Oil keeps whipsawing wildly as a mix of good and bad news buffets prices. The North American benchmark West Texas Intermediate (WTI) has pulled back sharply to be down by 17% over the last year. While the outlook for crude remains weak, these latest ructions shouldn’t deter investors from adding energy stocks to their portfolios.
Wide economic moat
Key among Enbridge’s strengths is its wide almost insurmountable economic moat, which protects it from competition while bolstering its growth prospects. An economic moat is a businesses’ ability to maintain a competitive advantage over competitors.
Enbridge’s position as a leading North American provider of petroleum pipeline and storage infrastructure ensures that is possesses a wide moat. It transports around a quarter of the oil produced in North America and fifth of the natural gas, making it a vital link between Canada’s energy patch and crucial U.S. energy markets.
The energy infrastructure and midstream services industry has exceptionally steep barriers to entry, which reinforce Enbridge’s moat and create an oligopolistic industry, the key being significant regulatory and capital requirements. When these are combined with growing environmental pressures and community opposition, it’s virtually impossible for companies to construct new pipelines.
Even expanding existing pipelines is proving difficult in the current environment. When these factors are considered along with the significant costs associated with building or buying energy infrastructure, it makes it extremely difficult for companies to enter the industry.
This further bolsters the oligopolistic nature of the industry in North America, which, when combined with the dependence of Canadian oil producers on Enbridge’s infrastructure, further reinforces its ability to serve as a price maker with 98% of Enbridge’s revenue generated from regulated or contracted sources essentially guarantees earnings.
There is significant growing demand for the utilization of Enbridge’s services and infrastructure. Existing transportation constraints and growing Canadian oil production means that demand for the use of Enbridge’s assets will expand at a solid clip. The Canadian Association of Petroleum Producers (CAPP) expects oil output to expand by 33% between the end of 2018 and 2035.
The existing shortage of pipeline capacity is so acute that it caused the price differential between Canadian heavy crude known as Western Canadian Select (WCS) and WTI to reach record levels in 2018. That occurred because drillers were forced to store the oil produced due to a lack of available capacity, causing Western Canadian oil inventories to rise to record levels and the price of WCS to collapse.
The local oil glut forced the government of Alberta to introduce mandatory production cuts to drain inventories. The importance of Enbridge’s infrastructure to the energy patch is underscored by Edmonton vowing to end the cuts once the company’s Line 3 Replacement project is completed.
There is, however, uncertainty about when the provincial production limits will end. Enbridge was forced to move the scheduled in-service date for the Line 3 Replacement from the second half of 2019 to one year later because of permitting and regulatory issues.
Another notable aspect of Enbridge’s operations lies in the diversification of its assets. It has amassed infrastructure across all parts of the energy value chain, which include its liquids and gas pipelines as well as storage facilities, renewable power assets and gas delivery system, which sees it ranked as one of North America’s largest gas utilities. This further shields Enbridge’s earnings from the impact of a downturn in any single industry while enhancing growth.
Putting it together
The three characteristics endow Enbridge with solid defensive attributes, which, in combination with the inelastic demand for energy makes it almost immune to economic downturns. They also guarantee earnings growth, thereby supporting Enbridge’s planned 10% dividend growth by 2020 and 5% to 7% thereafter.
Its appeal as an investment is enhanced by a stronger balance sheet, where it’s focused on reducing debt to below five times EBITDA. Loyal investors are rewarded by Enbridge’s regularly growing dividend, which has been hiked the last 23 years straight to its current juicy yield of 6%.
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Fool contributor Matt Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of Enbridge. Enbridge is a recommendation of Stock Advisor Canada.