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Investing in Low Oil Prices

A Three-Pronged Strategy to Follow

Written by Brian Hicks
Posted December 8, 2014

In November, the Eagle Ford formation in South Texas produced its billionth barrel of oil.

Unfortunately, many followers of oil and gas news let this milestone slip through the cracks and instead focused on low oil prices and oversupply fears.

But the story is an integral piece of the complicated geography that is the world oil market.

The Eagle Ford's continued growth during the bear market suggests soaring production and low demand aren't hurting all energy investments — no matter what herd investors do.

Think about it: Could Eagle Ford companies still produce if they lost money on every barrel?

The answer is no.

This means there are stocks getting hit by low oil prices unfairly.

For you and I, it means undervalued investments that are ripe for the picking.

So I figured I would provide you with a simple three-pronged strategy on how to invest successfully in energy during this bear market.

Costs Change by the Wellhead

The first step is to find the companies that can still profit comfortably.

According to Wood Mackenzie, a leading industry research firm, 70% of the billion barrels in Eagle Ford oil came in just these last two years.

And in 2015, the shale will produce 2.8 million barrels of oil per day.

So it looks like oversupply will still be the status quo next year unless something drastic occurs that affects world oil production. But neither I nor anyone else can predict such a black swan event.

Thus, logic dictates that oil prices will remain steady or move lower.

But if producers in the Eagle Ford can still grow production, then oil prices must still be higher than the cost to harvest it.

Wood Mackenzie confirms this when it says, in the same report, that in certain areas of the Eagle Ford, drillers can break even at $49 per barrel — much lower than the current $70 per barrel price for Brent crude...

Brent

However, the firm also said that in the fringe areas of the Eagle Ford, where wildcatters are praying to strike oil (and piling up debt), break-even prices are over $100 per barrel.

So locating the companies that can still profit comfortably without taking on more debt is of the utmost importance.

High-Yield Cushion

The second step is to narrow this down to companies that pay high yields.

Over the last few months, these were some of the only energy companies to see any price growth.

An example is Midcoast Energy Partners LP (NYSE: MEP). On Friday, the company was up over 10%.

Midcoast

Despite the overall losses in the commodity market, the company reported a great financial third quarter and forecast a 71% increase in distributable cash flow for next year.

When a company pays out so much of its cash in dividends (Midcoast currently pays 8.6% per share), investors are bound to flock to it when other energy investments tumble.

Also, you can't help but get excited when a company forecasts so much distribution growth in such a short time.

Of course, I should be clear that Midcoast isn't an oil investment — it's actually a midstream company with natural gas and natural gas liquids pipelines and infrastructure throughout Texas and parts of Oklahoma.

But this is still an important piece of our strategy, which brings me to the final part...

Always Look Long Term

Part of the reason some oil companies — even in the Eagle Ford — are struggling with debt and high costs is that those firms lean too heavily on high oil prices.

When WTI prices were over $100 a barrel, many drillers were selling natural gas and other less-profitable assets to buy oil acreage for huge premiums.

But with oil prices down, these companies have bitten off more than they can chew. Now, they will either have to transition back to gas or wait for oil prices to go back up.

Investors should learn from these mistakes and always look to the long term. And that's part three of our strategy.

For years, the commodity poised for the most growth in the U.S. has been natural gas. We produce more than we ever have, coal-fired power is getting crushed by regulations, and natural gas exports are now just a year away.

If you add all three parts of this strategy together, you get this: Buy stock in companies that are consistently profitable, pay high yields, and can maintain those high yields for a long time.

And in today's economic environment, natural gas midstream companies such as Midcoast are the cream of the crop.

Good Investing, 

alex-martinelli-signature

Alex Martinelli

With an eye squarely focused on the long-term, Alex Martinelli takes the art of income investing to a higher level within the energy sector. His research has helped hundreds of thousands of individual investors identify well established companies that have a long history of paying out dividends to their shareholders. For more info on Alex, check out his editor's page.

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