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Keystone Could Set The Bar High

Tuesday - 5/14/2013, 3:37pm  ET

TransCanada's proposed Keystone pipeline has been mired in government red tape for years. With a massive body of information and increasingly stringent regulations floated as requirements for the project's approval, all pipeline companies may be impacted by the project, even if it gets turned down.

Keystone

The Keystone pipeline is intended to bring oil from Canada's oil sands region down through the United States to the U.S. Gulf Coast. There it would be used as feedstock for refineries and reduce the country's dependance on Middle Eastern oil.

That sounds like a winning proposition, but there have been debates about everything from how many jobs it will create to how safe it is to let the pipeline cross over important watersheds. Environmental issues have been the biggest sticking point, with approval now bogged down in politics.

Safety is a clear concern, and it's an area on which Keystone could have a lasting impact for the entire pipeline industry. For example, Bloomberg reports that TransCanada is being asked to put in writing that it will pay for the damage from any oil spills.

If that's not enough to put a scare into a pipeline company, consider the fact that Joe Oliver, the Canadian minister of natural resources, told the Bloomberg New Energy Finance Summit that "the new pipe itself would have 57 more safety features than are found in the hundreds of thousands of miles of pipelines already crisscrossing the U.S."

Pipeline companies, then, could see increased safety regulations because of the contentious battle over Keystone. That risk will be there even if the pipeline never gets built.

How to Play

Investors who see and rightly fear the risk that Keystone will lead to increased industry regulation should probably stick to the companies most capable of affording such changes.

A Giant without a Partner

Enterprise Products Partners is one of the largest limited partnerships (LPs) in the pipeline space. Its operations span the country and just about every aspect of the midstream space. It has been a reliable dividend grower and its business has expanded rapidly.

Well financed, it could easily afford the impact of new regulation. Of course its size means that it would face massive changes, but those costs would likely be passed on to customers relatively quickly.

One nice feature about Enterprise is that it doesn't have a general partner (GP). Thus, the incentive distributions that other companies in the LP space pay to their GPs get put toward growth and/or unit holder distributions.

That said, this LP is an industry leader and is afforded a premium price. Conservative investors willing to trade yield for safety might find Enterprise of interest.

Complex Structure Discount

Kinder Morgan is every bit as impressive as Enterprise, but normally trades at a discount. That's because Kinder still has a GP. It also has a share class that pays stock dividends instead of cash dividends. Basically, the business structure is much more complex than that of Enterprise.

It is, however, large and well financed. So, if there are any negative industry implications from the Keystone project, Kinder in all of its forms will be able to handle the changes. The complexity, meanwhile, leaves investors with a chance to get a little more yield than they would with Enterprise.

For income investors, its worth the extra effort to get to know Kinder. For those who want exposure to an LP in an tax advantaged account, like an IRA, meanwhile, Kinder's stock dividend share class (KMR) is the ideal option. Cash distributions from LPs don't play well with tax sheltered accounts.

The Problem Child

TransCanada is actually a pretty solid option for investors despite the Keystone fiasco. It is a massive pipeline player in Canada and has been diversifying its business beyond its current reliance on natural gas pipelines. That's on top of an energy business that already provides a good amount of diversification and support for the company's modest dividend.

The Canadian pipeline company is not an LP, so its dividend yield is below that of Kinder or Enterprise. However, it is financially strong, and TransCanada has shown that it is capable of taking on big projects and long fights. So, if the rules change after Keystone gets approved or denied, TransCanada should be able to handle the impact and be well versed in the changes.

Investors, meanwhile, seem to like the company's prospects with or without Keystone, since the shares have been on a fairly steady climb over the past few years. That said, if Keystone isn't approved, the shares are likely to trade lower on the news. That could be a good buying opportunity.

Yield or Growth

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