Western Gas Equity MLP Plays Shale Oil And Gas Boom

Master limited partnerships have sold off modestly in recent days on concerns that interest rates will rise soon.

When interest rates are on the rise, investors often switch from yield stocks to growth stocks.

But some MLPs are also growth investments in that their underlying assets generate increasingly higher quarterly dividend growth.

Up 53% in the stock market so far this year, Western Gas Equity Partners benefits from Anadarko Petroleum's strong stance in oil and natural gas. View Enlarged Image

One is Western Gas Equity Partners (NYSE:WGP), an MLP that has ties to an operating subsidiary formed by Anadarko Petroleum (NYSE:APC) to own and run midstream gathering and processing assets in oil and natural gas basins in the U.S.

That subsidiary, Western Gas Partners (NYSE:WES), is also an MLP.

One of its key operating regions is in the Niobrara formation of the Denver-Julesburg Basin, or DJ Basin, in Colorado.

Anadarko's Coattails

Oil and gas companies have been busy extracting shale oil and natural gas liquid there. Anadarko is one of the play's top producers.

Anadarko owns 100% of the mineral rights in the DJ Basin and as a result has lower operating costs than others and over 100% rates of return, says Ben Fink, chief financial officer for both Western Gas MLPs.

In April, Western Gas Partners opened a new throughput plant in the DJ Basin, which was soon running at capacity, thanks in large part to its No. 1 customer, Anadarko. A second plant is expected to open in the DJ Basin next year.

"We expect midteens rate of return on the first plant and 17% to 24% on the second plant," Fink told IBD.

He says Anadarko has guaranteed 90% of the capacity on the first and two-thirds capacity on the second, making the latter a bit riskier.

"We feel we'll be successful filling the (second plant) with third parties," he said.

Anadarko formed Western Gas Partners in 2007 and has been dropping down, or selling assets, to it in various plays ever since.

Besides the DJ Basin, those assets are in the Marcellus Shale in Pennsylvania, the Eagle Ford in Texas and the Powder River Basin in southern Wyoming, among other areas. Money it has made from those assets has enabled Western Gas Partners to buy assets from third parties as well.

Western Gas' commodity risk is reduced because most of its volume is sold back to Anadarko at fixed prices.

Though Western Gas Partners is involved mostly in natural gas, most drilling in the U.S. is driven by crude-oil prices, Fink says.

"We gather and process gas, but most of the gas we process is associated with crude-oil production," he said. "Wherever there's oil, there is also gas."

Though oil prices dipped last week on lower global demand for oil, "I don't think we've reached levels at which producers will lay down rigs, at least not in the DJ," Fink said.

In the latest Baker Hughes rig count survey, the rig count in the DJ-Niobrara basin stood at 62 for the week ended Sept. 12, up from 47 in the same week last year.

How The Partnership Works

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Anadarko formed Western Gas Equity Partners in 2012 to own its general partner interest in Western Gas Partners and 100% of the incentive distribution rights. Anadarko figured the new MLP was worth more than the market was giving Anadarko credit for.

Anadarko held all but 9% of outstanding shares until July, when it sold 5.75 million shares. The public float then rose to 11.7%. Anadarko's stake is worth about $11 billion.

Anadarko has stated it plans to sell about 20% of its stake over the next couple of years.

A Growth Play

As Western Gas Partners goes, so goes Western Gas Equity.

That's because Western Gas Equity is entitled to a growing percentage of the cash distributed by Western Gas Partners.

As analyst Elvira Scotto of RBC Capital Markets put it in a recent research report: Western Gas Equity is "the levered way to play the strong growth story" at Western Gas Partners.

Energy production in the U.S. has been on a spectacular run, and Houston-based Anadarko and its subsidiary Western Gas Partners are in on it.

"In terms of production growth in crude oil, natural gas and natural gas liquids, it's hard to find a historical scenario where the fundamentals have been so good," Brian Kessens, portfolio manager at Tortoise Capital Advisors, told IBD.

Tortoise is particularly focused on the energy sector and has interests in both Western Gas MLPs.

Tortoise Capital expects 6% to 8% growth in the midstream MLP sector over the next 12 months.

Kessens calls midstream gathering and processing MLPs Western Gas as well as Access Midstream Partners (NYSE:ACMP) and MarkWest Energy (NYSE:MWE) growth companies.

He says they'll likely grow faster than the sector average because of organic growth as well as their drop-down opportunities from sponsors.

Net natural gas throughput by Western Gas Partners in Q2 was up 13.4% from a year earlier to 3.56 billion cubic feet per day. In addition, total throughput of crude oil and natural gas liquids jumped to 115 thousand barrels per day from 26 thousand barrels a day a year earlier.

In turn, Western Gas Equity Partners generated $59.6 million in distributable cash flow in Q2, up 37.3% from the prior year and 8.5% from Q1.

Western Gas Partners raised its capital spending budget this year to $720 million-$770 million from $650 million-$700 million previously due largely to increased activity in the DJ Basin.

That spending increase "should help drive future growth," wrote analyst Eduardo Seda of Ladenburg Thalmann in a research note in mid-August.

About 60% of the investments will go to the DJ Basin. An additional 16% will be earmarked for the Marcellus and 7% to the Powder River Basin in Wyoming, among a few other places.

Anadarko "has a large and growing inventory of midstream assets that can be sold" over time, Scotto noted.

The company currently has the equivalent of around $300 million worth of EBITDA (earnings before interest, taxes, depreciation and amortization) in midstream assets, Fink says.

He notes that some of those assets are just getting off the ground, meaning they could grow quickly.

This year, Anadarko sold Western Gas Partners 20% interest each in the Texas Express Pipeline and the Texas Express Gathering system, plus a 33.3% interest in Front Range Pipeline, for $375 million in total.

These assets marked Western Gas' entry into the long-haul natural gas liquids transportation business, Seda notes.