The energy sector is not the easiest to invest in. Other than when you buy an energy sector ETF index fund and leave it at that, you need to learn a considerable amount before you can feel confident about it. It certainly pays to do your homework first.
There are different approaches to take when it comes to energy investments. Some people shoot for income and others aim for capital gain waiting patiently for their returns over a full economic cycle.
Let’s now look at some interesting options for different types of energy investments.
Investing in Oil Stocks for Income
Investing in oil stocks for an income is a popular way to increase the dividends from your investment portfolio. Many US companies either don’t pay a dividend at all or pay very little. For retired investors, if their collection of investments fails to pay 4%+ per year in cash dividends, they’re forced to sell some shares to get enough money to live. For silver-haired investors, seeing green with their investments means cash money coming every month, quarterly, or bi-yearly; and they depend on it too.
Buying into oil companies, you have choices like exploration companies, companies with proven and probable reserves that they drill every year to generate income, and other ones that own oil reserves alone and don’t explore. For income investors, they need oil companies that own oil fields with proven reserves that pay out a significant percentage of their earnings as a dividend. Companies like ExxonMobil and Occidental Petroleum are usually ones to watch.
Not every oil company pays a large dividend. You also want to see which ones historically have cut their cash dividend heavily when the price of oil dipped substantially. This way you can avoid buying stock shortly before an oil price decline which could lead to a cut in dividends and a fall in the value of your holdings too.
Investing in Oil & Gas Pipelines for the Income
Oil and natural gas pipelines are a useful option for people who like the idea of being involved with energy but don’t want to own an energy company per se. These pipelines own the infrastructure – the pipeline that runs from point A to point B – but not the oil fields. They often also have storage containers near the pipeline to hold natural gas or oil before transportation through their pipeline network.
These pipeline companies tend to hold a large amount of debt. It is funded by the payments made by owners of the oil and gas that need it transported on their behalf. The money made pays the cost of the financing and most profits tend to get distributed to unitholders/shareholders. The transportation deals tend to be long-term ones and the income can be 6-10% annually. They’re a little tricky on the tax side for investors, so people invested in pipelines will probably need to use the services of an accountant.
Investing in Oil Stocks for Long-term Capital Gain
Buying into oil stocks for long-term capital gain often ignores the income that they pay out. While the income is part of the return, these types of investments are for total return over the full investment period. When investing this way, oil price investing comes into play.
Oil companies that drill for oil and sell oil on the open market rely on a healthy crude oil price to make their ventures profitable. When oil drops too low in price, they can no longer run exploration on potential oil fields because the returns won’t be enough. While they will usually continue to sell oil to generate returns for investors even when the oil price has fallen, cash flow is reduced.
Investing in oil stocks for long-term gain is very much about understanding the cyclical nature of oil investing. Buy at the wrong time, and you’re likely to lose your shirt or sit at a loss for many years. On the flip side, get the timing right about a future uplift in the price of oil and oil companies will be priced cheaply. At which point, companies will subsequently increase production leading to a boon in cashflow and increased exploration leading to higher values when productive fields are discovered. A win-win situation.
Canada’s Shale Oil the Next Big Thing?
Up until recently, shale oil has been something that companies in the United States have been able to successfully exploit much to the chagrin of the Canadians who’ve lagged behind. Not everyone has done well with large-scale production using shale. Indeed, Argentina, Russian and China have recently struggled with upping their production of their ample shale resources. That’s surprising for China considering they traditionally have been low on oil reserves and often are forced to be a net importer at considerable expense to help fuel their economic production.
Only 8 percent of the oil production in Canada currently comes from shale, but that’s set to rise over time as the country’s shale oil producers put more effort behind the initiative to boost production levels over the coming years. The Montney and Duvernay formations are the most promising for shale producers there with natural gas, liquid natural gas, and barrels of oil ready for production. Both Suncor and EnCana are poised to take advantage of the boost in planned shale-sourced energy reserves. There are quite a few public companies that are already involved and some have American Depository Receipts listed on the US stock market making them easier to acquire shares from a US broker.
To become an effective energy investor, it requires knowledge acquired over time. Being interested in the topic helps in gaining the required insight. Choosing between income or capital gain as the primary goal is helpful at the beginning because it helps shape what investments to select and those to ignore. Switching strategy later is not advisable. Lastly, there’s also the choice whether to buy into more established companies with more predictable returns or to experiment with smaller companies that could have outsized returns to come.
