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Shale boom drives surge in equity issuance

A flare in the Montney shale gas formation of British Columbia

The U.S. shale boom has come to Wall Street with new share issuance associated with the sector driving equity capital market activity this year.

Investment vehicles known as Master Limited Partnerships (MLPs) that buy and develop gas and oil assets have raised $4.3-billion (U.S.) through share issuance this year. That is almost a third of the record $13.8-billion raised by the sector last year, and accounts for 20 per cent of all U.S. equity capital raising in 2012, according to Dealogic.

MLPs gather assets that provide steady cash flow and seek to make regular dividend-like payments to their investors. With natural gas prices at decade lows, many energy companies are looking to sell their gas assets to fund exploration for higher value shale oil deposits, creating buying opportunities for MLPs.

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"MLPs are enjoying a perfect storm: the shale boom means there are a lot of mature gas assets available, while they can issue equity easily because investors value their payouts in the current low interest rate environment," said Ethan Bellamy, an analyst at RW Baird.

"However, if natural gas prices do not recover, investors could be disappointed by the level of returns in future years," he added.

A third of the cash has been raised by MLPs that buy up oil and gas fields, where reserves have been proved, and production costs stabilized.

Linn Energy, for example, raised $700-million in January in the largest MLP share issuance so far this year and then purchased a natural gas field in the Hugoton Basin in Kansas from BP for $1.2-billion.

The company says it has purchased derivative contracts that lock in a natural gas floor price for the next five years, guaranteeing some profit as long as production costs do not rise substantially.

However, MLP hedging strategies have been undone by commodity price falls in the past. For example, Constellation Energy Partners , another MLP that invests in natural gasfields, saw lenders reduce credit lines during the financial crisis, as the natural gas price fell rapidly, reducing the value of its outstanding reserves.

Constellation was forced to stop making dividend payouts in early 2009, and its share price has fallen from above $40 (U.S.) in 2007 to less than $3.

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Most of the remaining cash has been raised by MLPs that buy or build oil or gas pipelines, and use the charges levied for using the pipelines to fund regular dividend-like payouts. The rapid increase in production in isolated shale oil and gas plays has led a to a surge in pipeline construction to connect the new fields to consumers.

Investors are receptive to MLPs in large part because of their steady cash flow that generates strong dividends. Some corporate bond funds are seeking to capture yield against a backdrop of historically low rates on US Treasuries.

"We believe that onshore natural gas shale and oil shale developments are creating opportunities to invest in energy companies that may grow significantly faster than the overall U.S. economy," said Mark Kiesel, managing director at Pimco. "Growth, high yields and growing distributions in the pipeline sector are attracting new equity investment, while rising volumes and free cash flow are expanding asset coverage for bond holders."

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