Wunderlich Securities Senior VP Names Favorites In MLP Sector; Touches On Significant Projects, Infrastructure Economics, Profitable Operator Production
December 23, 2010 - The Wall Street Transcript has just published Best High Yield Stocks For 2011 offering a timely review of the General Investing sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
ETHAN BELLAMY, Senior Vice President of Natural Resources within the equity research department of Wunderlich Securities, specializes in the analysis of master limited partnerships. He was a doctoral student focusing on energy policy at the University of Colorado at Denver, with a focus on energy infrastructure and renewable energy policy. He holds an M.A. from the University of Colorado at Boulder and a B.A. from Clemson University.
TWST: With these unconventional plays that you touched on, what are the economics? I mean, are they much more profitable for the industry than the older plays?
Mr. Bellamy: I think that you can make 10% type of rates of return and $3, $4 level for some of these new shale plays. Devon (DVN), for example, just drilled a well that came on at a 30 million cubic feet a day rate in the Haynesville Shale, and that is a pretty sizable well. That's what you would have seen in the past from a big offshore well.
So depending on where you are drilling, those costs and how prolific these wells are, the breakeven costs can be pretty low. But in general, especially with conventional production, I think you need to see probably $5.50 or $6.00 before operators get comfortable with bringing production back online. So I think prices will need to come back up in order to stimulate the drilling necessary to provide a base level amount of production in the U.S.
On the producers' side, the difference has really been hedging and location, and many of the firms that were underhedged and overlevered, some of those have gone away, some have been acquired. But certainly earnings have been poor in this downturn.
Now looking forward, Chesapeake (CHK) which is one of the largest producers of gas in the country and certainly the largest firm with shale play exposure, has made an argument that there are essentially shale play haves and shale play have-nots. Those firms that don't have shale play exposure will have higher costs and ultimately won't do as well, or will be forced to do something else longer term.
TWST: Where should investors be looking at this point?
Mr. Bellamy: Well, it really depends on risk tolerance. So I'll give you a few answers. For investors who have higher risk tolerance, what I expect to see is the smaller-capitalization, higher-yielding, lower-liquidity MLPs with greater commodity price sensitivity outperform in 2010 as yields continue to compress, as the credit and equity markets continue to normalize and as the macroeconomic climate improves. That is for more aggressive investors with risk tolerance.
For investors seeking very stable distributions with no commodity price sensitivity, you are better off sticking with larger-cap, investment-grade MLPs. Those would include the traditional favorites, such as Enterprise Products (EPD), Kinder Morgan (KMP) and some smaller newcomers with large corporate C-Corp parents, such as El Paso Pipeline Partners (EPB) and Spectra Energy Partners (SEP).
In my coverage, my favorite natural gas-oriented play is Inergy LP, ticker NRGY, and I think the best-performing MLP of the next three years is likely to be Inergy Holdings LP, ticker NRGP, which is the general partner and owns incentive distribution rights in NRGY. Forty percent of their business is midstream and 60% is propane.
You have significant expansion projects in natural gas storage in the Marcellus Shale. Their assets are in New York and they are at the terminal of many of the pipelines that take natural gas from the Gulf Coast to the Northeast and consuming regions. I think NRGY is poised to grow substantially over the coming years. If I'm right, then the higher beta way to capitalize on that is through NRGP.
TWST: Anything else we should touch on?
Mr. Bellamy: What I'd like to point out would be the significant need for natural gas pipeline and storage infrastructure. The Interstate Natural Gas Association produced a report in October 2009 where they estimated total infrastructure needs for natural gas of between $133 billion to $210 billion through 2030, which equates to about $6 billion to $10 billion per year of investment.
Add to that, depending on what type of CO2 regime we get, another $25 billion to $100 billion in carbon dioxide capturing sequestration infrastructure, and you can see that the long-term investment horizon is pretty significant for gas infrastructure. MLPs are the most tax-efficient and logical vehicle through which most of this development should occur. And so I would describe the MLP sector as a whole and natural gas MLPs in particular as a secular growth industry with a very strong long-term positive outlook.
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