Friday, March 10, 2017

Pipe and a Hard Place

Kinder Morgan Pipeline Explosion
Mid February 2017, a 36-inch gas pipeline owned by Kinder Morgan in Refugio County exploded and burned.   An orange fire ball could be seen as far away as Corpus Cristi and Houston, reminding the public of the dangers in oil and gas pipelines strung out across our country.  The alternatives are not much more appealing.    Indeed, North Americans are positioned uncomfortably between a large rock in the form of a pipe and a very hard place.  
What is the best way to transport fossil fuelsIs there an opportunity for investors?

As much as anyone with a care for the environment might want it so, renewable energy sources have not yet developed sufficiently to eliminate the need for fossil fuels.  The Fraser Institute estimates that based on ton-miles, as much as 70% of crude oil and natural gas products in North America are transported in pipelines.  Shipment by tanker over water accounts for 23% of transport, while trucking and rail account for 4% and 3% of total volume, respectively.
Built-in Dilemma
Fossil fuel refinery capacity in the U.S. is highly concentrated in large facilities.  The Congressional Research Services notes that there has not been a new refinery built in the U.S. since 1976.  Numerous facilities have been shuttered as uneconomic.  There are refineries located in 33 states, but most of the capacity is positioned along the Gulf Coast and in California, where it was possible to receive crude oil imports from the Middle East by ship.  Capacity expansion has been limited to those that remain in operation such that now as much as 25% of total U.S. oil and gas refinery capacity is found in only eleven facilities. 
As a consequence of capacity and location decisions made by refinery operators such as Exxon Mobil (XOM:  NYSE), Royal Dutch Shell (RDS:  NYSE), Valero (VLO:  NYSE) and others fossil fuels derived from North America often have a lengthy transport requirement before reaching the market. 
Indeed, the recent controversy over the Dakota Access Pipeline in the middle section of the U.S. arose because its developers, Energy Transfer Partners, LP (ETP:  NYSE) and Marathon Petroleum (MPC:  NSYE) and others, wanted to provide transport for Canadian shale oil to refineries in the U.S. Gulf Region.  Canada can produce as much as four million barrels of crude oil per day but has refinery capacity of only two million barrels per day.
Investors appear not to have been distressed by the controversy.  ETP is up approximately 27% over the past year.  Indeed, during the stormiest moments with Dakota Access Pipeline protesters going head to head against sheriffs’ deputies, the stock set a new 52-week high price.  MPC has enjoyed the same warm sentiment from investors with a 35% price increase over the last year.
Hard Place Halt
Investors may be sanguine about fossil fuel issues, but safety data sounds a loud alarm.  An online news source, Citylab, published a map of pipeline and rail incidents together beginning in 1986 through the end of 2016.  The list of incidents had been compiled by an environmental researcher at the University of California in Santa Cruz.  The university estimates the incidents involved 548 deaths, 2,576 injuries and cost communities $8.5 billion in financial damages. has concluded that truck transport of fuel is worse than trains, which are worse than pipelines.  Worst of all are ship transport.  The ranking is based on data for death and property destruction.  When the environmental damage is included in the equation, ships are worse than pipelines, which are in turn worse than trucks.
Pipeline Pause
Pipeline owners such as Energy Transfer Partners and Marathon Petroleum invest heavily in technology to monitor pipeline integrity.  Digital sensors and infrared cameras provide real time data on pipeline integrity and check for leaks.  Autonomous drones stalk the lengths of pipelines to monitor security.  Unfortunately, these high tech gadgets only alert pipeline owners that an incident is unfolding.  Often the information is too late to prevent injuries, loss of life or environmental damage.
According to the Center for Effective Governance there have been 3,300 incidents of crude oil or liquefied natural gas leaks or ruptures in U.S. pipelines in the five years beginning 2010.  That is approximately 660 per year or 1.8 incidents per day.  There does not appear to be any let up on the pace of problems.  There were eight incidents in the first two months of 2017 alone.  Just five days before the Kinder Morgan pipeline incident, a natural gas liquids pipeline owned by Phillips 66 exploded while being cleaned, killing one worker and injuring a second.  The community was evacuated until the fire was contained. 
A new report from the Association of Oil Pipe Lines (AOPL) provides an alternative perspective on pipeline safety, albeit a view tinged with self-interest.  The AOPL claims incidents impacting people or the environment are down by more than 50% since 1999, despite a 13% increase in pipeline miles. 
Rock and a Hard Place
It seems the question of how best to transport fossil fuel is secondary to exploitation opportunities.  In the United States now that job creation is of primary importance ahead of environmental concerns, it is not likely that much effort will be expended to find the least harmful fossil fuel transportation.  There will be little pressure to find new efficiencies or better safety, leaving little incentive for innovation or invention.  Indeed, the view on environmental protection appears to be one of ‘let the environment fend for itself’.  In such circumstances, with no concerted policy, there is typically little opportunity for investors.  Companies are not encouraged to innovate or bring new products to market.  Furthermore, when policy goals such as safety, sustainability or environmental care are not in the fore, there is more likely to be adverse events that roil the stocks of existing companies.  This puts investors in their own ‘rock and hard place’ of no innovation and increased risk.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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