The year 2011 marked 12 months of game-changing events in domestic energy production and transportation, as companies across the globe continued to provide significant capital to develop North American oil and gas shales. More than $30 billion was invested in shale-related acquisitions in 2011, following over $80 billion in 2009 and 2010.This large-scale global investment focus validated the tremendous oil and gas resource production anticipated within our borders, as a result of technology improvements and new supply sources.
A Pipeline of Growth
The growing production of our domestic resources will provide what we believe to be unprecedented growth opportunities for midstream energy transportation companies. Substantial pipeline infrastructure is needed to take energy from new areas of expanding supply to growing areas of demand. Tortoise estimates over $23 billion was invested in 2011 and an additional $42 billion will be invested through 2014 on pipeline infrastructure projects. These are not “build it and they will come” type endeavors, but are generally identified and committed projects, with long-term user contracts in place.
In addition to new build-out projects, acquisition activity also remained elevated with a record $76 billion in master limited partnership (MLP) and pipeline c-corporation acquisitions announced in 2011. The biggest announced deal of the year, Kinder Morgan Inc.’s pending acquisition of El Paso Corporation, would create the largest midstream company and the fourth-largest energy company in North America. In our view, the deal further confirms the essential role of natural gas in America’s future. Similarly, the second-largest announced transaction of 2011, Energy Transfer Equity’s pending bid for Southern Union, confirmed the potential value in linking increased supply with demand centers.
The capital markets supported midstream companies in their growth initiatives through continued access to capital to support the significant uptick in announced acquisitions and growth projects. In 2011, MLPs alone issued more than $40 billion of new capital, over two-thirds of which was issued by pipeline MLPs. The pace of IPOs picked up as well, with 14 IPOs raising more than $5 billion during the year, including eight midstream companies.
Fundamentals Remained Important
Macroeconomic events dominated the headlines in 2011, as Eurozone debt concerns, the U.S. sovereign debt downgrade and slower-than-anticipated economic growth, generated uncertainty (and its cousin, price volatility) in all markets – including energy. Fortunately, the market recognized quality over longer periods, as evidenced by the performance of energy infrastructure companies compared with the broader equity market (see chart).
We attribute the strong performance of midstream energy companies to a number of factors:
The underlying business fundamentals of midstream energy infrastructure remained intact, with companies well positioned by strong balance sheets;
- The supply and demand for energy hydrocarbons, including crude oil, natural gas and natural gas liquids grew throughout the year;
- The Fed’s Operation Twist guided Treasury yields ever lower, boosting performance of dividend-paying equities;
- North American pipeline companies (particularly pipeline corporations) benefited from heightened actual and anticipated acquisition activity; and
- A proliferation of newly announced energy infrastructure internal growth projects accelerated growth potential.
Despite what may be a slow-growth economic environment, we believe midstream energy infrastructure companies enjoy several tailwinds. First and foremost, their businesses are anchored in providing an essential service that impacts our daily lives. The relatively inelastic demand for energy should continue to generate long-term stability across various economic conditions for the midstream energy transporters.
Additionally, we believe that significant growth opportunities remain on the horizon and are accelerating, and that midstream energy companies are well positioned to support the extraordinary build-out taking place in domestic shales. We view the delay in the last leg of the Keystone pipeline that will bring Canadian crude to the U.S. Gulf Coast as a relatively isolated event. Regardless of the Keystone outcome, we believe numerous other energy infrastructure projects will continue to be built across the United States and Canada, as we strike the proper balance between our need for energy and safeguards that assume its safe production and transport.
Capital markets are presently open for energy infrastructure companies to support this growth and a number of companies are also in registration to launch IPOs in the months ahead. Tortoise expects accompanying propelled growth of midstream energy companies in 2012, with distribution and dividend growth potential of 6 to 8 percent.
For petroleum pipelines, we should continue to see the benefit of the Federal Energy Regulatory Commission’s increased PPI (Producer Price Index) tariff escalator. The escalator (PPI plus 2.65 percent) currently results in a 6.8 percent tariff, that could potentially increase to over 8 percent in July 2012, based on current PPI levels. We expect natural gas pipeline companies anchored in long-term contracts to offer stable cash flows in 2012, with upside from increased volumes.
We continue to see natural gas as an attractive, domestic, abundant and cleaner energy alternative. This view was supported by the Environmental Protection Agency’s recent passage of emission rules promoting increased natural gas usage. Regulatory focus on cleaner energy sources, as well as additional uses of natural gas liquids, such as in the petrochemical industry, should continue to drive demand. Along with greater supply, comes the need for pipeline investment.
Pipeline safety continues to be at the forefront for policymakers, and we believe pipeline companies will take steps to improve the integrity of their pipeline systems in the coming months. These improvements will likely lead to increased costs but are not expected to have a significant impact on their profitability.
Hydraulic fracturing continues to garner headlines, yet we think the impact will be relatively minor. The EPA is set to release a condensed version of their report on fracing and its impacts in late 2012, with the full report scheduled for early 2014. We anticipate a standardization of best practices as it relates to fracing and increased disclosure requirements, which should marginally increase costs, but we do not believe it will hinder development.
We continue to expect substantial growth activity in our nation’s shales to drive energy infrastructure build-out. New domestic resources are becoming a more important part of our economy as we reduce dependence on foreign sources. We believe the investment merits of pipeline companies are particularly attractive as we find ourselves in this new chapter of North American energy.
About Tortoise Tortoise Capital Advisors, L.L.C., is an investment manager specializing in listed energy infrastructure investments. Tortoise has the longest tenure of managing registered MLP funds and pioneered the first MLP listed fund in 2004. As of Dec. 31, 2011, Tortoise had approximately $7.6 billion of assets under management in NYSE-listed closed-end investment companies, an open-end fund and other accounts. Tortoise’s investment strategies include investing in MLPs, pipeline corporations and other energy infrastructure companies. Visit www.tortoiseadvisors.com or call 866-362-9331 for additional information. Zachary Hamel, CFA, and Terry Matlack, CFA, are managing directors of Tortoise Capital Advisors and part of the team that co-founded Tortoise in 2002. Source: Tortoise Capital Advisors