4 ways to get paid in natural gas

Here's how to rake in dividends from every step of the cycle.

By InvestorPlace Nov 12, 2012 1:13PM
Natural gas plant copyright Kevin Burke, CorbisBy Bryan Perry

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With Obama's continued support and policies that bolster the already-strong demand for natural gas, this energy play isn't going anywhere, making it a great sector for income investors.


First-to-mind names like diversified Exxon Mobil (XOM) or more targeted EnCana (ECA) aren't the only ways for income investors to play natural gas, though. There are a number of companies with specific roles throughout the entire natural gas cycle -- from exploration and production to storage to even end-products like fertilizer -- that will keep you rolling in dividend checks.


Drilling:  

As we saw during election season, there is pressure to allow for increased domestic oil and gas production to help rein in gas prices. In my view, domestic onshore oil and gas exploration and production is the best way out of the Middle East: It creates high-paying jobs at home while simultaneously developing energy alternatives.


BreitBurn Energy Partners (BBEP), currently yielding just more than 10% based on its past four payouts, is a straightforward MLP focused on the acquisition, exploitation, development and production of oil and gas properties. Given the bullish outlook by management and a large increase in capital spending, further increases in the quarterly distribution should follow in the next several quarters.


Pipelines:  

Natural gas pipelines have a great business with high barriers to entry. They charge a fee for the use of their infrastructure, and dividend investors reap the benefits.


Plains All American Pipeline (PAA) is one of the largest components of the ETRACS 2XMonthly Leveraged Long Alerian MLP Infrastructure Index (MLPL) and tends to bolster that index's performance.


The company reports that, on average, it handles more than 3 million barrels of oil, refined petroleum products and liquefied petroleum gas (LPG) across the United States and Canada each day. Across its three main segments -- transportation, facilities, and supply and logistics -- PAA manages 18,000 miles of pipelines and houses 120 million barrels worth of storage capacity for its products at plants in Canada and in the Gulf Coast area.


In its Q3 earnings report, PAA reported EBITDA of $470 million, an 11.6% increase over the same quarter last year. And all three of its individual segments saw year-over-year revenue gains as well: transportation was up 21%, facilities was up 37%, and supply and logistics gained 5%.


PAA currently yields 4.6%.


Storage:  

As natural gas supply/demand fundamentals have tightened and the price of natural gas fluctuates dramatically, many customers look to storage so they can protect against extreme price shocks. When you add to that the improvements in operational reliability, transportation efficiencies and the numerous arbitrage opportunities that can arise, there's a great increase in the overall value of employing natural gas storage.


Gas storage also plays an insurance function by helping producers meet their sales requirements and keep transportation fully utilized. By using gas storage, producers can maintain production and sell more of their production on average at peak season prices -- even in poor markets. In essence, storage acts as the "shock absorber" for the natural gas industry.


The National Petroleum Council, a multi-company organization that studies supply and demand, has advised that North America is "storage short" and that this problem isn't going to go away.


Niska Gas Storage Partners (NKA), yielding roughly 13%, is the largest independent owner and operator of natural gas storage assets in North America, and has spent the past year expanding its storage capacity by 20%, providing for future revenue and profit growth. An NPC study forecasts the need for about 700 billion cubic feet of additional storage capacity out to 2025 to meet the demands of a normal winter. NKA owns and operates approximately 221.5 billion cubic feet of total working gas capacity.


Hurricane Sandy aside, experts expect this winter to be much more wintry than last year's unusual warmth. Holders of Niska will fare very well as prices for stored gas will spike.


Fertilizer:  

Fertilizer might not be the most obvious end-product related to natural gas, but it is one primed to explode.


Natural gas is 65% of the cost of manufacturing nitrogen and ammonia fertilizer products, and demand should continue with this administration’s ethanol mandate and this past summer’s drought.


Terra Nitrogen (TNH), yielding 7.5%, isn't the most liquid stock at roughly 16,000 shares traded daily, and because it's a commodity, the level of volatility is extreme. So why bother when there are plenty of other high-yielding fertilizer names out there?


Remember that volatility is a double-edged sword. The global secular bull market for higher-quality foodstuffs in the BRICs and frontier economies drives this stock and others like it, but with TNH's low volume, it doesn't take much to drive the price way up -- or way down. But again: TNH is for the risk-tolerant only.


Bryan Perry is editor of Cash Machine, a newsletter focused on dividends and income investing.


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