Last week, the price of WTI crude tumbled from $66.42 to $62.46 (a 6% drop) in just a couple of days. When the price of oil drops sharply, so do the share prices of energy stocks. If you know the types of energy companies to buy, buying the dip will pay off handsomely.
The energy sector is divided into three subsectors: upstream, midstream, and downstream.
Upstream energy companies are the ones drilling for oil and gas. While they can hedge a portion of their production, the fortunes of upstream energy companies are closely tied to the prices of crude oil and natural gas.
Downstream energy involves refining crude oil and natural gas into fuels and chemicals. Refiners face a double challenge because the costs of their inputs, crude oil, and the prices of their outputs, gasoline, diesel, and jet fuel, are set by the commodity markets. Profits for refining companies can swing wildly.
Midstream energy companies, however, operate with a very different business model. These companies own and operate natural gas processing plants, pipelines, and storage terminals. Midstream revenues are derived from long-term contracts with upstream and downstream companies and are mostly immune to market swings.
Midstream companies are organized as either master limited partnerships or corporations. Before 2014, when the Saudis crashed the price of oil, most midstream companies were set up as MLPs. The entire energy sector was turned upside down, and it took several years to get things back on track. Currently, the majority of midstream companies are corporations, but MLPs continue to play a significant role.
Investors buy shares of midstream companies for the attractive yields and growing dividends. The cash flow to pay dividends is not dependent on fluctuations in energy commodity prices.
This means that when the energy sector tumbles due to falling oil prices, it’s an excellent opportunity to pick up midstream dividend income streams “on sale.”
My go-to investment when the market gives us a deal on midstream is the InfraCap MLP ETF (AMZA). This ETF owns midstream corporations as well as MLPs. Dividends are paid monthly. The current yield is 8.4% and the dividend growth has been 8% to 9% per year. I got very excited when the share price dropped by more than two dollars last week and I got to buy the dip. Don’t be afraid to pick up shares anytime there’s a drop in price. It’s like buying stocks on sale… and who doesn’t like a sale?
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