High-Return Investments in Natural Gas Potentially Worth the Risk

By Markets Fool.com

Natural gas prices have crashed 40% during the last 12 months. With market supply perennially in excess of total demand -- except for the four winter months -- it's not exactly a surprise why natural gas is currently trading below $3 per million Btu, or MMbtu. However, savvy investors will recognize that it's this supply glut in natural gas that provides a window for high-return investments in this commodity.

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Henry Hub Natural Gas Spot Price Chart

Henry Hub Natural Gas Spot Price data by YCharts.

Despite the current oversupply of gas, the natural gas midstream industry is a compelling opportunity, and should remain so for the next few years. Fee-based master limited partnerships, or MLPs, continue to offer solid returns when compared to other asset classes. The vast majority of the generated cash flow is paid out to investors; therefore, MLP management is required to maintain strong financial discipline that, in turn, requires them to operate the partnership efficiently.

Natural gas mid-stream business in here to stay
Natural gas production volumes are growing steadily, albeit at a slower rate in comparison to previous years (see graph above). Gathering, processing, transporting, and storing of natural gas will not only continue to be big business, but a stable one, as well.

In Graham-Buffett speak, there's an upside economic moat, as well as downside protection -- or margin of safety -- within the midstream business. The Energy Information Administration forecasts that drilling efficiency and associated natural gas production through oil drilling will continue to support natural gas production growth for the next couple of years.

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In terms of risk, lower prices could technically bring production to a standstill, which could adversely affect midstream activities. But practically speaking, such chances are low, and prudent investments in stable midstream companies are worth the risk. Below are three high-return investments in natural gas potentially worth the risk:

Enable Midstream Partners : Founded in 2013 as a pipeline partnership between OGE Energy and Houston-based CenterPoint Energy , Enable Midstream Partners owns an integrated network of gathering, processing, transportation, and storage assets that operate over the entire value chain -- by connecting wells to major pipelines, providing storage, and delivering the end product to local distribution companies and industrial markets.

This MLP's business is significantly fee-based, which means exposure to commodity prices is minimal. An overwhelming 88% of forecasted gross margin for 2015 is either hedged, or fee-based. This provides tremendous stability to its earnings.

The MLP enjoys investment-grade debt ratings with access to $1.1 billion via a revolving credit line. Enable's current yield of 7.3% is attractive, with management forecasting a distribution growth of 3% to 7% during the previous year. Additionally, it forecasts this year's distribution coverage ratio to be somewhere between 1.0x and 1.08x. It means available cash flow after maintenance capex and interest expenses should comfortably be able to cover distribution.

Enable Midstream Partners gathered 3.34 trillion Btu per day of natural gas per day while processing 1.56 TBtu/day in 2014. However, this traditional natural gas transporter and storage company is also looking to diversify by expanding its crude oil gathering network in high-growth basins in order to strengthen its competitive positioning.

For 2015, management forecasts a 450% hike in crude oil gathered volumes over the previous year. This should further increase stability in earnings as the company will be more diversified. The risk, however, remains in the low-drilling-activity environment

ONEOK Partners : Currently yielding an impressive 7.6%, this MLP has an extensive network of natural gas and natural gas liquids, or NGLs, pipelines measuring 36,000 miles and crossing 17 states. For 2015, a whopping 91% of its margins are either fee-based, or hedged. Management estimates backlog revenue between $4 billion and $5 billion, with nearly $3 billion in capital growth projects announced.

ONEOK Partners is the largest independent gatherer of natural gas in the Williston basin, which gives the MLP a tremendous competitive advantage. With further expansion planned, management estimates processing capacity in the basin to go up to 980 million cubic feet per day, or MMcf/d, by the third quarter of 2016 from the current capacity of 600 MMcf/d.

Coverage ratio for 2015 isn't very attractive, and is estimated to be less than 1.0. However, management is targeting a long-term annual coverage ratio between 1.05 and 1.15, while maintaining investment-grade credit ratings.

Targa Resources Partners : Houston-based Targa Resources Partners is a more diversified master limited partnership, with assets in both natural gas and crude oil. The companyowns approximately 11,400 miles of natural gas pipelines and processing assets across the Permian Basin, Williston Basin, and the Barnett Shale. It also owns or operates 39 storage wells for propane and butane, comprising of a storage capacity of 64 million barrels.

One of Targa's biggest competitive advantages lies in its robust natural gas liquids pipeline network leading to Mont Belvieu, the NGLs hub. It also enjoys the second largest fractionation presence in Mont Belvieu. Neither of these two competitive advantages can be easily replicated.

Since its IPO in 2007, the company has strived to grow organically and strategically. Its expected fee-based margin for 2015 is between 65% and 70%. With a yield of 7.9%, Targa looks very attractive.

Management believes that the company's sheer diversity and scale allows it to mitigate low commodity prices. Targa's distribution coverage ratio for 2014 was a solid 1.5, which makes this MLP highly stable.

Foolish outlook
In an uncertain commodities market, going for investments that have yields in double digits isn't really prudent. It would be wiser to look for stable companies with above-average returns. Such a strategy provides a solid margin of safety, as well as an economic moat.

Investing in the above three MLPs gives investors an average yield of 7.6% currently, with additional growth opportunities in the pipeline. I would hold these MLPs as high-return investments in natural gas worth the risk.

The article High-Return Investments in Natural Gas Potentially Worth the Risk originally appeared on Fool.com.

Isac Simon has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.