Pipeline companies generally do not own the products they transport. Instead, they are paid by the oil and gas producers and major consumers of the products – industry and utilities – for transporting the products through the pipelines.
What makes pipeline companies attractive long-term investment opportunities is that the pipelines they own are well-established, durable physical assets with predictable cash flow streams. Pipeline companies represent real, physical, enduring infrastructure with low risk of falling into disuse or becoming out of date, and have economic lives that are measured over decades, and benefit from relatively inelastic demand. Existing pipeline companies are near-natural monopolies, dominating the markets they serve and enjoying significant barriers to entry – from cost to regulatory right of ways.
Because they do not own the commodities that are transported through their networks, pipeline companies generally have limited direct commodity price exposure and make money from other energy companies who pay a fee to effectively “rent” the pipelines, terminals and services needed to transport oil and natural gas from where they are gathered to refineries, storage facilities and end points of usage.
The fees they charge are generally tied to multi-year (five to 20) contracts, providing predictable and steady cash flows for a period of time. Fees are recontracted when the contracts expire. Most natural gas pipeline contracts are tied to capacity reservations, typically called “take or pay,” meaning producers pay to use the pipelines for a given amount of time, even if part of that time nothing is being transported. Petroleum pipelines operate a little bit more like the toll roads we sometimes drive on to reach a given destination. A volume-based fee is charged to move a given amount of product through; as dictated their fees are also tied to an inflation escalator, which is based on the Producer Price Index and is adjusted annually. Interstate pipelines are regulated by the Federal Energy Regulatory Commission, while intrastate pipelines are generally regulated by a variety of state agencies.
As a result, pipelines are similar to toll roads for energy. Just as a toll road does not distinguish between a Bentley and a car of lesser value so long as the toll is paid, much the same can be said for the price of oil or gas moving through the nation’s pipelines.