Finding profits in oil and gas pipelines
Targa Resources owns and operates natural gas pipelines, gas plants, liquefied petroleum gas (LPG) export facilities and crude oil terminals across the US. In mid-August, its shares rose 10% after it announced a 20-year midstream deal with ExxonMobil to build and operate a portfolio of energy infrastructure assets for the oil and gas giant.
Targa’s deal is the latest in a series of multibillion-dollar projects recently commissioned by oil giants and governments to help move oil and gas around the world.
Targa Resources (NYSE:TRGP) is a midstream energy group, playing a vital role in the energy sector. These businesses link upstream companies, which drill and extract the raw product, and downstream businesses, which refine and sell it to consumers.
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Most oil and gas majors manage this part of the process themselves, but in markets such as the US, where thousands of smaller producers in oil fields need to connect to major refining and storage hubs, midstream firms are a vital part of the chain.
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Growth in the pipeline market
The $65 billion Targa is just one such company in the industry. The firm was founded in 2003 and has grown steadily through organic growth and acquisitions. In 2004, it purchased midstream natural-gas operations from oil major ConocoPhillips and in 2005, it acquired an asset from energy supply business Dynegy. In 2007, the company listed as Targa Resources Partners LP, using the money from the initial public offering (IPO) to seal more deals.
Over the following two decades, Targa secured 20 further agreements, encompassing joint ventures, partnerships, asset sales and stake sales in key infrastructure assets.
Today, the group owns and operates assets across New Mexico, Oklahoma, Texas and Louisiana. It is active in the key oil-production regions of the Permian, the Bakken Three Forks Shale, Eagle Ford Shale and Fort Worth Basin.
The Permian has become one of the most important oil-producing regions in ExxonMobil’s portfolio. When the group sealed the $60 billion deal to buy Pioneer Natural Resources in May 2024, it doubled its footprint in the region and laid out plans to drive production to two million oil-equivalent barrels per day (boepd) by 2030, up from the 612,000 barrels Exxon produced from the region in 2023.
Production hit a record boepd in the second quarter and is now close to 1.8 million as the group continues to grow at a breathtaking pace.
Exxon’s total Permian production consists of between 70% and 75% liquid hydrocarbons (crude oil and natural gas liquids) and 25%-30% natural gas. This needs somewhere to go, and that’s where the deal with Targa comes into play.
Exxon has agreed to so-called natural gas liquids (NGL) dedications with Targa, whereby it is legally committed to using the company’s midstream assets for transport, processing, or fractionation (a physical and chemical separation process) of NGL production from its key fields in the Permian region.
Following these commitments, Targa has announced three new natural-gas processing plants in the Permian Delaware: Wrangler, Ranger, and Ranger II, with a combined capacity of approximately 825 million cubic feet per day.
The plants are expected to be operational in the first half of 2028, with scope for up to five additional processing plants. It also announced plans to build a new, approximately 70-mile, natural-gas pipeline called Bull Run II, supported by take-or-pay commitments (whereby producers buy a fixed amount of capacity and pay whether they use it or not).
To meet these commitments, Targa has upgraded its expected capital spending for the year from $4.5 billion to $5 billion. The business spent $2.1 billion on growth and maintenance capital in the first half of 2026, up 23% from the same period in 2025.
A new gold rush
Despite substantial efforts by policymakers over the past two decades to wean the world off its addiction to hydrocarbons, there has been no let-up in the relentless march of the oil and gas industry.
Pipelines and midstream assets are an often overlooked part of this market, but the conflict in the Middle East has highlighted their importance to the global economy.
With the Strait of Hormuz closed to shipping, pipelines across the Middle East have become critically important for the region’s oil and gas producers.
In the past two months, the United Arab Emirates has announced plans to open a new pipeline alongside its existing Habshan-Fujairah pipeline, doubling its capacity.
Meanwhile, America, Iraq and Qatar have also announced plans to upgrade a pipeline from Iraq to Syria, and Chevron is in talks to build a series of them from Iraq to Syria and Turkey.
According to The Economist, citing information from Global Energy Monitor, an oil data and research firm, 12,300 kilometres of pipelines are currently under construction worldwide, with an additional 20,100 kilometres proposed.
Taken together, these additions represent nearly a 10% increase over the 350,000 kilometres of pipelines currently in operation worldwide.
The most cost-effective way to get oil and gas from production fields (usually located inland or in deep water) to refineries and key export markets is by tanker.
Transporting each barrel of oil on the world’s largest seagoing tankers can cost as little as a few dollars a barrel. But when it is impossible to use tankers to transport them, producers have no choice but to turn to other methods such as rail, road or pipelines.
