Think ‘midstream’ during the energy rebound

It has taken a while to get the U.S. energy patch back on the mend.

But there’s no mistaking what is happening now. Reserves are up, mergers are increasing and drilling is going strong in all the shales.

While it’s impossible to call a top or a bottom until you’re farther down the road, energy stocks have ticked all the boxes indicating a rebound.

The irony is, while Saudi Arabia’s production cut may have been the key factor for the bounce, the boom in U.S. production will actually keep oil and natural gas prices down.

But this isn’t an issue since oil in the mid-50s is profitable for U.S. shale producers — and demand is picking up to meet supply. That’s a crucial piece for a sustained recovery.

At the bottom of the cycle demand slows and even though prices are low and supply is available, lack of demand pushes prices lower. That means less exploration, and production companies that make their money at the wellheads have to start shutting down.

That lack of demand would then start to extend across the entire industry.

This time around Saudi Arabia’s pumping furiously for the past couple of years was meant to cripple the U.S. energy sector. The Saudis’ mature fields are profitable at much lower prices than U.S. unconventional shale fields.

But now that strategy has backfired. First, Saudi Arabia got embroiled in Yemen. The war there has been very expensive and the Kingdom has been bankrolling it.

As is usually the case when fighting a major war, the money sent to the front leaves gaps in spending at home. That is very dangerous for the Kingdom because if it loses its grip on the large and restive Shi’a population in Saudi Arabia it could spell the end to the House of Saud and create a huge vacuum in the center of the oil universe.

The government spent big on social programs and is taking the state-run oil company Saudi Aramco public. That will be the largest IPO in history and that money will go back into the government’s coffers to pay down some of the massive bills it has run up in the past few years.

Now, OPEC (Organization of the Petroleum Exporting Countries) is no longer speaking with a unified voice, which is also to the U.S. energy patch’s advantage.

If you look at the list of countries — Algeria, Angola, Ecuador, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela — it’s obvious that many of these countries have struck out on their own regarding their oil supplies to provide much needed revenue for their citizens.

Saudi Arabia is the biggest producer of them all, but it no longer holds the power to enforce these deals whether with its Arab neighbors or more far-flung member nations.

This is great news for the U.S. energy sector.

Where to invest?

But — this isn’t the time to dive back in and buy big integrated oils and exploration and production (E&P) firms.

Getting back in now means you have to go about it by dipping your toe. And the first toe in should be feeling around for solid midstream companies.

What does that mean?

Midstream firms are basically the pipeline companies that ship oil from the fields to distribution points where the oil, natural gas or petrochemicals derived from them get refined or distributed.

They are immune to the price of the products that flow through their pipes; they make money from the volume that flows.

And the supply side is growing. The good thing about this approach now is, prices will likely be volatile in coming months and may likely head lower than higher. Regardless, demand is growing and that’s good for midstream firms.

One stock worth a good look here is Energy Transfer Partners (NYSE: ETP), which is a master limited partnership. That means it pays shareholders a percentage of its profits, like you were a business partner. Currently ETP delivers a 11.2 percent dividend yield.

It is the pipeline company that has been at a standoff with Standing Rock Sioux in North Dakota and finally got approval to finish the pipeline.

It was also a holding of President Trump, who authorized the new permit.

There are other players in this space that might be even better. They’re worth a look and you can get the inside scoop in the exclusive bonus report you can get by going to the bottom of this page.

— GS Early

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