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 a shaky economy and despite the Obama administration's likely crackdown on speculators that 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. Lots of investors are looking toward names like Williams Companies (NYSE: WMB  ) , EnCana (NYSE: ECA  ) , and Suncor Energy (NYSE: SU  ) to lead a major rebound in natural gas.

But I, for one, have instead been loading up on specialty deepwater drillers like Transocean, and looking at other smaller oil-services companies like Global Industries (Nasdaq: GLBL  ) and Helix Energy Solutions (NYSE: HLX  ) .

I've even picked up shares of the Energy Select SPDR, which provides exposure to both oil and gas behemoths like ExxonMobil and lesser-known energy companies like Peabody Energy (NYSE: BTU  ) and Denbury Resources (NYSE: DNR  ) . Better yet, it pays a decent 1.7% dividend.

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 dividends expert, James Early, to ask him about the other way to play energy.

No, I'm not referring to dividend-paying energy companies like Halliburton or Schlumberger. Instead, I'm talking about a group of often-overlooked energy investments that make big money regardless of the price of oil and gas -- and that 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 or maintained its quarterly payout (called a "distribution" in MLP land) for 33 consecutive quarters. Granted, it has already shot up 75% since James recommended it last November -- but he still thinks it has another 30% or so of upside, and it pays a juicy 7% dividend.

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.

This article was originally published Aug. 28, 2009. It has been updated.

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


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