“If you thought mountains of wealth were made in the Bakken, then check this out…
“A strange side effect of this oil boom is set to pay out even MORE regardless of how oil prices move…And there’s one company I’m particularly excited about.”
That’s the intro to the latest ad from Keith Kohl for his Energy Investor newsletter, and it’s all about flaring gas and how it’s gonna make us filthy, stinkin’ rich.
You see, when companies produce oil they generally also produce natural gas — but in the Bakken and in many other oil-producing areas, there’s not enough monetary incentive for companies to have built the infrastructure to profitably handle that natural gas… so instead of bringing that gas out of the well, shoving it into a pipeline in North Dakota, and sending it on its way to generate electricity in California or heat homes in Chicago, they just burn it off right at the well. That’s the “flaring” that you hear about, and that you might have seen pictures of.
This is especially true in the Bakken because the field grew so fast and so explosively over just the past ten years or so — there isn’t even enough pipeline capacity for the crude oil, either transport pipelines or gathering pipelines, so huge amounts of the stuff travels in trucks and, as many investors have been quite aware, on trains (generating a few headline-grabbing disasters as those trains have derailed — Bakken crude is apparently light and very flammable). And if they haven’t even put in enough infrastructure for the lucrative oil production, you can bet that there’s less still for the “afterthought” natural gas production (and you can’t move the natural gas on trucks or in train cars, they need either at-the-well consumption — as from the various companies trying to sell small generators that are trucked to gas wells to turn flared gas into electricity — or a pipeline).
Kohl’s argument is, essentially, that one of his favorite stocks is going to profit from that — with the tailwind coming from the fact that North Dakota is fighting all this flaring with new regulations that require capturing more gas (both the government and the royalty-receiving landowners want the gas sold, not wasted), and from the fact that, over time, the Bakken will become more of a natural gas-focused field and they need to prepare for that evolution. None of this is a deep, dark secret — the Wall Street Journal had a good article about the situation last Summer, when (much) higher prices made it perhaps more of a headline issue.
What, then, is the stock that Keith Kohl is hinting at to profit from the buildout of natural gas infrastructure in North Dakota? Here are the clues:
“See, the companies that build these pipelines and processing facilities already have a two-year backlog.
“And one small Oklahoma builder in particular is on fire.
“In fact, some estimates say it has a whopping $4 billion in revenue already booked for the next two years.Are you getting our free Daily Update
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“And it’s no wonder…
“It is operating at the heart of North Dakota’s boom in the Williston Basin, helping companies to extract and process natural gas that would otherwise be burned off….
“This company is currently in the process of building or having completed 11 new natural gas refining plants — including eight in North Dakota’s Williston Basin that cover 3 million acres of energy-rich land.
“Remember, the amount of gas that can be processed in North Dakota’s oil fields is expected to more than DOUBLE by 2017.
“And this company will be in a prime position to capitalize on it, handing you hefty payouts in the process!
“This small firm also has several more projects planned in Montana, Wyoming, and Oklahoma.”
So that narrows it down quite a bit… but then we do get a few more tidbits so we can approach certainty on this tease…
“As the company’s CEO recently put it, ‘[our firm’s] investments will reduce flaring significantly.’
“It gets even more amazing when you look at what all this development will do for this company’s earnings…
“Its earnings are expected to grow at 16% PER YEAR for the next five years — more than DOUBLE the growth rate of the rest of the industry!
“Yet so far, this company has attracted the attention of only the most dedicated market watchers.
“I believe that will change over the next six months as this flaring issue hits fever pitch.
“The amazing story of this company’s future earnings will reach the general market. And that could send the stock skyrocketing.”
That “skyrocketing” word is perhaps a little hard to swallow, given investor worry about energy prices and interest rates, but you never know — this stock, sez the Mighty, Mighty Thinkolator, is OneOk Partners (OKS). Though, frankly, it could just as easily be OneOk itself (OKE), the general partner that’s essentially a levered, lower-yield/faster-growth play on OKS. OneOk Partners owns the assets and does the investing, OneOk is the general partner, owns 38% of OKS, and gets an incentive distribution (so as OKS dividends rise, OKE cash flow rises more quickly).
If I were investing in a company to capitalize on the need for natural gas infrastructure in North Dakota, I might go with OKE (I prefer the general partner over the MLP), but it’s not a construction company or a company that’s being paid upfront to install this infrastructure and book a sudden windfall — it’s a midstream gas company that’s investing in building up the pipeline and processing plant infrastructure to help handle all that excess natural gas being produced in the Bakken. The company is focused on the area, this is one of their major growth initiatives — though they are currently more reliant on their much larger footprint of pipes and facilities to the South, in the more traditional oil and gas hub centered on Oklahoma.
