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Smart Money Heads to Natural Gas

Two recent deals in the natural gas world give some insight into where the "smart money" is being bet on the fuel, and both tell me that natural gas remains the strongest opportunity in the energy space for the medium- to long-term and worthy of a sizable portion of your energy portfolio allotment.

In both, the drop-down deal of $498 million of midstream assets from parent company Anadarko Petroleum to Western Gas Midstream Partners and with the newest midstream IPO, Chesapeake Midstream Partners last week, we're seeing more and more growth and deal-making inside the industry despite huge supply and relatively weak pricing for natural gas.

Natural Gas
Natural Gas

The inside players are telling you something about the future of the fuel, however, and you need to listen.

Let's take a closer look at both deals and see how the both indicate where the smart money believes the industry is headed — and how we can benefit from their insight.

Anadarko Petroleum is the minority partner of the blown-out well at Macondo with primary owner BP. For most of May and June, Anadarko shares have gotten pummeled, moving from about $74 when the rig caught fire on April 20 to a low of nearly $36 in late June.

But as BP's response in the Gulf has begun to show tremendous progress, Anadarko has begun also to recover, trading today at close to $53. Part of the danger in owning Anadarko has been their relatively limited cash position, in contrast to BP; without a clear understanding of Anadarko's liabilities and possible fines, it's been equally difficult to value the shares. Enter the latest Western Gas Partners deal, at $500 million, almost twice as big as the last large "drop-down" sale from its parent company, Anadarko in February.

These drop down deals are becoming more and more common. In essence, a parent company will commit itself to growth and development of raw reserves — finding, drilling and extracting oil and natural gas.

It has become more common for those parent companies to take the processing and transport assets that they have created around those developed, producing assets and "drop them down" to a subsidiary Master Limited Partnership, a mutually beneficial arrangement of capital for both entities. Western Gas has this direct relationship to Anadarko, in which fully 80% of its throughput is from long-term deals with Anadarko production assets.

The very large recent acquisition by Western Gas of Anadarko's Colorado assets, including a 1,700- mile gathering system, represents two very obvious conclusions. First, Anadarko was interested in raising capital in front of any liability and fines from the Gulf spill, but second, and more importantly, both Anadarko and Western Gas believe that the future of natural gas development and throughput are only going to rise — and rise significantly over the next several years.

Anadarko's share price will continue to be tethered to natural gas prices and although Western Gas's distribution is not, they are still banking on increasing drilling and production around its newly purchased pipelines. Both companies, in essence, are betting big on increased demand for natural gas and an increasing price.

The same can be gleaned from the latest Master limited partnership rollout, Chesapeake Midstream Partners. This is the latest subsidiary of a natural gas parent to debut as an MLP, almost exactly in the same form as Western Gas.

Chesapeake Midstream is using its capital raise to purchase midstream assets, mostly in the Barnett shale region of North Texas. Despite an unclear distribution return, the new IPO priced at the absolute upper end of its range, at $21 dollars a share and succeeded on the Street, where it is now trading at almost $23 dollars a share. Again, the timing of the IPO and success of the offering demonstrate the optimism for the growth potential surrounding Chesapeake's shale assets, both in the Barnett and Marcellus shale regions.

From both of these deals we can make a solid case for owning both of these types of stocks, both the upstream parent companies, more tethered to commodity prices and the midstream partner MLP's, less connected to raw natural gas prices but still dependent upon the growth of more and more producing assets surrounding their processing and transport pipelines.

By their individual and spectacular success even during depressed prices and current oversupply of natural gas, both the Western Gas and Chesapeake Midstream deals signify a bold bet among industry insiders as to the future of the natural gas: They are betting on increasing growth and rising prices.

We should listen to the insiders. I think they will turn out to be right. Both Anadarko and Chesapeake are trading at extreme historical discounts, while their subsidiaries are positioned to benefit from their parents' growth while delivering a tasty distribution. It is worth looking into all four stocks for your portfolio.

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