How to Invest in Oil as Pipelines Release Trapped Profits – Money Morning

The story of how to invest in oil in the U.S. is changing thanks to a new development…

Before now, much of the increased oil production (U.S. output at a 17-year high) from the Bakken in North Dakota and the Eagle Ford and Permian Basin in Texas never reached the marketplace. It simply piled up in storage facilities at the main U.S. oil hub in Cushing, OK.

The huge inventory of oil at Cushing was the main culprit behind domestic WTI (West Texas Intermediate) crude oil selling at a discount to the global benchmark, Brent crude oil.

But, as pointed out by Money Morning Global Energy Specialist Dr. Kent Moors, that is all beginning to change.

Already the spread between WTI and Brent has narrowed dramatically from about $20 a barrel in February to less than $3 a barrel today.

The reason for the change is the amount of pipeline infrastructure being added to move oil from the Cushing choke point to refineries on the Gulf Coast.

Oil Pipelines Coming Online

At least seven pipeline projects are underway with the goal of moving oil from Cushing to the Gulf Coast, which has the largest concentration of refineries in the U.S. The area refines roughly one-quarter of the country’s gasoline supply.

Some of the notable oil pipelines include:

  • The Seaway Pipeline, owned 50/50 by Enbridge (NYSE: ENB) and Enterprise Products Partners (NYSE: EPD), had its flow reversed last year to move oil southward. In 2014, it is expected to have its capacity expanded to 850,000 barrels a day.
  • The recently opened Permian Express pipeline, owned by Sunoco Logistics Partners (NYSE: SXL), moves about 150,000 barrels of oil a day from the Permian Basin to Gulf refineries.
  • In late September, the Longhorn pipeline will have about 225,000 barrels a day of Permian Basin oil flowing through its pipes. This reversed-flow pipeline is owned by Magellan Midstream Partners (NYSE: MMP).

The build-out of oil pipelines is also good news for those oil companies producing in the Eagle Ford and Permian Basin, such as Pioneer Natural Resources (NYSE: PXD).

Production in the Eagle Ford alone has jumped 10-fold over the past three years to about 900,000 barrels a day. By 2020, output is expected to reach 1.6 million barrels of oil per day.

The president of Plains All American Pipeline (NYSE: PAA), Harry Pefanis, told this to Reuters: “We went through a period of time where we had a ramp up in production and not enough capacity in either (the Permian or Eagle Ford) areas. . .In the next 12 months or so you are going to see more pipeline capacity than production in both those areas.”

Texas Refineries to Benefit

The increased flow of domestic oil to the Texas refineries will greatly benefit them. Previously, these refineries had to import oil from overseas or use more expensive rail cars to gain access to crude.

Among the big names, ExxonMobil has a major refinery in the area. But since it is such a huge firm, its gain may not be noticeable by investors.

But The Wall Street Journalpointed out three mid-sized firms with refineries in the region that also will benefit: Valero Energy (NYSE: VLO), Marathon Petroleum (NYSE: MPC) and Phillips 66 (NYSE: PSX).

Morningstar research claims Valero will see profit margins of $12.80 per barrel through 2017, versus $10.50 in 2011 and 2012. Morningstar also says Phillips will see their profit margin rise from $11.40 to $13.50 per barrel.

Of course, those refineries that had benefited from the oil glut in the Midwest will suffer now as the oil flow moves south. An example cited by the Journal is CVR Energy (NYSE: CVI), which produces fuel in Kansas and Oklahoma.

This warning was sounded in a recent article by Dr. Moors, who gave his reasons why many refiners are now facing a “quadruple whammy.

New Problem Arises

But that’s not to say refineries on the Gulf coast have everything going their way. They can process only so much oil.

Once all the pipeline capacity comes online, there is a very real risk that there will be a glut of oil on the Gulf Coast. Greg Garland, CEO of Phillips 66, told The Journal, “We think the U.S. Gulf Coast gets saturated.” In effect, the glut will have moved from Cushing to the Coast.

If this does happen, the oil will have to be moved to East and West Coast refineries by either rail or ship.

This is due almost entirely to government regulations. There is a decades-old ban on selling U.S. crude oil overseas. Only refined products may be sold. The shortage of refining capacity in the country, thanks to environmental regulations, completes a circle of confused government energy policies.

How to Invest in Oil

In addition to the Texas coast refineries, there are other places to profit from the changing U.S. energy landscape.

One sector that Dr. Moors particularly likes: the midstream segment of the energy market.

This sector includes the aforementioned pipeline companies that are moving crude oil south, many of which are listed as master limited partnerships (MLPs).

As pointed out by Reuters’ Robert Campbell, pipeline firms only build a pipeline when a large amount of the capacity is locked up under long-term contracts. These contracts assure the pipeline company a steady stream of income, since the shipper pays whether or not the line is actually used.

In addition, valuations are still reasonable despite having such a good year. The Alerian MLP index is up over 20% so far this year.

Chris Eades, director of research at ClearBridge, told the Financial Times, “no corner of the U.S. equity market is more inefficiently valued than MLPs.”

We put together our favorite MLP picks here.

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Syndicated repost courtesy of : Money Morning


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