The Only Way to Play Energy Now

You and I both know it's coming ...

And when it does, millions of us will look back on the past year longingly. Meanwhile, a handful of us will look back triumphantly ...

$5 gas, here we come -- again!
That's right, I said it ... despite being smack dab in the middle of the "second great depression," and despite the Obama administration's likely crackdown on the speculators the Commodity Futures Trading Commission now blames for 2008's historic run-up.

Because let's face it -- over the long haul, demand for oil and gas will drastically outstrip supply. And the majority of that supply is controlled by a handful of obscenely wealthy foreign businessmen who, as old T. Boone Pickens points out, don't like us very much.

Point being, oil and gas prices will eventually recover -- and then soar to new highs. When they do, everyone's going to get pinched at the pump -- yet only a few will get rich.

Will you be one of them?
Frankly, that all depends on what you do right now. I've been loading up on specialty deepwater drillers like Transocean (NYSE: RIG  ) , and I've even picked up shares of the Energy Select SPDR, which counts oil and gas behemoths ExxonMobil (NYSE: XOM  ) , Chevron (NYSE: CVX  ) , and ConocoPhillips (NYSE: COP  ) among its top holdings.

I've also had my eye on smaller, specialty energy players like seismic data acquisition companies Dawson Geophysical and even tiny TGC Industries. They're both swimming in cash, trading near historically low multiples, and well-positioned to shoot higher when the price of oil and gas finally rises. Of course, there's only one problem.

You don't want to wait forever to cash in, do you?
Neither do I. So I sat down with our in-house dividend expert, James Early, to ask him about the other way to play energy.

No, I'm not referring to dividend-paying oil-services companies like Halliburton (NYSE: HAL  ) , Schlumberger (NYSE: SLB  ) , or Baker Hughes (NYSE: BHI  ) . Instead, I'm talking about a group of often-overlooked energy investments that make big money regardless of the price of oil and --and pay you big bucks to own them.

The only way to play energy now
You may already know that I'm talking about master limited partnerships (MLPs), but in case you don't, here's a quick rundown.

MLPs were born out of two Reagan-era tax reforms instituted to spur the development of U.S. energy infrastructure. Consequently, nearly all MLPs are involved in the transportation, storage, refining, or processing of oil and gas.

Yet MLPs charge by the volume of oil or gas they transport, refine, etc., so fluctuations in the price of the commodities have only a minimal effect on their earnings. And because they're organized as partnerships, they're not taxed on the entity level -- which, for reasons I'll explain in a moment, provides investors a huge tax advantage.

It also means that by law, they have to pay out the great majority of their earnings to their investors -- hence their ultra-high yields (typically from 6% to 10%).

You can buy MLPs online or through your broker, and they trade on major exchanges right along with regular dividend-paying stocks -- the one exception being that instead of shares, you purchase units, making you a unitholder, rather than a shareholder.

"For investors who want a lot of payout without a ton of risk"
That's how James Early describes these investments in the comprehensive MLP guide he recently put together for members of our Motley Fool Income Investor community.

One of the MLPs he's recommending is Magellan Midstream Partners. Though lesser-known than Kinder Morgan Energy Partners, Magellan actually operates the longest oil and gas pipeline in the U.S. -- a huge advantage when you consider that it more or less runs an oil and gas toll road.

Magellan is also flush with cash, and since going public in February 2001, it has increased its quarterly payout (called a "distribution" in MLP land) for 31 consecutive quarters. Granted, it has already shot up 53% since James recommended it last November -- but he still thinks it has plenty of room to run, and it pays a juicy 7.8%.

More good news
Because MLPs aren't taxed on the corporate level, you won't have to pay taxes on the majority of the cash you earn until after you sell the units, making it a great way to earn tax-deferred income.

In short, if you're looking for a way to cash in on energy right now, I'd look no further than Magellan Midstream Partners. It's just one of five MLPs, and more than 50 dividend-paying stocks, that James is recommending to Income Investor members.

You can get in-depth research on every single one, plus get James' comprehensive guide to MLPs absolutely free, by accepting a 30-day guest pass to Income Investor.

It costs nothing, and there is no obligation to subscribe. All you have to do is click here.

Austin Edwards owns shares of Transocean and Energy Select SPDR. Magellan Midstream Partners is an Income Investor recommendation. Dawson Geophysical is a Motley Fool Hidden Gems selection. The Motley Fool has a disclosure policy.


Read/Post Comments (15) | Recommend This Article (60)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 28, 2009, at 2:11 PM, plange01 wrote:

    the only energy play for now is in natural gas etf's.gas stocks have already been pushed up to high by speculators..the etf's follow the commodity itself which is at historic lows.with the light summer driving season ending and oil use dropping even more prices in oil stocks will fall back to spring levels.trash funds will be to afraid of going to jail to push prices up more than a few dollars...

  • Report this Comment On August 28, 2009, at 4:57 PM, TxTom wrote:

    Can someone tell me how UNG works? I would like to invest in NATURAL GAS now, but am not sure about the best way to do this.

    Comments please.....

  • Report this Comment On August 28, 2009, at 5:07 PM, CoastalTrader wrote:

    Thank you Austin. The pipeline avenue is very compelling as an adjunt to producer stocks.

    The emphasis of your argument should be NOW as in today (IMHO).

    I personally will be watching the producers, as well as something like SJT for an entry point. Probably in the end of September-October. NG (the commodity) is most definitely undervalued ATM, and the long term outlook looks to be very profitable.

