Pipelines that transport America's energy sources are increasingly linked to the buildout of AI infrastructure rather than black gold. That's all the better for investors.
Artificial intelligence's insatiable energy demand is well documented, for better or worse, and the number of power-hungry data centers looks likely to rise, despite grassroots opposition.
The upshot is that the outlook for midstream companies, the "toll roads" that connect sources of oil and natural gas to their destinations at refineries, petrochemical plants and transportation hubs, has changed. They are more geared toward the AI growth story, which has changed the demand side of the equation for the better. That's led Barron's to recommend companies like Kinder Morgan and Williams Cos. in the past: Multiyear contracts that stipulate midstream companies get paid whether their infrastructure is used or not means investors can be more confident about increasingly upbeat revenue estimates.
Melius analyst James West agrees. He recently initiated coverage of the midstream operators with Buy ratings on both those names, while rating Energy Transfer and Enterprise Products Partners at Hold.
The ever-growing need for AI compute power is part of his thesis. Hyperscalers can't tolerate any service disruption, meaning that the natural gas-fired generation is often the only option in many areas-an obvious demand boost for companies transporting gas.
It isn't just U.S.-centric AI growth that's powering these companies, West writes. "The United States has solidified its position as a global leader in LNG exports, and because supply chains are built around the American sources, "midstream pipelines are running near maximum capacity to transport raw gas...Export growth alone could account for more incremental gas demand than the rest of the U.S. market combined." Demand from Europe and Asia is projected to jump 30% by 2030, and overseas companies signing long-term contracts helps paint a stable picture of yearslong utilization.
As for the specific stocks, West writes that Kinder Morgan is the "most directly exposed to both structural demand drivers behind the sector thesis: power generation tied to data center load growth, and LNG feed gas exports." Likewise, a majority of the company's cash flow comes from long-dated, inflation-linked contracts that are 'take or pay' (the company gets paid whether or not customers use its infrastructure to move LNG). He thinks the shares should trade to $38, or roughly 16% upside.
He has an $84 price target on Williams, signaling a return of about 14%. "Williams is the only name in this initiation that owns and sells power directly, a capital-intensive step beyond the gas transportation model its three peers run, made possible without straining the balance sheet or diluting equity" thanks to joint venture with Blackstone, he said.
There does appear to be investor appetite for the group as a whole, however, with the Alerian MLP exchange-traded fund and the Global X MLP & Energy Infrastructure ETF both running ahead of the S&P 500 year to date, just like the State Street Energy Select Sector SPDR ETF.
Toll roads might not be popular, but they are necessary, and can be more profitable than people give them credit for.
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