With oil prices falling, investors have turned bearish on exploration and production companies. The reason is simple: as oil prices fall, oil production companies earn less for every barrel sold. However, their cost of production remains the same. This results in shrinking profit margins.
It makes sense that oil stocks are falling. The following one-year chart shows the close correlation between crude oil prices and oil stock prices. The red line shows United States Oil ETF (NYSE: USO). The blue line tracks the performance of the SPDR S&P Oil & Gas ETF (NYSE: XOP).
Crude Oil Takes Down Energy Stocks
Source: Yahoo! Finance
I’m bullish on America’s energy independence. It’s clear that excess oil supply from North America is pushing crude prices lower.
Lower prices may become the norm. That’s bad for companies that are in the business of producing oil. But a select group of energy companies will continue to thrive.
Those companies are Master Limited Partnerships, or MLPs. I’ve written a lot about MLPs in past issues of Income & Prosperity.
MLPs service the energy sector by providing pipelines, processing plants, storage, and refineries. They provide important infrastructure that allows exploration and production companies to operate. These businesses are capital intensive. It takes a lot of money to build oil pipelines or storage facilities.
Many MLPs service the energy sector with long-term contracts. They’ve agreed to provide a service for a specific fee. And that fee structure remains in place, whether oil is at $70 per barrel or $100.
My favorite MLPs profit from the growth of oil and gas production. And their profits aren’t dependent upon high oil prices.
For income investors, MLPs are a better investment than the big-oil companies. The main reason is that MLPs are required to pay out healthy dividends to their shareholders. By doing so, they’re able to avoid paying federal income taxes.
The JPMorgan Alerian MLP (NYSE: AMJ) is an exchange-traded note that tracks a popular index of MLPs. It pays a 4.4% dividend. That generous compared with a 0.8% yield from the S&P Oil & Gas ETF or the 2.9% dividend from Exxon Mobil (NYSE: XOM).
MLP share prices took a hit in October. At one point, they were down more than 15% from their highs. They’ve since recovered much of that decline. The JPMorgan Alerian MLP ETN is now trading about 6.5% below its high.
MLP Drop Creates Buying Opportunity
Source: Yahoo! Finance
Because MLPs are down from their highs, that creates a buying opportunity for income investors. I recommend focusing on MLPs that are in the pipeline business. Specifically, I like MLPs that don’t have their profits tied to the price of crude oil.
This article is brought to you courtesy of Ian Wyatt from Wyatt Investment Research.