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Dec. 5, 2011, 12:01 a.m. EST
By Nicole Hong, MarketWatch
SAN FRANCISCO (MarketWatch) "” The latest technology for producing natural gas from shale rock is not only altering the American energy landscape "” it's also opening a host of entry points for investors eager to profit from this booming new industry.
But rather than simply snapping up shares of the biggest producers or drilling companies, many favor investments that are not directly tied to the price of the underlying commodity, especially as growing supply pushes natural gas prices to near-historic lows.
These investors are turning instead to companies providing midstream services, which include processing, storing and transporting natural gas.
Pipeline companies are a frequent choice, given their reputation for steady revenue streams and high dividends. Many pipeline operators are master limited partnerships, also called MLPs, or publicly traded limited partnerships, which do not pay federal income tax and can confer these tax benefits on shareholders in the form of dividends.
"MLPs and pipeline companies are basically charging a toll for every molecule that runs through the pipeline," said Geoff Jay, energy analyst at Janus Capital Group. "These companies are standing in front of a tsunami of investment."
Investors are especially keen on midstream services provider Enterprise Product Partners LP /quotes/zigman/229258/quotes/nls/epd EPD -0.38% , the largest publicly traded energy partnership. Enterprise charges customers a volume-based fee, which reduces its exposure to natural gas price swings, said Steve Howard, a portfolio manager at Morgan Stanley Smith Barney. Howard also cited Enterprise's strong free cash flow and transparent business model.
Enterprise shares are up 11% so far this year, most recently closing at $46.28 a share. Howard, whose portfolio owns the stock, said he expects it to trade toward $50 a share over the next year.
Other options include Schlumberger Ltd. /quotes/zigman/170324/quotes/nls/slb SLB +2.53% and Halliburton Co. /quotes/zigman/228631/quotes/nls/hal HAL +1.23% , a couple of giants among international oil field service providers who are also leaders in hydraulic fracturing. Fracking, as it's also known, injects water under enormous pressure into a well, shattering the underground shale formation and freeing the gas trapped within.
MarketWatch's Stacey Delo talks with Edmunds.com Senior Editor Bill Visnic about the natural-gas powered Honda Civic and why it's been difficult to bring alternative-fuel vehicles into the market.
Schlumberger and Halliburton are both down about 10% this year but have rebounded over the past month, with Halliburton shares trading recently at $36.58 and Schlumberg shares at $75.01. These companies' valuation reflect the belief that production is ramping up significantly for both companies, said Janus's Jay.
Analysts polled by FactSet have a consensus 12-month price target of $54.75 a share for Halliburton and $91.80 a share for Schlumberger.
There is especially high demand for companies that process natural gas, which strips the raw gas of corrosive materials to make it safe for pipeline transport. Natural gas is also separated into other hydrocarbons, such as ethane or propane, which are widely used in other industries.
One such processor is Pembina Pipeline Corp. /quotes/zigman/597391 CA:PPL +0.75% . The Canada-based company expanded its business to include natural gas processing in 2009. Pembina has exclusive transport agreements with energy giant Canadian Natural Resources Ltd. /quotes/zigman/16932 CA:CNQ +1.30% , which will translate to stronger cash flow and higher dividends as production ramps up, said Roger Conrad, editor of Utility Forecaster.
"These processing companies can decide on a project, line up customers and have sales locked in before they even begin work on the project," Conrad said. "That provides a lot of visibility on future earnings and dividend growth."
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