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.

$4 gas, here we come -- again!
That's right, I said it: $4 gas will be back, despite a shaky economy and 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. I, for one, have been loading up on specialty deepwater drillers such as Transocean and looking to other lesser-known drillers such as Atwood Oceanics (NYSE: ATW  ) and Diamond Offshore (NYSE: DO  ) .

I've even picked up shares of the Energy Select SPDR, which counts oil and gas companies such as Anadarko Petroleum (NYSE: APC  ) , Apache (NYSE: APA  ) , and Marathon Oil (NYSE: MRO  ) among its top holdings.

I've also had my eye on smaller, specialty energy players -- for example, seismic-data-acquisition companies Dawson Geophysical and tiny TGC Industries. They're both swimming in cash and are 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 oil-services companies such as Halliburton, Schlumberger, or BJ Services (NYSE: BJS  ) . 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, and so on, 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 put together for members of our Motley Fool Income Investor community.

One of the MLPs he's recommending is Magellan Midstream Partners. Though not as well known as Kinder Morgan Energy Partners (NYSE: KMP  ) , 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 doubled since James recommended it last November -- but he still thinks there is plenty of upside, and it pays a juicy 6.1% 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 these investments 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 four MLPs, and more than 50 dividend-paying stocks, that James is recommending to Income Investor members.

You can get access to 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. To learn more, simply 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. Atwood Oceanics is a Motley Fool Stock Advisor recommendation. Dawson Geophysical is a Motley Fool Hidden Gems selection. Magellan Midstream Partners is an Income Investor recommendation. As always, The Motley Fool has a disclosure policy.

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  • Report this Comment On March 26, 2010, at 3:38 PM, Boscobomber wrote:

    Bold prediction but it ain't gonna happen. First of all, there is (and was not before) any supply disruption of crude products. Folks, we are swimming in oil reserves as new finds are taking place around the globe. Second, in the space of two years, more efficient vehicles are on the road today (and this upcoming summer) than two years ago. This does have an impact. Unless there is an attack in the ME or other event caused by Mother Nature, there is no reason for high oil prices. Within a few years, Iraq may be adding 2-5MM barrels per day on the market due to the under-developed Giant Oil Fields near Basra.

    On a side note, I do own BP & ExxonMobil stock and will be looking to buy Marathon in the near future. Look for oil companies that are on the cutting edge of energy technology - whether oil sands, solar, wind and micro-biology as well as good ole fashioned drilling companies with large reserves and the means to transport the products to market. Paying good dividends helps as well. But, please - spare me the $4 gallon of gasoline - this is all by speculation not by pure and simple economics of supply and demand. Demand is down and supply is plentiful - no reason for $4 gasoline.

  • Report this Comment On March 26, 2010, at 7:23 PM, leeirony wrote:

    I agree except your Demand and Supply is based on a free market. Soon we may have OBAMARKET, which is anything but free. Their whole point is to make energy more expensive and tax it more, along with everything else. We shall see.

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