Throughout this year, the political implications of building new pipeline infrastructure throughout North America will have some serious consequences on market movements. Between the Keystone XL pipeline running from Canada across the USA, and the ever growing demand from developing nations inspiring project due to rising oil prices, it is important that we keep in mind just how much opportunity is present in the energy industry these days.
However, given the extremely volatile nature of these ventures, it is also important to understand these opportunities as much as possible. While I can’t go into detail about every single nuance of the energy business in a single post, I can take a moment to discuss why it is that these major pipeline infrastructure projects are so important to the economy, and more importantly, how it is that they create tangible value for us as investors.
The biggest thing to remember when looking at pipeline value is that the price of petroleum is just like the price of any other good, in that it depends on the accessibility of the product itself. Because petroleum products are generally only available for extraction from isolated pockets in the earth, transportation costs become particularly meaningful. As a general rule, the further that oil needs to travel from a refinery to its final destination, the more that final product will cost.
This is where infrastructure companies come in. While petroleum may originally be transported from its source by truck or boat, it is extremely cost effective in the long run to setup a fixed solution to the transportation issue. Thus emerges the pipeline as a solution. By building a pipeline, the cost of transportation is greatly reduced, which therefore increases the feasibility of other extraction projects.
By building in access points throughout the pipeline, a company like Enbridge creates a great deal for its consumers by reducing the final price of gas products, and making life a great deal easier for the petroleum companies themselves. What’s more, pipeline access creates a great deal of value for investors, either through direct or indirect investment.
There are three main ways to invest in a pipeline project. The first method is to invest in the pipeline company itself, with the intention of collecting dividends generated from royalty revenues that are paid to the pipeline for the right to transport fuel. This is a fairly effective means of boosting a portfolio’s yield, and reducing its risk, as infrastructure companies tend to be relatively stable investments.
So long as the company can maintain its usage capacity, the money keeps flowing in. Alternatively, an investor might choose to invest in a company that is bidding on building the pipeline itself for an infrastructure company. While a bit riskier of an option, an investment in this sort of endeavour can have a great payout after the project is completed, assuming the company is the successful bidder.
Finally, an investor can benefit from a new pipeline project by investing in a production company that will greatly benefit from the new infrastructure. A pipeline essentially allows production companies to scale more quickly than they would otherwise. This means that the pipeline provides the producing company with greater access to markets, and a means of either producing more oil, or transporting it to a more profitable region.
By investing in a production company that will have access to a new pipeline, an investor is investing in the ability of management to continue successfully increasing the production volume of the company in its current holdings.
Realistically, the economic implications of large pipeline projects are large enough to have a major impact on many different kinds of securities. However, the performance of oil companies is most readily observed. In the next article, I’ll go into a bit more detail about how it is that different kinds of oil companies are impacted by a new pipeline, and how to benefit from these discrepancies as an investor.
