An Easy Way to Profit on Wyoming's Billion-Dollar Gas Problem

The boom is on in Wyoming's natural gas industry...

Explorers are finding gas beneath the Rocky Mountains in huge reservoirs, like the Powder River Basin. After Texas, Wyoming is now the second-largest producer of natural-gas in the country.

Natural gas is cheap compared to oil. It's clean and easy to transport. And the United States has more natural gas than any country in the world except Russia. As America struggles with dependence on foreign oil and looks for ways to reduce carbon emissions, it is finding natural gas is the perfect solution...

Wyoming's government collects royalties and taxes from the profits of companies that produce natural gas there. Gas companies generate higher profits on the back of the higher gas prices. So when prices rise, Wyoming's government collects more taxes. And higher prices encourage more drilling, which eventually means more taxes for the state.

But right now, Wyoming has a problem: The industry and the government are losing billions of dollars from a shortage of pipelines...

Wyoming gas has historically traded at around a 50¢ discount to the price on the New York Mercantile Exchange and at Louisiana's Henry Hub (the main pipeline terminus of America's natural gas industry).

Wyoming doesn't have enough pipelines to carry its gas to the major consumer centers in California, Texas, and along the East Coast. So a surplus of gas has built up. Gas producers have to accept a lower price for their gas. And this discount is costing Wyoming's gas industry billions in lost profits and the state's government billions in lost tax revenues.

Recently, production has increased in Wyoming, and pipeline capacity has gotten even tighter. In January, Wyoming gas was 12% cheaper than Louisiana gas. In June, the discount rose to 32%...

According to the Wyoming Pipeline Authority, this discount cost the state government $500 million in lost tax revenues in 2007. If prices stay where they are, Wyoming's government will miss out on a billion dollars in 2008.

There's an easy way to profit from this situation: Buy pipeline partnerships.

After bottoming out in 2004, American natural gas production has risen for three consecutive years. According to the Energy Department, 449,000 wells currently produce natural gas in the United States, versus 373,000 in 2001. And onshore production of natural gas is up 12% from the same time last year...

The major American natural gas deposits are in Texas, offshore in the Gulf of Mexico, and under the Rocky Mountains. California, the Northeast, Midwest, and South are the major destinations for natural gas. Most natural gas production travels long distances in pipelines. So the current environment presents an excellent opportunity for the natural gas pipeline industry to expand...

The government says the pipeline industry will lay 4,400 miles of new pipeline in 2008. That's 250% more pipeline than it laid in 2007... and the biggest annual addition since records began 10 years ago.

I looked up the most recent quarterly results for the 10 largest pipeline partnerships. Here's some of what I found:

• Magellan Midstream (MMP) just made its 29th consecutive dividend increase... reported operating profit growth of 34%... and raised earnings guidance for the rest of 2008.

• Energy Transfer Partners (ETP) just made its 18th consecutive dividend increase... reported 55% growth in revenue... and beat analysts' profit expectations even after raising guidance last month.

• Plains All American Pipeline (PAA) just reported its 17th consecutive dividend increase... quarterly revenues are up 131%... and the company beat analysts' profit expectations by 37%.

Those are just a sample. All the companies I looked at have similar stories.

It's the opposite.

Over the last year, pipeline investments have fallen week after week. I use the Alerian MLP Index to measure the performance of the pipeline industry. The Alerian Index is a basket of the 50 most prominent publicly traded pipeline and energy infrastructure partnerships.

Closed-end funds are the easiest way to invest in pipelines. There are 10. Or buy a pipeline partnership directly. You can choose from around 50. The The index peaked on July 13 at 342. As I write, it's at 264... a loss of 23%. On July 13, the index had a yield of 5.4%. Today, it yields 8%.

Good investing,