect dividend growth over the next 12 months of about 22%, and
our target price is $37. I think the interesting thing about Williams is that
it has really set up a promising footprint in the Northeast. We feel it is
going to become one of the dominant players in the Marcellus and possibly
Utica shale plays. It has a great set of pipeline assets in that region, as
well as in western Canada. It has one of the best balance sheets and we think
the company will see continued volume increases in the Northeast from gas and
Transco pipeline goes from the Gulf Coast up to the Northeast, and I think it
is one of the better pipelines in the U.S. It is close to the Eastern
Seaboard, and there will be a lot of expansion because of increases in demand
from utility companies. There could be upward of a couple billion dollars of
expansion projects on that pipeline alone because of increases in power
generation and ongoing abundant gas supplies.
Who else stands out in this space?
would say another one right now would be Atlas Energy
L.P. (ATLS:NYSE). This is more
of a small-cap name. The current yield is about 3.3%, but it has the highest distribution
growth of any company that we cover right now. The distribution is currently
$1 per unit, and we see it growing to $1.87 per unit for the full year 2013.
Atlas is unique in that it owns the general partner of two separate
companies. One company is Atlas Resource Partners L.P. (ARP:NYSE) and the other is Atlas Pipeline Partners L.P.
(APL:NYSE). The Atlas Pipeline assets are in some of the best
basins—Oklahoma, Mississippi and West Texas—where there is a
tremendous amount of expansion opportunities. We believe Atlas Pipeline will
be growing cash flow by 10% or so over the next year. Atlas Resource Partners
is a unique exploration and production (E&P) company with very little
debt on its balance sheet that has been out buying assets from distressed
E&P companies. The combination of the organic build at Atlas Pipeline
Partners and the acquisition and production growth story at Atlas Resource
Partners is fueling Atlas Energy L.P. Our target for Atlas Energy L.P. is
$48. We see a lot of upside there.
Stephen, is there one more you can mention?
One last one I would mention is Energy Transfer Equity L.P. (ETE:NYSE), which has a current 6% yield. We
have the distribution growing 10% next year. Energy Transfer Equity recently
purchased Southern Union Co., and its subsidiary, Energy Transfer Partners L.P. (ETP:NYSE), is now in the process of
acquiring Sunoco Inc. (SUN:NYSE), which owns an interest in Sunoco Logistics Partners L.P.
(SXL:NYSE). I think the purchase of Sunoco is an important
step for Energy Transfer as it adds an oil pipeline, storage and refined
product business that it didn't have before. This will help diversify Energy
Transfer. Sunoco Logistics already had strong excess cash flow, a good
balance sheet and a unique footprint with over 5,000 miles of oil pipelines
in the Midwest, as well as a sizeable oil storage position along the Gulf
Coast and some refined product terminals in the Northeast. It's very well
positioned for the increasing oil production flows in the United States, and
I don't think Energy Transfer Equity is getting full credit for the Sunoco
Thank you, Stephen.
Stephen Maresca is a managing
director of Morgan Stanley covering energy Master Limited Partnerships (MLPs)
and diversified natural gas companies. Prior to joining Morgan Stanley in
2008, Maresca spent 10 years at UBS focused largely
on the energy sector. From 2001 to 2008 he was a director in UBS' equity
research division covering energy MLPs. From 1998 to 2001 he was an associate
director in UBS' investment banking energy group and from 1997 to 1998 he was
in PaineWebber's fixed income department. Maresca
holds a Bachelor of Science degree in accounting from Providence College and
the Chartered Financial Analyst designation. He is a member of the New York
Society of Security Analysts.
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1) George S. Mack of The Energy Report conducted this interview. He
personally and/or his family own shares of the following companies mentioned
in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Energy
Transfer Equity L.P. Streetwise Reports does not accept stock in exchange for
services. Interviews are edited for clarity.
3) Stephen Maresca was not paid by Streetwise
Reports for participating in this interview. Click here for disclosures.