When investing in energy companies, you must be prepared for the occasional price collapse. These past several months have offered a prime example of this danger, but it isn't the first time this has happened. In making long-term investments in this space, you should look for the right companies that can survive a downturn and even (better yet) take advantage of cheap oil.
We gave our analysts a hypothetical situation: What company would you hang on to if the price of oil fell all the way to a measly $10? Here is what they said.
Dan Caplinger: One of the most misunderstood things about energy companies is that they don't all rise and fall with the price of oil. Indeed, for refiner Valero Energy (NYSE:VLO), falling oil prices can be a good thing, especially if they come from lower-priced domestic crude supplies that offer a big price differential to other global sources of oil.
Valero's strategy in recent years has been to buy relatively cheap U.S. crude oil at a discount, refine it into gasoline and other products, and then sell those products both inside and outside the U.S. market. Because refiners are allowed to export their products freely, the prices Valero gets for selling gasoline and diesel are based on the global market, which have been consistently high. Moreover, demand for those refined products has remained elevated, as low prices have spurred vehicle owners to use more fuel, thus supporting Valero's sales volumes.
The main question for Valero isn't so much whether oil drops to $10 but rather whether the spread between domestic and international crude prices narrows. Valero is vulnerable to a disappearing spread, but as long as it can get its feedstock cheaply, it should be able to capitalize on cheap oil well into the future.
Jason Hall: Cheap oil prices are hurting many petroleum producers right now, but it's important for investors to remember that demand for oil and oil products is still growing. Furthermore, demand for natural gas and natural gas liquids, or NGLs, is also incredibly strong. With that in mind, investing in companies that gather, transport, and store these commodities is a great way to go.
ONEOK (NYSE:OKE) is one of my favorites in the midstream segment, operating as the general partner of master limited partnership ONEOK Partners LP (NYSE:OKS), which owns the actual pipeline, storage, and gathering assets.
ONEOK's business is based on charging fees for transporting and storing products, and not on the actual price of the commodity. In addition, it has long-term contracts that call for minimum volumes and don't fluctuate with gas or oil prices. Think of it like a toll road -- one in which the travelers sign contracts for a decade of use, and agree to pay a minimum toll whether they travel the road or not.
The bottom line is this: Demand for natural gas and NGLs is growing. Not only are they a major source of energy for heating and cooking, and used by utilities to produce power, but there is serious demand momentum from chemical companies, transportation, and exports that will further increase demand and production. ONEOK is positioned to benefit from this megatrend, and in a big way.
Tyler Crowe: What better place to invest when oil prices hit the skids than in a company that relies almost entirely on the total volume of oil and gas moving through its transportation network. That's why right now I'm looking very hard at adding to my position in Enterprise Products Partners (NYSE:EPD).
Not only do the company's revenue sources give some encouragement to investors -- 85% of total revenue is generated from fixed-contract fees -- but Enterprise's major competitive advantage is its massive transportation and processing infrastructure for natural gas liquids such as propane and butane. These products come from both oil and gas wells, and lower prices for these products mean the company can reap the benefits of cheaper feedstock for its processing and chemical manufacturing facilities.
Enterprise also benefits from an investment-grade credit rating and a management team that has shown great ability to maintain a safe coverage of its hefty distribution through several commodity cycles. As long as we're pulling hydrocarbons from the ground in the U.S., Enterprise will almost certainly generate hefty profits no matter what the price of oil.