2 Safe Ways to Generate Cash Flow in the Energy Sector

As America experiences a revitalization of its oil and gas sector, major income opportunities are popping up all over the country.

One company's trash is another one's treasure
Oil producers are in constant need of cash, and BreitBurn Energy Partners L.P. is happy to take unwanted, mature assets off of their hands. In 2012, BreitBurn Energy Partners spent ~$600 million doing just that, purchasing assets with a history of production in low risk areas.

What BreitBurn Energy Partners does with mature assets is purchase them for cheap, as E&P players look for a cash infusion to focus on different assets. After BreitBurn purchases the asset, it tries to wring out as much value as possible.

There are two ways BreitBurn goes about doing so. One involves using an enhanced oil recovery technique that pumps CO2 into the well to extract more oil from each well. The other is by locating as many potential drilling locations as possible to drag up all the crude and gas it can. It is BreitBurn's goal to make sure that no oilfield goes underutilized.

Plenty to give
BreitBurn Energy Partners has a lot to offer investors, such as a distribution of $1.95 on an annualized basis. That works out to be a payout of 9.8%, which beats out the historical return of the S&P 500.

Some of you may be wondering just how sustainable the $1.95 distribution is. Well don't be alarmed, this deal is good enough to be true. In BreitBurn Energy Partner's latest quarter, its distribution coverage ratio stood at 1.3x. This leaves amble room for BreitBurn to grow its payout, or at the very least maintain it.

Nice yield, but what about growth?
A big part of BreitBurn's strategy is growth through acquisitions. In July, BreitBurn Energy Partner's paid $864 million for assets in the Oklahoma Panhandle and New Mexico that had a production mix of 87% crude oil and 11% NGL.

That purchase was a strong shift toward oil and NGL production, which is much more profitable than natural gas at the moment. In 2012, BreitBurn's production mix was 45% liquids. This acquisition will help BreitBurn achieve a liquids production mix of 63% by the end of the year. More NGL and oil production will drive BreitBurn's distributable cash flow higher through wider margins.

Another part of BreitBurn's growth strategy is adding to its acreage in the Permian. Just a few weeks ago BreitBurn Energy Partner's paid $282 million for additional assets in the Permian Basin.

The big idea
The whole idea is that BreitBurn Energy Partners will grow through a better production mix and more assets where it can use enhanced recovery techniques to increase production.

This strategy has worked out so far, with BreitBurn Energy Partners' distributable cash flow up 47% year over year. Liquids production was up by 94% year over year as total output grew by 43%. BreitBurn is a good income play, as it offers stable income growth through low risk assets combined with a large distribution that is cushioned by a 1.3x coverage ratio.

For BreitBurn to even exist, it needs a friend. A friend that is also an MLP. BreitBurn needs Magellan Midstream Partners' pipelines and terminals.

More crude is good for the soul
Magellan Midstream Partners was able to grow its net income significantly with help from crude oil. Year over year, Magellan grew its revenue from crude oil to $49.5 million versus $23.9 million last year. What makes this great is that Magellan Midstream Partners' operating expense from crude oil transportation and storage grew by only $0.7 million to $4.1 million.

While money had to be spent to expand its operations in the crude segment, in the long run the additional cash flow will be very accretive. Magellan Midstream Partners was able to grow its distributable cash flow by 40% year over year, which management partly attributed to the Longhorn pipeline.

The growth doesn't stop here, Magellan is expanding the capacity of its Longhorn pipeline by 50,000 bpd, which carries crude to Houston from the Permian Basin. This expansion is due to the increased demand coming from its customers, which Magellan will cater to further by adding a new point of origin by 2015.

So how does Magellan fit into your income generation?
You want income, and Magellan can offer you income. At an annualized distribution of $2.23, Magellan pays out a 3.8% yield. With a distribution coverage ratio of 1.24x, Magellan should have no problem maintaining and raising its distribution.

To reduce your reliance on the upstream part of the oil and gas industry, you should also invest in the downstream part through Magellan Midstream Partners. This way you aren't at risk of losing all your income if oil prices drop significantly (on a side note, BreitBurn is very well hedged).

Foolish income
While BreitBurn may pay out a larger yield relative to its unit price, you should always diversify. Both these MLP's have sizable coverage ratios, so investors can sleep comfortably at night knowing that their income will keep rolling in. America's energy sector just got a huge shot of adrenaline, and with the revitalization of a major industry comes great investing opportunities.

We have identified 3 such opportunities here:

Record oil and natural gas production is revolutionizing the United States' energy position. Unfortunately, finding the winners to invest in can prove difficult. Thankfully, the Motley Fool is offering you a free, comprehensive look at three energy companies set to soar during this transformation in the energy industry in our special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 

The article 2 Safe Ways to Generate Cash Flow in the Energy Sector originally appeared on Fool.com.

Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends BreitBurn Energy Partners L.P. and Magellan Midstream Partners, L.P.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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