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Analyst Sees LNG Imports as Boon for Pipes, But Not Gas Processors

The growing influx of liquefied natural gas (LNG) imports into the Gulf Coast will be a boon for interstate and intrastate natural gas pipelines, but it could take a toll on gas processors in the region, according to a report issued by investment banker Harris Nesbitt.

Increased LNG imports in the Gulf Coast will help replace dwindling production from that region, which in turn should continue to support demand for interstate pipeline services from the Gulf Coast to the Midwest, Northeast and Southeast, said Harris Nesbitt analyst Patrick C. Rau in a recent report. This would be especially beneficial for Williams' Transcontinental Pipe Line, El Paso Corp.'s Tennessee Pipeline, Gulfstream (50% owned by Williams) and Florida Gas Transmission, which is 50% owned by El Paso, he noted.

The stream of LNG imports into the Gulf Coast also will require more intrastate pipelines in Texas and Louisiana, Rau said. "We believe this would provide the greatest growth opportunities for Crosstex Energy Partners, Enterprise Partners and Kinder Morgan..., all of which have a significant intrastate pipeline presence in this region."

However, LNG imports could exact a toll on natural gas processors "since natural gas that emerges from regas facilities will by and large already be of pipeline quality," Rau said. "In fact, LNG could be a threat to both the gathering and processing segments, especially if an overabundance of imported LNG ends up crowding out and lowering U.S. production more than we forecast. This would be potentially negative for Enterprise Products and Crosstex Energy Partners, both of which have significant processing facilities in the Gulf Coast."

Harris Nesbitt, in its initial coverage of the domestic natural gas pipeline industry, issued a negative rating for the sector due to concerns over rising interest rates, increased recontracting risks and growing political and public opposition to new pipe projects.

The company initiated coverage on seven pipeline stocks: Crosstex Energy ($43.70, Outperform); Enterprise Products ($27.07, Neutral); El Paso Corp. ($12.36, Underperform); Kinder Morgan ($88.97, Neutral); Northern Border Partners ($51.85, Underperform); Questar ($68.45, Outperform); and Williams ($20.80, Neutral).

"Although we are negative on the outlook for the industry because of the expected negative impact from higher interest rates and because of high valuations, we believe the natural gas pipeline industry offers a compelling opportunity for income-oriented investors. Natural gas pipelines have relatively stable cash flows, thanks to regulation and high barriers to entry. U.S. pipeline company dividend yields tend to outpace the 10-year U.S. Treasury yield over time and have grown faster than inflation since 1994," Rau said.

He sees the Rocky Mountains and the Southeast regions as key growth markets for gas pipelines. "Potential bottlenecks in the Rocky Mountains and Southeast should create incremental expansion opportunities for pipelines serving those markets over the next three years, while the 'not in my backyard' (NIMBY) issue should enable pipeline companies serving the Northeast to continue to charge at or near maximum rates."

Major challenges facing pipelines involve a reduction in contract length, the NIMBY sentiment and a growing U.S. supply-demand gap, Rau said. He noted the weighted-average contract length for major U.S. pipelines, which was 6.93 years in 1996, is expected to fall to 4.66 years in 2005 and 4.25 years in 2006. "We believe the reduction in overall contract length is largely the result of LDCs contracting for shorter time periods because of directives from the individual state legislatures, a trend we expect to continue." Rau said local distribution companies and electric utilities generally hold a combined 55-60% of firm transportation capacity on long-haul pipelines.

He sees no letup in the NIMBY opposition to pipeline projects in the years ahead, particularly in key consuming regions of New England and California, and a potential widening of the U.S. supply-demand gap to 3.7 Bcf/d in 2010 and 9.4 Bcf/d in 2014 if sufficient LNG facilities are not built. But Rau expects more than enough LNG capacity to be built to bridge the divide.

Excelerate Energy's 0.5 Bcf/d Energy Bridge project in the Gulf of Mexico was completed in the first quarter of this year, and three of five other LNG regasification terminals that are currently under construction will be located along the Gulf Coast. In addition, three separate 0.8 Bcf/d LNG import facilities are being planned for the Bahamas that would then ship natural gas to Florida via pipeline, he noted. "Although these LNG facilities have yet to be approved, the FERC has already given the go-ahead for the related pipeline projects. We expect at least one of these three LNG facilities to be constructed," Rau said.

"Overall, we expect these seven new LNG import facilities to provide 8.2 Bcf/d of additional import capacity, which we estimate is more than enough to satisfy the potential supply gap through 2014 -- and there could be even more LNG capacity on the horizon."

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