It’s Time to Buy These Energy Stocks

Dividend Investing, Master Limited Partnerships (MLPs), Undervalued Stocks

I heard a term today: “Stealth bear market,” and the energy sector is definitely experiencing one, but the recent drop in crude prices have pulled away the “stealthy” part. I cover the master limited partnership –MLP– type of companies that operate in the energy sector, and values have been hammered across the board, pointing to a fear driven sell-off that does not reflect the longer term prospects of these companies. If you own energy stocks, or are looking to get in near a bottom, the information presented here is very important.

Not Just Crude Prices

The best sign that energy MLPs are in a fear-driven bear market is the fact that almost all share prices are down a lot. In reality, there are many different subsectors in the energy space, and many will either not be affected by lower crude oil prices or even be more profitable with lower crude prices. In the first case, consider Williams Companies (NYSE:WMP) and Williams Partners LP (NYSE:WPZ). The Williams duo is almost entirely in the natural gas gathering, processing, and transporting business. No crude oil exposure at all. Yet, WMP is down 15% in the last month after rejecting a $64 per share buyout offer. In the second case, crude oil is falling, but you have probably noticed that fuel prices have not followed over the last month. This means that refiner profits are going to be high for Q2 and even higher when third quarter results are reported. CVR Refining LP (NYSE:CVRR) is an MLP that owns two Midwest refineries and pays a variable quarterly distribution based on profitability. CVRR is down 10% over the last three months, even though cash payments to investors should be 4% to 5% or higher for each of the next two quarterly payouts. These are just two examples of how investors can profit from the energy related sell-off, and in the rest of the article, I go over why there is a strong bull case for the oil sector in the long-term.

Crude Oil is Not a Global Business

The financial press and investing public view the crude oil production business as a global confluence of production rates and demand. The recent drop in crude is due to about 1.5 to 2 million barrels of daily production above the global consumption of about 90 million barrels per day. In reality, the global production market needs to be viewed as about three separate systems.

  1. All of the production growth over the last half decade has come from North America. Total daily production from the rest of the world has been flat to slightly falling. The growing production here has reduced demand for oil from those areas where U.S. used to source crude, Nigeria as the primary example. Also since U.S. companies are prohibited from exporting crude, excess production readily shows up as a building inventory in the U.S.
  1. Saudi Arabia stands alone as a country that can increase or decrease production rates to affect crude prices. However, the Saudis seemed to have maxed production levels at about 10 million barrels per day. At the same time, in-country energy consumption is growing rapidly, reducing the crude available for export. Also, the Saudi governmental budget needs $100 per barrel oil to not run at a deficit. Currently, the country’s very large –but not unlimited– sovereign wealth fund is covering the budget deficit. It is a big question how long the Saudi’s will be willing to live with $50 oil.
  1. The rest of the world. This is where falling production will soon reverse the global over supply of crude oil. Consider these recent quotes from sources like the Wall Street Journal and the Financial Times.

“Oil companies need to replace between 5% and 8% of crude output each year just to offset shrinking production from old wells, analysts estimate. But only six major oil projects world-wide received a go-ahead last year, compared with an average of more than 20 a year from 2002 to 2013,” according to Deutsche Bank.

“As oil prices slump for a second time this year, the world’s biggest energy groups have shelved $200 billion of spending on new projects in an urgent round of cost-cutting aimed at protecting investors’ dividends,” FT reports.

“Falling crude production in areas including Colombia, Norway and northern China is posing a long-term supply-growth threat, even as the U.S. and the Organization of the Petroleum Exporting Countries flood the world with oil. The International Energy Agency said non-OPEC supply growth would “grind to a halt” in 2016, with output due to fall in Russia, Mexico, Europe and elsewhere.”

“One example is BP’s 30% stake in Indian oil and gas fields operated by Reliance Industries Ltd. The project is stalled, production there has dropped 80% since 2010 and it has required more than $1 billion to stem further declines. The company also faces political hurdles in Russia.”

For the non-U.S. crude production areas and crude dependent countries to start investing enough to stop the upcoming production decline, crude oil needs to climb back up to the $100 per barrel range. At some point in the near future, the markets will suddenly be surprised by an energy market with lower production than consumption rates and the prices of crude oil will start to climb.

Another piece of the puzzle is the selling of MLPs by different types of funds. The MLP sector was hot in 2013 and 2014, and billions of fast profit money flowed into these funds. Now that prices are falling, investors are bailing out of funds, leading to forced selling and falling MLP values. This video of a recent Jim Cramer rant does a pretty good job of explaining, in that unique Cramer way:

The discussion above does not mean that MLPs and energy stocks have yet hit a bottom. There may be more months of ugliness for investors. My point is that there must be a recovery in energy prices and related stock values at some point in the upcoming few years. When the turn will come is anyone’s guess. In the current market I recommend that my subscribers continue to average into shares/units of high yield energy companies with strong dividend growth potential in both the current energy price environment and when energy commodity prices again move higher.

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