A Boring... and Lucrative Income Investment

In the early morning hours of April 8, 1942, the oil tanker, SS Oklahoma, exploded off the coast of St. Simons Island, Georgia.

After the Japanese bombardment of Pearl Harbor, German U-boats began to prowl the American coast with the aim of crippling American and British industry. Their favorite targets were oil tankers... ships that were about as easy to hit as a fat guy in a paintball game. The Oklahoma was one of the hundreds of ships that German submarines sank in the early part of the war.

The American government knew it had a big problem, if it couldn’t get oil from the fields in Texas to the industrial centers of the northeast. Without that oil, we couldn’t produce the guns, tanks, and ships that would eventually win the costliest war in history. The government’s solution was The Big Inch.

The Big Inch was a huge undertaking... a 24-inch diameter pipeline that stretched from Longview, Texas, to Phoenixville, Pennsylvania. The government built the 1,254-mile pipe in one astonishing year. Nothing like it had ever been built. Soon, The Big Inch was carrying half of all crude oil sent to the East Coast.

In 1947, Texas Eastern Transmission Corp. (TETCO) bought The Big Inch and its sibling, The Little Big Inch, for $143 million. That works out to $57,000 per mile, big money at that time. The management of TETCO knew the value of those lines. The company has shipped millions of barrels of oil and natural gas since that purchase.

Most investors ignore pipeline businesses, despite their importance to our energy needs. Most folks would rather hear about the far more glamorous (and far riskier) business of oil exploration. If you're ignoring pipelines, though, you’re ignoring one of the best income investments on the market. In fact, there are currently 15 pipeline companies yielding over 5.9%.

These aren’t speculative little companies looking to lure your investment dollars. For instance, Kinder Morgan Energy Partners (KMP) is a $10 billion dollar company that yields 6.7%.

These companies aren’t only producing great cash streams through their dividends. Their share prices are on a tear lately. In fact, Kinder Morgan Energy Partners went from a recent low of $42.53 on October 11 to $48.46 on December 1. That’s a 14% increase in less than two months. I’m guessing some of the money flowing into pipelines is flowing out of Canadian income trusts.

The key to buying pipelines is a little different from other businesses, according to industry analyst Daniel Johnston. He doesn’t recommend paying more than 1.5 times to 2.0 times book value.

That’s because the rates that these companies earn in exchange for transporting gas and oil in the pipes is highly regulated by individual states and the Federal Energy Regulatory Commission (FERC).

To get started on your own research into pipelines, here’s a table of few of the best pipeline companies based on price to book value and dividend yield:

Pipelines are highly regulated, stable, boring industries. Pipeline company earnings are negotiated tariffs in a highly structured process, according to Johnston. When shopping for pipelines, you need to understand that and buy cheaply using the price-to-book-value multiple as a guide.

Once you understand those simple rules, you can buy a cheap company that will be a long-term dividend cash machine. The S&A Oil Report holds two companies with significant pipeline assets. Both are up by double digits since late September... and we're looking to hold these boring-but-lucrative businesses for years.

Good investing,

Matt Badiali