The Best Way to Avoid Oil Price Volatility: Invest in MLPs
Energy market is uncertain and volatile. Nobody has much visibility into the future. So, when you think of something as a clear line of sight one quarter, it can soon be overshadowed by an unforeseen event. The recent spate of conflicting economic reports and events have made assets like oil even riskier.
For those of you who wish to avoid direct commodity price sensitivity, publicly traded energy master limited partnerships (or MLPs) – that derive their revenue based on the volume of resources they carry – might be great bets.
The surge in oil and natural gas production over the past few years have made pipelines, storage and associated infrastructure MLPs attractive bets in the energy midstream space. This is because these network providers derive a major portion of their revenues from fee-based contracts based on volume and are largely insensitive to commodity price fluctuations. MLPs also attract investors through the high distributions/dividends that they typically shell out.
A Revenue Model That’s Not Dependent on Energy Prices or Economy
Most MLPs are involved in processing and transportation of energy commodities such as natural gas, crude oil and refined products, under long-term contracts. As such they have relatively consistent and predictable cash flows, unlike exploration and production (E&P) companies, whose profits are highly correlated with commodity prices. Notwithstanding the state of the economy, pipeline firms enjoy strong demand for their infrastructure and processing services.
Generally viewed as defensive instruments, a majority of these North American midstream firms enter into long-term contracts of around 10-20 years with inflation protection clause. This enables the MLPs to generate stable income practically under all conditions, providing high cash flow visibility and reducing the risk profile.
Record-Breaking Production to Drive Sector Fundamentals
We believe that the primary driver for the midstream operators is the pace of U.S. oil production growth. And with output in America recently surpassing longtime top producers Russia and Saudi Arabia, the environment looks bullish for partnerships engaged in transportation and storage of the commodity.
Looking ahead, EIA forecasts domestic crude volumes to average 12.3 million barrels per day (bpd) and 13.2 million bpd in 2019 and 2020, respectively – both new all-time highs. Lest we forget, oil production in the U.S. jumped by around 17% in 2018 to set a new record of 11 million bpd.
Not to be left behind, American natural gas production reached a record 83.4 billion cubic feet (Bcf) per day in 2018. Its is expected to rise another 10% this year to 91.6 Bcf per day while the 2020 daily average is pegged at 93.5 Bcf, according to the EIA.
In other words, the robust oil and natural gas production growth in the United States is creating immense opportunities for midstream companies.
4 Stocks to Invest In
Although the benefits of MLP business model cannot be stressed enough, prospective investors need to do adequate research before betting one’s hard-earned money on such stocks. To guide them to the right picks, we highlight four stocks that carry a Zacks Rank #2 (Buy).
CNX Midstream Partners LP CNXM: CNX Midstream Partners is a natural gas midstream company that owns and operates gathering and other assets in the Marcellus Shale and Utica Shale in Pennsylvania and West Virginia.
NuStar Energy, LP NS: NuStar Energy is one of America's largest operators of crude oil and refined products transportation and storage infrastructure.
Global Partners LP GLP: It is a vertically integrated downstream energy partnership focusing on the distribution of gasoline, distillates, residual oil, and renewable fuels, apart from owning several refined-petroleum-product terminals.
Noble Midstream Partners LP( NBLX: Noble Midstream Partners predominantly focuses on providing gathering and processing midstream assets in the Permian and the DJ Basins.
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NuStar Energy L.P. (NS): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.