Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Should You Sweat Your Enbridge Energy Partners, L.P. (EEP) Investment?

When investing in master limited partnerships, one of the most critical objectives is to make sure that the company can continue to pay its distribution. Investors in Enbridge Energy Partners, L.P. (NYSE:EEP) might start to have their confidence shaken by the company’s recent performance. At the most recent earnings release, the company’s coverage ratio was at 0.79, which means that the company is taking in less money in free cash flow than what is required to service its debt and pay its distribution obligations. Could this be a bad sign for Enbridge’s 7.4% distribution yield? Let’s look at what’s happening and find out why this might not be as bad as it seems.

Enbridge Energy Partners, L.P. (NYSE:EEP)New market needs new infrastrucutre
Much like many players in the midstream space, Enbridge Energy Partners and its operating company, Enbridge Inc (USA) (NYSE:ENB), built its energy infrastructure around the theory that oil and gas needed to be imported into the United States. While there are still some imports coming to the country, the necessity of those imports is falling off every day. Greater and greater production from emerging unconventional energy plays has bumped domestic supplies and created severe price differentials on oil and gas throughout the nation.

As recently as 2012, Enbridge used both commodity-sensitive and fee-based pricing structures to generate more than 66% of its revenue. This makes the company very vulnerable to commodity prices. With gas trading at about $3.50 in the most recent quarter, it severely cut into revenue for the company.

Another major reason the company has been taking a hit as of late is the emergence of rail as a method for transporting oil from these emerging oil plays. Both Phillips 66 (NYSE:PSX) and Valero Energy Corporation (NYSE:VLO) recently announced the purchase of 2,000 and 1,000 railcars for moving oil, respectively. These rail cars will be used to move mostly Bakken crude to refineries on the East and West coasts to help replace high-cost Brent and Alaskan North Slope crudes that these facilities are currently processing. While rail is a more expensive option for moving crude than pipeline, it works for the time being because midstream companies lack the infrastructure to deliver crude from these emerging plays to the places of need.

Big plans, bigger profits
These changes in market dynamics have put Enbridge in catch-up mode. To meet the changing times, the company has needed to pour lots of money into capital expenditures. In 2012, Enbridge spent about $1.7 billion in capital expenditures. The company intends to bump that number to about $2.2 billion for 2013 and a return to 2012 numbers until about 2016. The most encouraging sign for all this investment is that it will almost completely change the revenue structure for the company. These new projects will use take-or-pay contracts, which will ensure that the company receives payment even if the pipeline isn’t used. It’s a much more stable revenue source than a fee-based contract. Once all of the slated projects are complete, Enbridge anticipates that the company will receive 60% of its revenue from take-or-pay contracts.

The largest project the company has coming online soon is the joint venture with Enterprise Products Partners L.P. (NYSE:EPD) for the reversal of the Seaway Pipeline from Cushing, Okla., to the Gulf of Mexico. This will also be tied to an extension in the works that will extend from Cushing to its mainline hubs around the Chicago area. This pipeline will put it in direct competition with TransCanada Corporation (USA) (NYSE:TRP)‘s Keystone XL pipeline to deliver Canadian oil sands to the Gulf of Mexico. Luckily for Enbridge, it hasn’t met the political resistance for its project that TransCanada has, and it will more than likely bring the project online sooner.

Enbridge also intends to tackle its rail problem by reversing and expanding its Eastern Access pipeline network. The project plans to add a spur to the Utica shale play in Ohio and will provide essential takeaway capacity for East Coast refiners. Once complete, it should provide even more options for those refiners to kick their expensive Brent habits.

Once all of these projects come online, Enbridge anticipates a return to a better than 1.0 times coverage ratio by 2016. It also still plans to maintain a 2% to 5% distribution yield growth between now and 2016.

What a Fool believes
Enbridge management anticipates that rail will continue to eat into pipeline revenue throughout 2013. Rail is still a $10 premium to pipe on average, but refiners are more than willing to pay the transport premium because it’s still better than Brent. Once midstream gets its act together, though, expect a shift back to pipe.

Until these projects get up to speed, don’t expect any great big upticks in Enbridge revenues unless we see a major upswing in oil and gas prices. At the same time, investors shouldn’t worry too much. The company’s plans should bring it back on the right track, and investors who hang on through this stagnant time will be rewarded.

The article Should You Sweat Your Enbridge Investment? originally appeared on and is written by Tyler Crowe.

Fool contributor Tyler Crowe has no position in any stocks mentioned. You can follow him on under TMFDirtyBird, Google +, or Twitter: @TylerCroweFool.The Motley Fool recommends Enterprise Products Partners.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.