    While I agree that the producers have rising gas prices baked into their respective prices, I also believe that an upcoming short-term correction will alleviate that obstacle.

    And kids, unless you really enjoy playing with fire, stay away, far away from UNG.

    Thanks again Austin. The pipeline play will definitely be part of my NG basket.

    CT

  • Report this Comment On August 28, 2009, at 5:38 PM, stan8331 wrote:

    I've been meaning to do some research on MLP's and add some to the portfolio. They do seem like an ideal income-focused investment - owning toll roads when there are massive barriers to the construction of free roads is a really good thing. Looked at Kinder-Morgan a while back and it seemed a little pricey - I'm sure there even better opportunities out there.

  • Report this Comment On August 28, 2009, at 5:47 PM, Fool wrote:

    Never read anything so stupid before. T Boone Pickens likes money, period and those foreigners, just like Pickens, want the most they can get for their oil. It has nothing to do with liking or not. The U.S is not in Saudi Arabia and Kuwait because they like them saudis and kuwaitis. They are there because of oil and money to be made selling those rich arabs all kind of weapons they don't need.

    As for oil, the world supply is 7% above the demand and with increasing demand from emerging countries like China, India,etc... we can expect a $200/bbl within 18 months.

  • Report this Comment On August 28, 2009, at 6:34 PM, RogueAccountant wrote:

    TxTom - UNG is an ETF and it closely tracks natural gas futures. If I were you I would stay away from it for now. If you really want to trade in the energy sector I would look into DUG (ETF - double short for Oil and Gas proshares). September has had, historically, the lowest trading volume, and this year it should be no different. Volumes will dry up, volatility will be chaotic and the market will undergo a correction/retracement. With that said, I see demand for oil contracting. If you play this ETF, do so only through September and I would close my positions daily (I'm assuming you know all that). Good Luck!

  • Report this Comment On August 28, 2009, at 9:59 PM, OldPyro wrote:

    Some of the things I've read indicate that holding MLPs requires filing K-1's for every state where they operate with your income taxes.

    The suggestion was to hold either Kinder Morgan Management - KMR or Enbridge Management to eliminate the paperwork.

  • Report this Comment On August 28, 2009, at 10:06 PM, TxTom wrote:

    Thanks for the info. Nat gas is a new venture for me. Seems to me it is underpriced relative to oil, but will wait and pick my spot. More research to do also.

    My success has been in the financial sector - several hundred percent since March. But I guess that's easy when all financials reached a "severely undervalued" state. It has been fun though.

    I believe HBAN is the next bank poised to go up substantially. C has been great, but is nearing book value now. About another 25% remaining. Mostly cashed out of BAC, FITB, STT, GS, etc.

    Still lots of bargains in this particular market.

    Happy investing!!!

  • Report this Comment On August 29, 2009, at 12:05 AM, tomd728 wrote:

    If you think NG is a rebound candidate you might want to look at CHK.

    Tom

  • Report this Comment On August 29, 2009, at 9:50 AM, NFLNostradamus wrote:

    The Spider seems like a safer way to go than the MLPs because of the international stake of the behemoths As far nat gas, this thing is a real logjam and IMO there's already been too much price put back into stocks based on anticipated price recovery and accelerated demand. I'm looking outside the box at this: UNG, maybe changes to the asset-backed part of its holdings improves its overall value and maybe the shares cap actually increases demand for the ETF. Also, a real dog on so many fronts - Dynergy - could be poised for takeove before all of it assets are sold.

  • Report this Comment On September 01, 2009, at 11:31 AM, theincidentalist wrote:

    Once the Cap-and-Trade bill becomes law (its a year out maybe?) natural gas will see a huge increase in demand...The US has so much of it and developers are getting better at extracting it.

    Once more natural gas is flowing around the country, you gotta love the fact that fan favorite in this field Kinder Morgan Energy Partners will only see revenue increase. I will be building a position once my personal short-term liquidity trap is over.

    -Hoffman

  • Report this Comment On September 03, 2009, at 11:40 PM, Lsurdi wrote:

    My broker tells me he sold MLP's twenty years ago and this investment, because of favorable tax treatment, is only for investor of high net worth!

    Comments?

    LouS

  • Report this Comment On September 04, 2009, at 5:28 PM, jumponit wrote:

    Two clarifications: the publicly traded MLPs are not restricted to HNW individuals. Many limited partnerships (not publicly traded) are restricted to "accredited investors", but not the likes of KMP, ETP, etc. They trade just like a normal stock.

    Second, the partnership files the K-1, the investor receives it and uses the information to include in Schedule E. Also, the distributions will likely be classified as return of capital, as opposed to taxable dividends.

  • Report this Comment On September 04, 2009, at 10:11 PM, TMFJamesEarly wrote:

    LouS,

    As jumponit has noted, MLPs are for everyday investors as much as for anyone else. The favorable tax treatment amounts to a deferral; in general, your return-of-capital payouts reduce your tax basis, and when you sell, the difference between your adjusted basis and the sale price is taxed at capital gains rates. You do pay ordinary income tax on your share of the accounting income (see the report for more clarity), and eventually pay a recapture tax on depreciation, but on the whole it's a nice tax break.

    And to be very, very clear, I'm just voicing thoughts and opinions, and not providing tax advice of any kind :-)

    Best,

    -James

  • Report this Comment On September 04, 2009, at 10:28 PM, Davigan100 wrote:

    And you can't possibly make your point without pushing yet another TMF subscription? How sad.

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