A safe profitable bet on the green transition

Companies in the business of storing and transporting natural gas don’t sound “growth-y” or exciting, but they are businesses with a deepening competitive moat and growing need.

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Over the last decade, U.S. dry natural gas production has grown 57% and demand (including for exports) has risen 45%, according to the U.S. Energy Information Administration. Over that period, interstate pipeline capacity for natural gas has expanded just 25%, according to Williams Companies, citing data from EIA. Meanwhile, natural-gas storage capacity has barely changed.

The bottleneck is allowing so-called midstream companies to charge higher fees when they negotiate new contracts. In its investor day earlier this year, Kinder Morgan said the average utilization rate rose to 87% in 2023 from 73% in 2016 for five of its largest pipelines. The company said the scarcity factor is helping it sign longer contracts with increased rates.

In its latest earnings call, Oneok said its natural-gas pipelines segment “significantly exceeded” its 2023 financial guidance due to higher earnings from its long-term storage services and higher rates from negotiated fee-based contracts. While natural-gas prices are currently in the gutter—at less than $2 per million British thermal units—the advantage of pipelines is that they don’t depend much on commodity prices—they are underpinned by long-term, fee-based contracts.

The EIA forecasts U.S. natural-gas production and liquefied natural-gas exports will likely grow through 2050. But the pipelines’ scarcity value seems likely to persist given the permitting and political roadblocks to getting them built. Moreover, like oil and gas producers, midstream companies themselves switched from capital spending mode to capital returns mode over the past few years, according to Spiro Dounis, equity analyst at Citi Research. Over the past three years, a basket of midstream companies in the S&P 500 on average returned about 5.3% of their market value in annual dividends compared with 3.1% for a group of utilities in the S&P 500.

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And the path to growth will likely be volatile for natural-gas prices—something that should make midstream companies’ storage assets even more valuable. The U.S. energy system is shifting in ways that can make those swings even bigger. For one, the ability of the electric grid to switch to coal in times of shortage is diminishing as coal-fired power capacity shuts down. Secondly, U.S. natural-gas prices are getting more linked to international demand as LNG export capacity keeps growing.

Natural-gas storage is “severely lacking,” according to Eugene Kim, research director at energy research firm Wood Mackenzie. Storage capacity grew about 20% between 2005 and 2015, during the fracking boom, but hasn’t expanded at all post-2015, when natural-gas production itself grew another 40%, Kim noted. Companies that own natural-gas storage capacity include Kinder Morgan, Williams, DT Midstream and TC Energy.

A basket of midstream companies in the S&P 500 has gained about 14% year to date, outpacing the broader index. Even so, their valuation looks reasonable, with enterprise value at about 10 times forward-12-month earnings before interest, taxes, depreciation and amortization, 28% lower than the overall index. Historically, midstream companies had traded at a more modest 5.5% discount to the S&P 500.

Investing in natural-gas infrastructure could be a relatively cheap, dividend-rich way to hitch your wagon to the energy transition.

Write to Jinjoo Lee at jinjoo.lee@wsj.com

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