A large-diameter pipeline that can carry around one millions barrels of oil per day costs, on average, about $5 million per kilometre, or $5 billion for a 1,000 kilometre pipeline.
That’s assuming the pipeline is laid over relatively flat terrain. If mountains, rivers and lakes get in the way, costs can rise significantly.
The significant upfront capital cost is why midstream companies and pipeline owners turn to take-or-pay agreements.
Under these agreements, customers purchase a minimum amount of transport capacity on the pipeline and pay a fee for this capacity, often indexed to the price of oil over an extended period (frequently a decade or more).
The company has to pay to use this capacity whether or not it has oil to transport. This dramatically reduces the risk inherent in the project for the pipeline-operating company and its lenders.
Pipelines require a lot of capital to start, but the long-term economics are hard to argue with.
Data compiled by The Economist shows that the cost of transporting oil via a pipeline is, on average, around $5 per barrel. The cost rises to $18 per barrel when oil is transported via road or rail.
At the height of the US-Iran conflict earlier this year, some reports emerged of companies in central Africa paying as much as $200 a barrel, with $50 of that covering transport costs alone.
No wonder, then, that there is heavy investment in expanding pipeline networks to cut costs and improve reliability. In East Africa, for example, a 1,500 kilometre pipeline is under construction to transport oil from Uganda to the Tanzanian coast.
Argentina is building a 440 kilometre pipeline to connect its key oil fields in the centre of the country to the Atlantic.
There is a growing opportunity for investors. Because returns from pipelines are relatively stable and predictable, thanks to pre-agreed take-or-pay contracts, private infrastructure funds have flooded into the market.
According to McKenzie, a consultancy, assets under management across private infrastructure funds have rocketed to $1.6 trillion in recent years.
This year, global investment group KKR finished raising money for its largest-ever infrastructure fund with a total value of $19 billion. It’s almost certain a large chunk of this will go to pipeline projects. Blackstone and Brookfield are also getting in on the action. KKR, Blackstone and Brookfield have signed a $16 billion deal with Kuwait’s oil company for a stake in the country’s pipeline network.
Don’t be tempted by partnerships
The midstream sector is particularly strong in the United States thanks to a quirk of US tax law.
Midstream firms can be structured as master limited partnerships (MLPs), which are pass-through entities much like real-estate investment trusts (REITs).
MLPs pay no taxes, so they can distribute much more of their cash flow to investors. Investors then pay tax on these distributions. Over the past decade, many former MLPs have transitioned to C-corporations (a standard limited company) following a change introduced by the 2017 Tax Cuts and Jobs Act.
The changes have opened these companies to a wider range of investors, but yields have fallen because dividends are now paid out after corporate tax; in the partnership model the tax liability falls on the investor.
As a rough guide, the Alerian MLP ETF currently yields 7.4% on a trailing 12-month basis, while the Alerian Midstream Energy Dividend UCITS ETF, which has strict limits on MLP exposure, yields just 3.6%.
The Alerian Midstream Energy Dividend UCITS ETF has enforced limits on exposure to MLPs owing to K-1 tax constraints – the reason why these MLPs are unsuitable for all but the most sophisticated investors. A Schedule K-1 Federal Tax Form is issued by US partnerships to report a partner’s share of its income, losses, capital gains and dividends.
In short, they are a nightmare for non-US investors. Even smaller domestic US investors generally avoid partnerships to avoid the added administration these tax requirements create. Very sophisticated investors who want exposure to these businesses may use total return swaps or other synthetic instruments instead, rather than becoming entangled in the web of compliance. Don’t be tempted by a high yield on a US midstream MLP.
Fortunately, plenty of other options exist for investors to play this theme. Kinder Morgan (NYSE: KMI), the largest natural gas-pipeline operator in the United States (and a former division of Enron) consolidated its various MLPs into a single traditional C-corporation in 2014 in order to lower its cost of capital and appeal to a broader range of local and international investors. Many of the company’s peers have since followed suit.
A tailwind from AI
Kinder Morgan reported record net income of $867 million in the second quarter, up 21% from the same period last year.
Around $660 million of new projects coming on stream helped boost the company’s top and bottom lines, including Tennessee Gas Pipeline’s (TGP) Cumberland Project, designed to serve a new gas-fired power plant in Tennessee.
The company said it had a construction backlog of $9.7 billion at the end of the quarter, with an additional $400 million of projects not included in the official backlog, but sanctioned to proceed.
Natural-gas projects made up 92% of the backlog, and 60% of those projects are designed to support local power generation and distribution. The company believes it will outperform expectations by 5% for the year, with adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) of $9 billion and a 12% rise in adjusted earnings per share.