Why is this a match? Well, the quote from the CEO is straight from the OneOk/OneOk Partners investor presentation from last Summer… they do have 11 new plants planned for natural gas, including eight in the Bakken area, and by some measures you could say that they do have $4 billion in revenue “already booked” — though both OKS and OKE have sales of well over $10 billion a year, I haven’t seen projections of exactly $4 billion for the next two years of Bakken gas processing/transportation revenue.
The company has also said, in their earnings release that came out just this morning, that they’re reducing guidance a bit for 2015 because of the commodity price environment (processing plants and pipelines are generally fee-based businesses, they get paid for the amount of volume they do, not based on any specific pricing for gas — but demand for the services can certainly dip when prices are low and investment by their customers is on hold). They have also slowed down their capital investment on a few of those new natural gas plants (though yes, as teased they do have 11 plants planned, including eight in the Williston/Bakken market).
I don’t think we have much chance that there’s another company whose CEO has spit out exactly that same quote, and who is building eight natural gas plants in the Williston area — so it’s difficult to conceive of another match for those clues. But that said, Kohl also notes that “Its earnings are expected to grow at 16% PER YEAR for the next five years — more than DOUBLE the growth rate of the rest of the industry” … and that’s certainly not true of OKS or OKE, at least right now. Maybe they had much higher anticipated growth rates at some point in the last year and Kohl’s copywriters are using older numbers, but 16% growth is about three times as fast as the analysts think earnings will grow at these companies — both OKE and OKS get analyst growth estimates for the next five years in the 5-6% neighborhood.
That doesn’t mean these are bad investments — these are solid natural gas infrastructure companies that own important assets, and they are investing in North Dakota gas fairly heavily right now. That could mean future earnings are going to be substantially better than current estimates if production stays high for oil and the region develops into a meaningful natural gas area that attracts investment and production increases… which, if you think between the lines a little bit, means that oil and gas have to both recover a bit for this to be exciting.
Still, exciting isn’t generally what you should be looking for with these yield-oriented investments. OneOk and OneOk Partners are owned primarily by people who want the cash flow from the distributions — about 5% for OKE and just under 7% for OKS — and the expectation of even optimists should probably be that you’d get that distribution and that over the long term the distribution/dividend might grow at a 5-10% annual rate if they do reasonably well (lower for OKS and higher for OKE). If it makes you lots and lots of money beyond that, it will be either because interest rates are falling again or remaining stubbornly low (that helps OKE both because they borrow a lot of money, and because it makes both OKS and OKE shares look good relative to other income-generating investments), or because enthusiasm rises again for energy infrastructure assets because producers are investing to increase production.
Over the last six months OKE is down about 33%, OKS down about 26% as a reflection of that leverage implicit in OKE shares — but over the last five years, OKE has been a dramatically better investment (and over the last year or so, the winner has actually been One Gas, OGS, the natural gas distribution utility that OKE spun out about a year ago, which is up by about 25%). You can generally see the OKE leverage in the reaction to news, as today with OKE down about 5% and OKS about 2% on the disappointment over 2015 forecasts (you can see the earnings conference call transcript here).
OKE is the general partner and the dividend should presumably be a regular corporate dividend, without the tax-deferral benefit (and recordkeeping headache) you can get from a MLP. OKS is a MLP and you would technically be a unitholder and partner, receiving distributions and an annual K-1 report for your taxes. Both are large, both have done well over a long period of time — I’d argue that OKE is perhaps more interesting because it gets a bit more juice from any improvement at OKS that leads to higher distributions, and because it has fallen somewhat harder during the crash in gas and oil prices… but during years like this when they’re already telegraphing pretty tepid growth it seems likely to me that the two will probably trade pretty closely to one another. And yes, the leverage means that OKE can keep falling harder than OKS if distributions from the MLP fall, as is certainly possible (though, given their history of rising distributions, arguably unlikely).
But, that said, I haven’t personally been rushing out to buy any of the energy infrastructure stocks over the last six months — perhaps I should, they were a great buy during the last oil crash, but I just haven’t been all that tempted yet. Maybe that will change, I’ll let you know if it does… or maybe you can talk me into buying OKE or OKS or something else in the midstream space, feel free to jump in and make your pitch with a comment below.