If there's one thing you have to expect in the energy patch it is volatility. Oil and natural gas are commodities driven by supply and demand -- and, often, geopolitical events. The price moves can be dramatic and swift, but there's a way to sidestep some of this industry-specific risk. That is why dividend investors might want to take a look at Enterprise Products Partners (EPD 0.02%) and Enbridge (ENB 0.38%) today.
1. Uncertainty
Geopolitical tensions are running high right now, resulting in tight energy markets. OPEC and its partners are adding to the stress by announcing plans to limit supply. The risk of a global recession, meanwhile, could result in a decline in demand that risks pushing oil prices lower even as Western nations are currently looking for more supply. In other words, it's hard to predict what is going to happen to oil and natural gas prices.
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The thing is, it's always hard to predict where energy prices are going. This period is stressful, but not in the least bit unique when you take a long-term view of the industry. Sure, the specifics are different, but history doesn't usually repeat, it just rhymes. So if you are an investor looking at energy stocks, you have to go in knowing that the risk of a business turn is always high.
2. Sidestepping the risk as best you can
That said, there is one niche of the energy sector that doesn't rely all that heavily on the price of energy. Midstream players like Enterprise and Enbridge own the energy infrastructure that helps to move oil and natural gas, and the products they get turned into, around the world. Midstream assets are generally toll takers, charging fees for use regardless of the price of the products passing through them. This creates a much more consistent cash flow stream than you'll find at an oil producer, where results are tied directly to commodity prices.
3. Solid income-producing histories
One of the main ways the consistency of midstream companies shows up is in the dividends and distributions they throw off. Enbridge and Enterprise are standouts. Enbridge, for example, has increased its dividend annually for 27 consecutive years. Enterprise's streak is 24 years. You simply don't build records like that by accident. Meanwhile, both Enterprise and Enbridge continue to invest in growth opportunities that should help to fuel continued distribution and dividend growth.
The yields here are also very generous. Enbridge's dividend yield is roughly 7.2%. Enterprise's distribution yield is around 7.6%. That's higher than you'll find at most energy producers, and, given the history of increases at both of these midstream players, there's not much risk of a cut. But to put that into better perspective, Enbridge's distributable cash flow payout ratio is a healthy 65%, and Enterprise's distributable cash flow covered its distribution by a huge 1.9 times in the second quarter.
4. Important differences
Why did Enbridge get a payout ratio figure and Enterprise a coverage figure? Because Enbridge is structured as a company and Enterprise is structured as a master limited partnership (MLP). There are different tax considerations here, with MLPs capable of generating tax-advantaged distributions (a portion of the distribution may be considered a return on capital, which doesn't get taxed immediately as it reduces the cost basis of the investment). However, MLPs don't play well with tax-advantaged accounts, so Enbridge might be the better option if that's where you have cash to invest. You need to consider the structures here before making a final selection.
The conservative way to play energy
All in, investors looking to add some energy exposure to their portfolios have to choose between accepting commodity risk or minimizing it. If you are a conservative dividend investor, Enterprise and Enbridge will probably be the way to go. They have impressive and long histories of rewarding investors with dividend and distribution increases, their yields are lofty, and volatile oil prices shouldn't have too much of an impact on their ability to keep paying shareholders and unitholders well.