Kinder Morgan, like other US midstream companies, is benefiting from increasing demand for power across the US driven by the AI boom. According to Goldman Sachs Research, domestic power demand from data centres is projected to more than double from 31 gigawatts (GW) to 66 GW by 2027, consuming over 8.5% of total US peak summer electricity.
To keep up, companies are commissioning new natural-gas power plants, which can be brought online in a few years and located next to data centres; pipelines are needed to connect these facilities to production zones.
Kinder Morgan may be the largest natural-gas pipeline operator in the sector, but peer Enbridge (Toronto: ENB) is worth nearly twice as much.
It plans to spend between C$10 billion (£5.3 billion) and C$11 billion this year, with half of that already spent in the first six months. It is constructing the $4 billion Sunrise expansion of its British Columbia pipeline (adding 140 kilometres of new pipeline in addition to upgrading the capacity of the existing pipeline) and spending $1 billion relocating a pipeline in Wisconsin.
Williams Companies (NYSE: WMB), the second-largest pipeline group after Enbridge in market value, has raised its spending guidance for the acquisition of Momentum Midstream. It is now projecting spending between $7.3 billion and $7.9 billion in 2026.
Enterprise Product Partners is spending around half as much, with capital spending earmarked at between $2.9 billion and $3.4 billion, net of asset sale proceeds.
Key projects include two new gas-processing plants in the Permian Basin, illustrating the growing importance of natural-gas processing and transportation.
Enterprise Product Partners is the fastest-growing of the large midstream companies, but it is also still structured as a partnership. It reported a 19% increase in adjusted cash flow from operations in the first half to $2.5 billion, as well as a 28% increase in net income, thanks primarily international demand for US natural-gas liquids and crude oil.
Energy Transfer also set several all-time record volumes, notably in natural-gas liquids transportation volumes, which increased 13%, and exports, which increased 25%. Distributable cash flow rose 32% to $2.6 billion. Enbridge, Williams and Kingdom Morgan are all trading at roughly the same valuation, with a price/ earnings ratio (p/e) in the low 20s and a yield between 3% and 5.5%.
The Alerian Midstream Energy Dividend UCITS ETF (LSE: MMLP) offers exposure to all three companies, plus 16 others, with Kinder Morgan, Williams, Enbridge and Targa comprising around 40% of the fund. Investors also get synthetic exposure to the Alerian MLP index.
The picks-and-shovels plays
Infrastructure provides a steady, predictable return. But if you want something offering a bit more excitement, consider the companies providing the picks and shovels to help build future pipelines. Companies worthy of research include Caterpillar (NYSE: CAT), Tenaris (NYSE: TS), MasTec (NYSE: MTZ) and Primoris Services Corporation (NYSE: PRIM). Caterpillar is a broad-based play on the health of the US economy. The company reported record revenue of $20.5 billion in the second quarter, up 24% year on year – the first time Caterpillar has reported more than $20 billion of revenue in a single quarter.
Meanwhile, the company’s order backlog hit a record of $72.1 billion, that’s not just related to its diggers. While Caterpillar is widely associated with earth-moving and construction equipment, it also operates the SPM oil and gas brand and manufactures equipment for gas power plants. This energy and transportation division increased sales by 17% year on year. While the stock has dipped recently, it is still trading at 25 times projected 2027 earnings.
Tenaris is one of the more interesting companies in the area. It supplies tubular steel used to make pipelines worldwide. Sales fell 4% in the second quarter, mainly because shipments to customers in the Middle East were postponed owing to the conflict.
Lower deliveries to Kuwait and Iraq were, however, offset by higher sales to Venezuela and Argentina, along with the start of delivery of offshore line pipes to the Sakarya Black Sea development in Europe.
The company reported a $3.6 billion net cash position at the end of June, compared with a $19bn market capitalisation. The stock is on a forward p/e of 13.9.
MasTec and Primoris are two of the largest engineering construction contractors in North America. The latter is more focused on utilities, while the former has a big pipeline and energy business. Still, both recently reported record second-quarter sales and record order backlogs.
MasTec reported a record 18-month backlog of $21.4 billion; of this total, $1.8 billion was allocated to its pipeline segment, while Primoris achieved a record total backlog of $13.9 billion (comprising $7.7 billion in the utilities segment and $6.2 billion in energy).
MasTec recently acquired The Superior Group to expand its services into datacentre infrastructure and trades at the higher valuation of the two (21 times 2027 earnings versus 14 for Primoris). That’s because Primoris reported a loss for the second quarter, despite record sales. The losses stemmed from cost overruns on six renewable-energy projects. All of these will be complete by the end of the year, which should draw a line under the situation.
This article was first published in MoneyWeek’s magazine. Enjoy exclusive early access to news, opinion and analysis from our team of financial experts with a MoneyWeek subscription.
