High-Yield Energy Stocks

Energy Strategist (07/26/2010)
Fed Chairman Bernanke has made it abundantly clear that rates will remain accommodative for some time; paltry yields on U.S. government debt, savings accounts and CDs are here to stay. Fortunately, the energy sector offers several alternatives for yield-hungry investors. MLPs and tanker stocks are two of my favorites.

MLPs are among the market's most best long-term performers: The benchmark Alerian MLP Index is up more than 700% since its inception; over the same period the S&P 500 is up roughly 130%. And prior to the crisis-induced action of 2008, the index's worst year involved a drop of slightly less than 8%.

But credit conditions eased in early 2009, and fears of major capital constraints never came to fruition. In fact, energy-focused MLPs gained access to credit before many other groups; most MLPs own and operate stable, fee-based assets such as pipelines and storage facilities for natural gas. Last year the Alerian MLP Index soared 76.5%. . .the fundamentals remained strong, and fears of a credit freeze were overdone; the selloff represented an outstanding buying opportunity.

Many readers are asking if it's too late to invest in our recommended MLPs now that the Alerian MLP Total Return Index has touched new all-time highs. Broadly speaking, MLPs don't appear to be overvalued; the graph below provides a closer look.

The oil tanker business is notoriously volatile because tanker rates fluctuate with demand for oil and the availability of ships.

Nonetheless, with global oil demand recovering, I expect the back half of the year to be a solid environment for tanker companies. Moreover, many stocks in the group offer substantial dividend yields—a great source of returns amid volatile and uncertain market conditions.

Tanker companies don't make money from rising oil prices. Tanker rates have no direct relationship whatsoever to energy prices; rates depend on demand for oil transport.

Gue energy


At present, the Alerian MLP Index yields roughly 6.7%, down nearly 100 basis points (1%) from its May lows. This doesn’t mean that MLPs have cut their payouts; rather, the rally in the Alerian MLP Index caused the yield to decline. With the yield on a 10-year U.S. Treasury at about 3%, the Alerian MLP Index offers slightly less than 400 basis points (4%) more yield than the 10-year Treasury.

Most MLPs own midstream-energy assets such as pipelines, storage facilities and gas-processing plants—operations that produce steady cash flows and are somewhat insulated from economic conditions and commodity price.

As most investors are well aware, U.S. oil demand collapsed during the 2008-09 recession. But weekly data from the Energy Information Administration indicates that U.S. oil demand is up roughly 3% from a year ago, led by a nearly 11% YOY jump in jet fuel demand.

Because major oil consumers. . .are also big importers, strengthening global oil demand spells rising rates for tanker shipping services. Roughly 90% of all OPEC-produced oil is shipped on tankers; an uptick in OPEC oil production means a lot more for tanker demand than rising non-OPEC output. When OPEC increases its output quotas, tanker companies reap the benefits.

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