U.S. energy development could be the single most important driver of economic growth in America over the next 25 years. The idea that the U.S. has become one of the largest oil and gas producers in the world will continue to drive investment and prosperity well beyond just the oil fields.
Capital expenditures and investments should continue to swell, resulting in numerous other industries thriving on demand for equipment and technologies to expand production and efficiencies. And the expansion will mean more jobs and rising consumer demand — fueling the economy towards further growth. In November 2017, the International Energy Agency (IEA) issued a forecast that U.S. crude-oil production will soar to 17 million barrels a day by 2030 from the current 11.9 million barrels per day. And the U.S. Energy Information Agency recently forecast that the U.S. will become a net oil exported by 2021.
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Now, this is not without the risk of supplies threatening prices. But as we seem to see, even with lower crude prices in prior years of 2015-2016, shale field efficiencies continue to improve. This means the cost of lifting oil and gas out of the ground could be much lower than in the last decade. Aiding prices though is the continued proof of the Organization of Petroleum Exporting Countries Plus Russia (OPEC+) reducing production per their agreement. The proof comes from tracked shipping from member nations.
But while there are opportunities in the production or upstream segment of the market, there’s another area that shows lower potential price and supply risk than producers.
My favorite part of the energy sector, which enjoys a collection of stocks in my Profitable Investing model portfolios, is the pipeline and storage terminal business. These outfits operate a steady, utility-like “toll taker” business — still sensitive to the price of oil and gas, but not to the same extent as a producer or refiner who buys or sells crude would be.
And my favorite among the pipeline companies are master limited partnerships (MLPs). With their rich quarterly cash payouts and tax advantages, MLPs are a kind of “wealth in the ground” investment.
However, there are certain tax complications if you own MLPs directly. Limited partnerships send you a K-1 form at tax time instead of the usual 1099 for dividends. The K-1 is a fairly straight-forward document that for a long time, many investors needed the help of a professional tax preparer to help place all the numbers in the right slots on their returns. However, most tax software programs these days make K-1 forms pretty much plug and play.
Furthermore, I don’t recommend holding individual MLPs inside a tax-sheltered retirement account. Because of a quirk in the tax law, Uncle Sam may deem part of your MLP earnings to be Unrelated Business Taxable Income (UBTI). Inside a retirement account (yes, even a Roth IRA), you’ll owe income tax on any UBTI credited to you above $1,000 a year.
The solution to both of these problems is to invest in MLP funds — particularly closed-end funds, but also some open-end funds and exchange-traded funds (ETFs) that are not partnerships themselves, but corporations that invest in partnerships (and, as such, pay taxes, but at the reduced corporate level, as do most ETFs).
One MLP fund that has been a longtime Profitable Investing favorite of mine is the Alerian MLP ETF (NYSE:AMLP), which delivers exposure to the Alerian MLP Infrastructure Index, a capitalization-weighted composite of MLPs in the storage terminal and pipeline businesses. AMLP is unleveraged and totally eligible for IRAs and will give you a shot at earning exceptional returns from a deeply undervalued market sector — you’re looking at nearly an 8% current yield from exposure to a multiple of leading U.S. MLPs.
And over the past trailing year alone, the ETF has generated a total return of 18.12%.
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The largest holding in AMLP is Enterprise Products Partners (NYSE:EPD), a holding in my flagship Total Return Portfolio, also acknowledged as one of the strongest and safest pipeline partnerships, and another MLP that increased its quarterly distributions on average by nearly 5% per year over the past five years (it has either maintained or increased them for more than 50 quarters in a row). And the stock is a particularly good bargain as it’s trading at a mere 1.7 times trailing revenues and just a bit more than twice its book value, which, given the limitations for new construction, makes it even more compelling to own.
Another of the largest holding is Magellan Midstream Partners, L.P. (NYSE:MMP), a stock in my Incredible Dividend Machine income portfolio — a superbly managed pipeline partnership with a rock-ribbed balance sheet that managed strong business momentum and a 12% increase in its payout over the past five years (a period of severe testing for the oil-and-gas industry). The company has wide operating margins at over 42%, making for great efficiency. And the debts are controlled at only 6% of assets.
If you’re an investor with a time horizon of three to five years, or longer, I think you’ll be very pleased with the returns you chalk up on high-quality energy assets purchased at today’s bargain prices in the Alerian MLP ETF.
You’ll be receiving a near 8% yield on your investment while you’re watching your shares of the ETF appreciate in value as the U.S. petroleum market further develops and expands.
Neil George is the editor of Profitable Investing and does not have any holdings in the securities mentioned above.
