How to Build the Ultimate Portfolio For The U.S. Oil and Gas Boom

For a targeted yet diversified energy portfolio to ride the boom in U.S. oil and gas production, look no further than these ETFs and large-cap players.

Jan 14, 2014 at 4:25PM

At this point, there is no denying the energy revolution happening in the U.S. Among other things, 2013 was the year the U.S. surpassed Russia to become the largest producer of oil and natural gas in the world.

The trend may be massive and indisputable, but it's also new and requires a fresh perspective when building a portfolio.

Changing times require changing tactics
In the past, the fear of "peak oil" led most investors to look to holdings that would capitalize on static or decreasing supply that would pressure prices higher. In the U.S. today, though, the investment landscape is being defined by increasing supply as a result of fracking and other advanced extraction technology.

To find winning companies, think in terms of cubic feet
With increasing supply, investors should look to securities that will benefit from a boost in volume rather than prices. Toll collectors, in essence. 

One such exchange-traded fund that can do this is the iShares Transportation Average (NYSEMKT:IYT). The thesis here is simple, and it's one that led Warren Buffett to purchase Burlington Northern Sante Fe outright back in 2009. As increasing amounts of oil and gas are extracted from the ground, someone must transport that raw product to the refineries and then end users. Railroads in particular stand to gain handsomely from an increase in volume, regardless of the market price of a barrel of oil.

For those looking for an investment in a specific stock instead of the diversified ETF, the iShares Transportation ETF points to Union Pacific (NYSE:UNP), its largest holding at slightly more than 12%. 

Approaching this thesis from a different angle, we can look to the companies building the infrastructure to allow for an increasing volume of extraction. These companies build refineries, pipelines, and transportation infrastructure. The Industrial Select Sector SPDR (NYSEMKT:XLI) is a good proxy for these companies. 

The companies that make up this ETF are weighted toward very large, diversified conglomerates, with General Electric (NYSE:GE) and United Technologies (NYSE:UTX) leading the way. Companies of this size have the capital, the technology, and the expertise to deliver the required infrastructure at scale. 

While absent from the top 10 holdings of the Industrial Select SPDR, Kinder Morgan (NYSE:KMI) is a diversified, well-managed, and energy-focused company that is strongly positioned to prosper over the next several years.

U.S. oil and gas is here to stay
The U.S.' rapid ascension to the upper echelons of world energy producers took many by surprise. But after decades of oil dependence, the surge in oil and gas volume is breaking those shackles. Investors should allocate a portion of their portfolio to this sector; my personal preference is a targeted, yet diversified, approach with the ETFs and large-cap stocks above.

The story will be driven by volume; now is the time to start thinking in terms of cubic feet.

More stocks for the American energy bonanza

Record oil and natural gas production is revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a comprehensive look at three energy companies set to soar during this transformation in the energy industry. To find out which three companies are spreading their wings, check out the special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free. 

Fool contributor Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends Kinder Morgan. The Motley Fool owns shares of General Electric Company and Kinder Morgan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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