The best-positioned natural-gas pipelines have benefited from surging production in the Marcellus Shale as well as growing demand for the thermal fuel among utilities, thanks to ultra-low prices and the retirement of coal-fired power plants. This tailwind looks set to continue in coming years, which helps to explain the accelerating pace of merger and acquisition activity targeting these assets.
But not all pipelines are created equal.
Gathering systems in out-of-favor shale plays have lost market share to the Marcellus Shale, resulting in declining throughput volumes and reduced cash flow.
Midcoast Energy Partners LP (NYSE: MEP), which has gas-gathering and -processing operations in the Barnett Shale and Midcontinent region, is the poster child for these challenges.
Meanwhile, some long-haul pipelines have fallen into disuse and struggled to renew expiring contracts because of the shift in gas flows spurred by the shale revolution.
Boardwalk Pipeline Partners LP (NYSE: BWP) slashed its distribution by 81.2 percent in February 2014, as its inability to renew expiring contracts on its west-to-east pipelines at previous levels dramatically reduced its cash flow.
Nevertheless, many pipeline operators continue to benefit from growing demand for domestic natural gas from US utilities and industrial customers and international trade partners—primarily in Latin America, though shipments to Europe and Asia could increase over time.
This tailwind looks set to continue. With battery-based energy storage still in its infancy, growing adoption of solar power and other forms of intermittent energy requires sufficient baseload capacity to offset shortages that could emerge when the sun isn’t shining or the wind isn’t blowing.
Meanwhile, electricity demand—and therefore consumption of natural gas—could receive a boost if electric cars really take off.
Coal remains the primary competitor as a feedstock for power plants. But the black mineral struggles to compete with natural gas on price, and utilities continue to retire older coal-fired power plants. Lawsuits related to pollution from coal-ash ponds and growing concerns about carbon dioxide emissions also help to explain why utilities generally don’t plan to build new coal plants.
These growth opportunities hold extra appeal when a 4.5 percent decline in cash flow tightened distribution coverage at the 25 largest midstream master limited partnerships (MLP) to 1.05 times in the second quarter, compared with an average of 1.15 times from 2013 to 2015.
Not surprisingly, distribution growth has stalled at many MLPs and more cuts could be on the horizon.
Consider Ferrellgas Partners LP (NYSE: FGP), a propane distributor that we’ve rated a SELL ever since we met the management team a few years ago at the MLP Association’s annual investor conference.
After abruptly jettisoning the CEO, the founder announced that the partnership would likely cut its distribution by up to 50 percent because of losses related to the terribly timed and terribly priced acquisition of Bridger Logistics, a midstream operator with poorly positioned assets and exposure to shaky counterparties.
In response to this news and a subsequent rating downgrade from Moody’s Investors Service, Ferrellgas Partners’ stock price has plummeted by more than 35 percent.
Against this backdrop, names that offer exposure to organic growth stories should outperform.
Before we highlight some of our favorite plays, let’s explore some of the key developments that have emerged in recent months.
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Elliott and Roger on Sep. 30, 2020
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