The Key to Pipeline Investing

Last Wednesday, the North Dakota Public Service Commission approved two small pipeline projects to alleviate crude oil congestion in the state.

Commission Chairwoman Julie Fedorchak said, “It’s a significant new pipeline system. It goes through the heart of the Bakken.”

The two lines are relatively small compared to pipelines that normally get media coverage. One line is about five miles long and will transport natural gas liquids, while the other is a 13-mile crude line.

Both are slated for construction in McKenzie County, the center of Bakken oil drilling activity, and should help smooth out the transportation process.

I realize this may not be big news to you. I mean, the two lines won’t cost more than $12 million to build — chump change compared to larger projects like the Keystone XL or Kinder Morgan’s Palmetto Pipeline.

However, the build-out of small pipeline systems in formations throughout the U.S. is changing the way investors can capitalize on the pipeline industry.

It’s difficult for investors to realize gains or even income from stocks involved in the build-out of these little pipeline networks because most of the companies that build them aren’t public…

That or the companies behind them are so large that these small systems are pretty much negligible on the balance sheet.

Of course, that also means few people are investing them, which offers a ground floor. You just have to get creative if you want them to be profitable.

Busy Places

When I say creative, make no mistake — I do not mean you should do anything complicated.

It all involves taking the simple facts that surround our oil industry and investing in them in a timely and appropriate manner.

A simple fact that has been unbearably unavoidable since oil prices started dropping is the weekly rig count updates from Baker Hughes.

Every week, the service company provides data on how many oil and gas rigs are drilling in the U.S.

Last week, a trove of oil and gas reporters tweeted out the dreaded rig count numbers with a subdued arrogance, as if the rig count is all that ever mattered. Really, though, the number of rigs isn’t as important as the number of barrels produced.

Rigs fell by 42 to 760, the lowest since December 2010.

But if drillers in shale formations produce more oil per rig, who cares how many physical rigs there are?

Yes, I know that if there are fewer rigs, that would likely mean less production, but that hasn’t happened yet.

While the Bakken and Eagle Ford have plateaued, the Permian has grown its production, and with oil prices inching higher, it’s only a matter of time before companies revamp drilling.

To get back to my point, as producers wait for oil prices to rise (probably in Q3 or Q4), the strategy for logistics will be piecemeal.

Much like the two small pipeline approvals I told you about earlier, midstream companies will want to build smaller pipelines in areas still crowded with rigs and connect them to nearby storage or larger pipeline networks already in place.

And despite the narrative that rig counts are falling, 760 rigs is enough to incentivize more construction in areas with high concentrations of activity:

Still, as small pipeline networks are built, my question at the beginning of this piece still stands: What’s the best way to invest?

The Key to Pipeline Investing

The key for investors who want to make money off the expansion of small pipeline systems is to not invest in the companies directly involved in their construction.

Instead, imagine for a moment that every midstream company has to follow a government regulation that says only a certain type of screw can be used when building pipelines.

Then imagine there are only one or two small companies that manufacture the approved screws needed for construction.

A smart investor would be able to capitalize on pipeline construction by buying stock in the company that makes all of the screws that go into these small pipeline systems.

It would be like making money off of every pipeline that’s built or slated to be built.

Not a bad strategy.

However, as far as I know, there is no such regulation on screws, and if there were, there’d be no telling how many companies make them.

But we can apply this same theory to other aspects of the pipeline business…

For example, every pipeline that’s built needs to be inspected and equipped with the latest environmental protections mandated by the EPA and U.S. law.

But companies don’t do this on their own. They hire inspectors to check the construction and maintain the environmental integrity of the systems.

Some of these inspection companies are public, and one of them has a significant presence in U.S. formations.

My colleague Keith Kohl has all of the details here.

Good Investing, 

Alex Martinelli

With an eye squarely focused on the long-term, Alex Martinelli takes the art of income investing to a higher level within the energy sector. His research has helped hundreds of thousands of individual investors identify well established companies that have a long history of paying out dividends to their shareholders. For more info on Alex, check out his editor’s page.