This is your Independence Day! No longer will you be dependent on foreign countries to supply your needs. From this day forward we can operate as an independent global power… in Energy!
Since oil was first discovered in Texas more than a century ago, the U.S. energy industry has had its fair share of ups and down. After peaking in the 1970’s, oil and gas production began to decline and the U.S. became dependent on foreign suppliers to meet our energy needs. Over the past decade, advancement in production technologies has revitalized what was once thought of as a dried out industry.
Over the last 5 years, natural gas production was up around 25% and oil production was up my more than 20%. Increased production is expected to continue at a pace that may result in the U.S. surpassing Saudi Arabia as the world’s largest oil producer by 2020, according to the World Energy Outlook 2012. U.S. based energy users are significantly shifting towards U.S. produced energy versus importing our energy. More importantly, technology is being developed that is allowing the U.S. to become a net exporter of energy rather than an importer.
Now you may be wondering how investors can participate in this Energy Renaissance? At Bloom Asset Management, we do it by investing some of our portfolio assets in Energy Infrastructure Master Limited Partnerships (MLPs). Specifically in what is called the “midstream” component. After the oil and gas is extracted from “upstream” it then needs to get down the road to the consumers “downstream”. That road is operated by what are called “midstream” companies that act like toll-takers. These companies are involved in the gathering, processing, storing, and transporting of oil and gas. They receive a specific fee for hauling a product over a certain distance. They do not take title of the commodity and are largely agnostic to the level of commodity prices because these prices do not directly enter into the company’s revenue equation. They receive a contractually pre-defined toll (that gets adjusted for inflation) no matter what the underlying commodity price is.
So why MLPs? Because they trade on major U.S. stock exchanges like regular stocks, but they are granted certain tax advantages when compared to regular corporations. MLPs do not pay taxes on their income because they pass the majority of their cash flows to their shareholders. This avoids the double taxation by shareholders that invest in regular corporations. The structure is designed for companies that participate in the development, production, and transportation of natural resources. Because of this cash flow structure, they produce a constant and stable yield for shareholders. Yet, they also have total return potential due to the expected growth of the industry. Again, Energy Infrastructure MLPs contracts are tied to inflation indicators so increase accordingly, giving them a hedge to inflation. Most importantly, Energy Infrastructure MLPs exhibit a low correlation to traditional asset classes and to commodities.
Now keep this in mind, the tax code makes buying Energy Infrastructure MLPs a little tricky. You can buy an individual MLP and receive an annual K-1 for tax reporting at the end of every year. Or you can buy an ETF that mimics the Alerian Index that tracks Energy Infrastructure MLPs. Just keep in mind, due to the strange tax rules the performance will usually lag the actual index. Then you have the choice of investing in actively managed open-ended mutual funds, which is the path we chose at Bloom Asset Management. Keep in mind, not all of these funds invest 100% in MLPs. Some of these funds do not want to deal with the added tax reporting that is required due to the strange tax code. I mention this because if you are looking to get the full benefit of investing in Energy Infrastructure MLPs you need to make sure you are investing in a product that invests completely in MLPs, so look closely at how the fund’s portfolio is constructed.
The energy boom is an exciting American story that we are all able to participate in. Now please keep in mind, this type of investment is not appropriate for everyone and I would recommend that you consult your investment professional for advice on it and how it should be positioned in your portfolio. Or better yet, talk to someone here at Bloom Asset Management. Finding these “diamonds in the rough” is one of the many services we offer.