Instability in the Middle East always has an impact on the oil industry. Sometimes that impact is short-lived: Last year's drone strikes on Saudi oil facilities, for example, only caused a brief spike in oil prices. On the other hand, Iraq's invasion of Kuwait in 1990 -- and the subsequent seven-month Gulf War -- caused Brent Crude prices to jump 130%. They didn't return to their pre-war levels until late 1993.
Right now, it looks as though tensions between the U.S. and Iran are de-escalating, but that could change at the drop of a hat. With that in mind, oil investors would be wise to focus on companies that don't have significant Middle East operations, and which aren't as affected by fluctuations in oil prices.
Nothing but the pipeline
While oil producers and the oilfield services companies that work with them have stock prices that are heavily affected by oil prices, midstream companies -- those that operate pipelines and storage terminals -- tend to be more insulated from oil-price volatility.
Many midstream companies use a "tollbooth" model, in which customers pay a fixed rate -- set either by a long-term contract or government regulations -- to ship a certain amount of oil through the pipe. This type of "fee-based" income tends to be very reliable -- and lucrative. Midstream master limited partnership (MLP) Enterprise Products Partners gets about 85% of its income from this kind of fee-based arrangement, shipping not just crude oil but also refined products and natural gas through the pipelines in its network.
Enterprise uses this reliable income to churn out gobs of cash that it's required to return to investors in the form of distribution payments (similar to a dividend). Enterprise is a leader in returning cash to its unitholders, having increased its payout every quarter for more than 15 years. While Enterprise underperformed the S&P 500 last year, its current yield of 6.2% should keep investors happy as the company invests in projects to fuel future growth.
Refinery with a side of pipeline
Unlike oil producers and oilfield services companies, oil refiners may actually see a benefit when oil prices drop. That's because refiners make money on the so-called "crack spread" -- the difference in price between a barrel of crude oil and the refined products that the refinery produces from that crude.
Going into 2020, refiners are benefiting from a big change in maritime law. The United Nations' International Maritime Organization established higher fuel standards for the shipping industry, effective Jan. 1. Because cleaner-burning fuel is a premium product for which refiners can charge more, the refining industry stands to benefit.
One refiner that's looking particularly attractive right now is Dallas-based HollyFrontier. The company makes the bulk of its money from refining operations, but also derives some income from its MLP Holly Energy Partners, and from a small but growing lubricants business. Unlike many other refiners, Holly's valuation is on the low end of its historical range (lower is better), with a price-to-earnings ratio of 9.6 and an enterprise value-to-EBITDA ratio of just 5.1.
Holly has been a cash-generating machine lately, with free cash flow up 725% over the last five years. Management has been deploying that cash on acquisitions and its respectable-but-not-outstanding dividend, currently yielding 2.8%. With a low valuation and plenty of opportunity ahead, Holly looks like a compelling buy right now.
Refinery plus pipeline plus gas station
A final sector of the oil industry that's insulated a bit from crude oil prices is the filling-station industry, commonly referred to as "marketing." Many of the gas-station names you recognize are owned by refiners -- including Phillips 66, which operates stations under the Phillips 66, Conoco, and 76 brands, and refines the gasoline it sells there. The company even gets some income from a pipeline network through -- you guessed it! -- its MLP, Phillips 66 Partners.
Phillips 66 derives about half of its adjusted earnings from its refining and petrochemical businesses, with the rest coming in roughly equal proportions from its midstream and marketing. This diversification is a point in Phillips 66's favor.
Because it's primarily a refiner, the rationale for buying is the same as for HollyFrontier: The company generates gobs of cash, is poised to benefit from the new maritime rules, and has valuations near the low end of its historic range. However, valuations across the marketing sub-sector are fairly high right now. Perhaps because of this, Phillips 66's valuations aren't quite as low as Holly's. Phillips 66's price-to-earnings ratio sits at 10.5, and its enterprise-value-to-EBITDA ratio is 7.4.
Phillips 66's current dividend yield of 3.3%, though, is superior to Holly's, and the shareholder-friendly company has a long track record of annual dividend increases. It's a solid pick for those wanting broader exposure to all sides of the industry besides production.
There's always some risk
Of course, even oil industry companies that are more insulated from oil prices are still in the oil industry. Enterprise Products Partners, HollyFrontier, and Phillips 66 can still be affected by disruptions in global oil supplies, economic recessions, and other factors. But for those looking to invest in the oil sector in January, these three companies are top picks to outperform even if the price of oil does not.