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Accessing The US Shale Boom - A New Route For European Investors

Harry Dickinson

Harrington Cooper

27 November 2013

This article is by Harry Dickinson, partner, – distributors of the Credit Suisse MLP Index fund. The firm says it is among the first UCITS funds offering Master Limited Partnership – or MLP - exposure to be distributed in the UK and Ireland markets. As ever, while this publication’s editors are delighted to carry such detailed commentary and analysis, they do not necessarily share all the views expressed.

It is no secret that the North American energy industry is currently undergoing dramatic structural changes. In recent years the US has become the world’s largest natural gas producer and in October 2013 US monthly oil production outstripped imports for the first time in 18 years. The country is on track to become the largest global producer of oil and gas by 2020 and in coming years US gross domestic product will be driven by building energy infrastructure.

From a situation of declining supply and depleting reserves that occurred several years ago, the sector is now looking at a surge in output growth rates, largely driven by technological advances in unconventional shale oil and gas drilling.

Looking at supply prospects, production is unlikely to peak any time soon. The US Energy Information Administration anticipates that production of both gas and liquids (oil and natural gas liquids (NGLs) will grow by about 13 per cent and 25 per cent respectively, over the next decade, and could revise these estimates higher.

However, the transformation of the US energy sector has occurred so rapidly that the country is currently facing important infrastructure constraints, which are limiting the ability to process all the new production. Most of the issues are concentrated in the US crude and gas transportation network. Historically, the US pipeline grid was designed to transport oil and gas from the Gulf Coast to the Northeast and Western regions.

Today, however, with the development of unconventional fields in Texas, North Dakota, Colorado and Canada, the oil and gas pipeline flow has changed and has created regional bottlenecks, with Cushing Oklahoma, the delivery hub of West Texas Intermediate crude oil, probably being one of the most famous.

Investment

Delivering these abundant new energy supplies to end-consumers requires considerable investment across the entire US energy value chain. Approximately $250–300 billion of infrastructure capital investment is needed between now and 2035.

Investors wanting to access the shale boom are considering the best way to gain exposure. One way which is proving increasingly attractive to European investors, having previously been confined to the US equity market, is via Master Limited Partnerships.

MLPs are partnerships traded on US stock exchanges that typically generate most of their income from mid-stream energy infrastructure services, namely the production, processing or transportation of oil, natural gas and coal. MLPs activities include building and operating pipelines, gathering/processing facilities and storage terminals.

MLPs have existed for more than three decades and have been rising in popularity because of their attractive yields relative to other investments gained from their direct exposure to the US energy infrastructure sector. MLPs have delivered an average annual total return of more than 16 per cent over the last 10 years. The dividend yield on the constituents of Cushing MLP Market Cap Index is 5.19 per cent annualised for 2013 (as of 1 November  2013), particularly attractive in the current low interest rate environment.

Instead of shares, MLP structures are denominated in units, and instead of dividends, investors receive quarterly distributions. When establishing an MLP structure, a minimum level of quarterly distributions is specified. This encourages managers to adopt an approach which can generate stable and predictable revenues.

MLPs can potentially be used as an effective hedge against inflation as businesses that they traditionally invest in will normally contract on the basis of “inflation-plus” pricing.

Midstream businesses predominantly generate revenues through long-term fee-based contracts. These contracts can be volume-based arrangements and/or capacity-based arrangements, with the latter type providing particularly stable revenues, even in periods of supply disruption.

Ten years ago, the total market capitalisation of MLPs amounted to just $40 billion, with 30 listed energy MLPs. Today there are around 90 listed partnerships with a total sector capitalisation of over $400 billion. 2013 has also been a record year for MLP initial public offerings, with 19 listings over the year-to-date raising over $4 billion. 

As the increasing growth in America’s energy output continues we expect more investors to consider MLPs as an alternative to using traditional equities to access the shale boom.