It’s like one of those dreams where you’re free falling, but right before you hit the ground, you wake up startled and sweaty.
After more than half a year of steady and continuous decline, the price of crude oil has yet to hit a bottom and rally. We’re still falling in this nightmare…
Of course, it’s not a nightmare for everyone. Most people, myself included, are pleased to see the price of gasoline at the pump at its lowest in a long time. But, I also know that if oil prices go too low, the energy industry could drastically change.
That means that investments in energy, especially U.S. shale and other expensive forms of production now carry much more risk for investors than they did not six or seven months ago.
The cost per well for shale drilling operations changes from well to well and company to company, but many people realize that if prices continue to fall further into the $40 per barrel range, there could be consequences.
I’ll admit that U.S. producers are still in better shape than those in Venezuela, Nigeria, and Russia, who face consequences beyond just faltering investments: failing government programs, social unrest, protests, and terrorist attacks among them.
However, that doesn’t mean we should hold our noses and watch our North American energy investment implode in our portfolios. Instead, it might be time to find a way to benefit from the drop in oil prices.
If you’re not familiar with my investing strategy, it’s very very simple: invest in profitable companies that stand to gain big over long periods of time. It’s best to buy these companies when they are trading below their typical value.
For example, McDonald’s (NYSE: MCD), the massive fast food conglomerate, saw its stock price plummet below $15 in 2003. Investors who bought and held shares would be up nearly 500% today.
So, when a profitable company that has a history of profit and growth loses some share value, it is usually beneficial to pick up some shares and see if the price grows again.
This same philosophy works with energy, especially oil and gas.
Right now oil prices are the lowest they’ve been in five and a half years, and because of this oil companies are making less money which means investors see shares of these companies as less valuable.
Now that prices are lower, the opportunity to buy is close, if not here already. It’s impossible to predict if the price will collapse further, but what we can say is that, no matter what, over time, the price of oil will go up.
That’s simply the nature of commodities. We may be oversupplied now, but as demand rises or supply decreases the price will go up again. It’s just a matter of time.
Investing now, in companies with proven track records and low risk of failure is a great way to set yourself up for longterm gains in the energy sector.
However, I understand that it may feel counterintuitive to put money into something that’s losing value on the open market. So, recently, my approach has been to find companies that still offer upside when the market is down. Enter: high yield investments.
In today’s price environment especially, it’s essential for investors in energy to find companies that are still making money, still growing, and that offer high yields. When the stock price goes down, you’ll still be able to find returns from dividend checks.
A popular investment for this is a master limited partnership. These are natural resources companies that operate similar to REITs. They pay no corporate income tax as long as they payout at least 90% of profits as dividends to shareholders.
That means that, unlike regular stocks like McDonald’s or Apple, the dividends are much higher because a level of taxation has been removed from the total distribution.
In a lot of cases, MLP companies can pay dividends in the double digits. And now that oil prices are low and the stock prices are lower on these high yielding MLP companies, it seems like a good time to start investing in master limited partnerships.
This way, while oil prices are low, you’ll still make money from the large dividends, and when prices creep back up, you’ll see shares return to their true market value on top of that.
If you’re looking for a list of decent MLPs, you can check out the holdings in the Alerian MLP ETF (NYSE: AMLP), or, if you’d like more specific choices, you can take a look at a recent portfolio developed by my colleagues Keith Kohl and Christian DeHaemer.
In it you’ll find MLP companies and other sources of valuable intel.
Good Investing,
Alex Martinelli
