Jason Seagraves June 29, 2014 Comments Off

The U.S. shale boom has caused an increased interest in midstream energy MLPs. Now with the amount of U.S. oil production exceeding domestic refining capacity, the government has relaxed the ban on the export of unrefined petroleum products. The shale boom has created opportunities in the midstream energy MLP space – and this even extends to companies not directly involved with oil.

The United States will soon be exporting unrefined oil for the first time since the Arab oil embargoes of the 1970s. Domestic upstream energy companies are tapping shale formations across the U.S. to such an extent that supply is overwhelming the refining capacity of domestic downstream energy companies. This has created tremendous opportunity for the U.S.-based midstream energy companies that store, transport, and can now export oil and gas through their systems of pipelines and other distribution channels.

Most U.S.-based midstream energy companies are organized as master limited partnerships (MLPs). A regular limited partnership (LP) differs from a corporation in that its owners are divided into two classes: general partners and limited partners. General partners assume all of the management duties and liability risks of the business, while the limited partners are “silent” investors. An MLP differs from an LP in that an MLP’s ownership interests trade on a stock exchange like shares of stock, whereas most LPs are privately held.

MLPs also have a unique set of rules governing them. MLP designation is designed to apply to natural-resource companies, and a business must derive at least 90% of its revenue from what the IRS considers to be “qualifying sources” in order to qualify as an MLP. MLPs are also required to distribute a certain portion of their earnings directly to shareholders each quarter, and while MLPs do not have to pay taxes on their profits, investors do have to pay taxes on the distributions they receive – these distributions, however, are typically taxed at lower rates than corporate income tax. In practice, owning shares of an MLP is essentially the same as owning shares of a corporation. MLPs trade on all three major exchanges and are part of the equities asset class.

With U.S. forces leaving Iraq, the nation’s need for an increased degree of energy independence has never been more paramount. Oil prices are remaining relatively stable despite hostilities in the Middle East thanks in large part to the U.S. shale boom. And with the federal government recently clearing the way to allow the export of unrefined oil, midstream energy MLPs should be among the top-performing groups in the stock market for the rest of 2014 – and beyond. Here are three names that should outperform among the group:

A Counterintuitive Shale Play

EQT Midstream Partners LP (NYSE: EQT) is a member of the Alerian MLP Infrastructure Index. The company operates natural-gas transmission, storage, and gathering assets in the Appalachian basin. In 2013, the firm reported net income of $110 million on sales of $186 million – a net margin of nearly 60%. EQT Midstream’s market cap currently stands at $16.24 billion.

EQT may not appear to benefit from the government’s relaxation of unrefined-oil exportation laws, but appearances can be deceiving: The shale boom is leading to investments in index-based products that focus indiscriminately on energy MLPs, and EQT Midstream Partners is among the leaders of that cohort. Last quarter, the firm beat earnings expectations by nearly 17%, and it has grown earnings per share (EPS) at an average annual pace of 18% over the past three quarters. Institutional investors have been buying its shares hand-over-fist, earning the stock an Accumulation/Distribution grade of A. Mutual funds in particular have added to their stakes for seven straight quarters, including a 4% jump in fund ownership over the past three months. This should only continue on the strength of the shale boom and related trends.

This Magellan Partners with Explorers

Magellan Midstream Partners LP (NYSE: MMP) has a market cap of more than $19 billion. The firm reported net income of $582 million in 2013 on sales of $1.9 billion, but unlike the historical Magellan, this Magellan is no explorer – it provides services to oil exploration companies instead, which is a much more bullish business to be in right now.

Last quarter, Magellan grew EPS by an astonishing 110%, which represented accelerated earnings growth over a three-quarter average of 94%. Estimates for the current quarter – the results of which will be released in early August – were revised up, and projections for the fiscal year are calling for 57.4% bottom-line growth. Institutional investors have been moderately bullish on the stock over the past six months, and more so than EQT, Magellan looks attractive from a technical perspective too, at just 5.6% above the support of its 50-day moving average line.

Profits from Economic Rent-Seeking

The classical economists of England were very concerned with rent. Today, this fascination seems strange to us, but in their day, all property was owned by the king (hence real estate) and “rent” was paid by peasants to “nobles” who had been given the privilege of the royal (real) estate. Modern economists still use the term “rent” in this way, meaning “income generated by government privilege” – and there are few sources of profit as surefire those from so-called “economic rent.”

This review of Econ 101 serves as an introduction to Enterprise Products Partners (NYSE: EPD). which is one of just two companies – the other being Pioneer Natural Resources (NYSE: PXD) – to have the government-granted right to export unrefined petroleum products. The $72.8 billion market-cap firm had already been growing EPS at an annual pace of 26% over the past three years, and institutional investors had already been loading up on its shares over the past six months – it’s almost as if they knew something. Now, with the amount of “fracked” oil from shale produced continuing to increase, no MLP is in better position to capitalize than Enterprise Products Partners.