Energy prices recently had a big run up, started to pull back, and could remain pretty volatile for a while based on renewed geopolitical conflicts. That has a material impact on the share prices of energy producers, where revenues and earnings rise and fall along with energy prices. But you don't have to play that game if you want to add some energy exposure to your portfolio.
With just a couple of hundred dollars you could buy reliable passive income stocks like Enterprise Products Partners (EPD 0.45%) and Enbridge (ENB -1.21%).
Volatility is the energy norm
When it comes to oil and natural gas, highly cyclical price moves aren't an outlying event. These two commodities have a long history of rising and falling in swift and dramatic fashion. Economic activity is part of the story, with recessions depressing prices and growth pumping them up. But there's also supply and demand, with OPEC playing a major role in global production levels.
And then geopolitics is a major wildcard, with regional conflicts in energy-producing regions often spurring investor concerns about supply disruption. You can't avoid the commodity price volatility.
Image source: Getty Images.
However, the energy sector isn't just about production. It spans from what is known as the upstream (drilling) through the midstream (pipelines) and to the downstream (refining and chemicals). Downstream companies can be just as volatile as upstream companies. Not only do energy prices impact operating costs, but the fuels and chemicals created are also commodities subject to their own ups and downs. The standout here is the midstream.
Midstream companies own the infrastructure that helps to move oil, natural gas, and the resulting products around the world. The energy industry couldn't operate without the midstream assets that companies like Enterprise Products Partners and Enbridge own. It is expensive to build this infrastructure, but once it is built the pipelines, storage, and transportation assets provide years of reliable cash flows.
The key here is that most midstream companies charge fees for the use of the assets they own. Even when oil prices are low, demand for midstream assets tends to remain fairly stable. The downside of this relationship is that midstream companies don't really benefit from high oil prices, so the upside is limited. But for an income-focused investor that probably won't be too big a deal.
Two of the biggest players in North America
To put a number on the income appeal here, Enterprise Products Partners' distribution yield is a hefty 7.4% while Canada's Enbridge is yielding 8.3%. Those are some big numbers, considering that the S&P 500 index is yielding a scant 1.5% and the average energy stock, using the Vanguard Energy Index ETF as a proxy, is yielding roughly 3.3%.
Before you jump aboard either of these midstream giants, however, you need to understand a few nuances. For example, Enbridge's dividends are paid in Canadian dollars, so the actual dollar amount a U.S. investor collects will vary along with exchange rates. Also, U.S. investors will have to pay foreign taxes on the dividends, though they can be claimed back come tax time.
Meanwhile, Enterprise is a master limited partnership (MLP). That's a special corporate structure that comes with some tax benefits, but requires extra work when you file taxes (notably, you'll have to deal with a K-1 form). In fact, if you own MLPs you might want to consult a tax specialist.
Beyond the basic structure of each of these midstream players, there are some business differences as well. For example, Enterprise is completely focused on moving energy commodities around the world. Enbridge also owns regulated natural gas utilities and has a renewable power operation.
Although both companies produce reliable cash flows, they are different from oil and natural gas pipelines. That could be viewed as adding diversification or as diluting the company's energy exposure, depending on how you view things. Still, when it comes to dividends, Enbridge has the better track record with 28 consecutive years of growth. That said, Enterprise isn't far behind at 25 years.
Income investors will be pleased
Both Enterprise and Enbridge can be had for less than $50 a share. And you'll be able to cash in on a reliable income stream with either one. But investors need to go in with their eyes open -- the yield is going to make up the lion's share of your return.
Given the global shift toward clean energy and the fact that the oil and gas sectors are already highly developed, there's just not a huge amount of growth potential. But considering the vital importance of these fuels to the world, there should be years of reliable dividends ahead just the same.
