The best risk rewards in oil

Oil prices are on the rise after OPEC+ reached an agreement on Sunday that will see the group add 400,000 bpd of production each month from August. Goldman Sachs says the deal is modestly bullish and has predicted that Brent will hit $80 a barrel this summer.

Piper Sandler says that while the backdrop of tighter monetary policy, the trajectory of the economic recovery and the sustainability of inflation will likely create some volatility curveballs, they won’t be enough to derail the secular bull market.

Meanwhile, the fossil fuel sector is experiencing a rare blowout season: In the past few earnings seasons, the majority of companies in the energy sector have far exceeded Wall Street expectations

With impressive bottom-line growth, many large energy companies are returning more capital to shareholders in the form of dividends and share buybacks. Companies usually buy back shares when they believe they are undervalued, a big boost for oil and gas beers.

The biggest winners in the current environment are integrated oil companies such as: ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX), which own assets spanning the entire spectrum of the oil industry, including drilling (upstream) and processing (downstream).

However, the latest drop in oil prices has reminded us that these companies are also often highly volatile, as their business model relies heavily on commodity prices.

To build a well-balanced and diversified portfolio, you should invest in the midstream sector that carries less risk to commodity prices.

Midstream oil companies provide the pipelines, processing, storage and transportation and processing assets that help move oil and gas raw materials from the point of production to their final consumption points. Many midstream companies are fee-based, meaning their businesses are more dependent on commodity demand and less affected by commodity price fluctuations, as demand tends to be more stable, while prices tend to be more volatile.

Another big draw: Midstream energy companies are among the highest dividend payers, with many sporting returns exceeding 6%.

That said, midstream energy companies are not without risk.

Like the rest of the oil and gas sector, the US midstream oil and gas segment was disrupted by the decline in global energy demand caused by the coronavirus pandemic. Many saw their market value halve, with massive production slumps and capacity reductions by refineries, liquefaction facilities and exporters, as well as rampant project cancellations, all taking a heavy toll.

Nevertheless, last year was an outlier, and it’s not likely we’ll see anything as dramatic in the near future. Here are our top picks in the midstream oil sector.

Enbridge Inc.

Market capitalization: $78.7 billion

Dividend Yield: 7.11%

If you prefer an energy stock that offers a rare combination of high returns and growth, look no further than Enbridge Inc. (NYSE:ENB), a Canadian energy transportation company based in Alberta. Enbridge owns a network of transportation and storage resources that connect some of the richest oil and gas fields in North America. As low-cost shale drilling continues to increase the continent’s energy production volumes, Enbridge should be able to see healthy demand for its pipeline and transportation facilities.

This midstream energy company has a healthy dividend yield with a goal of growing its dividend by 10% per year while maintaining an impressive distributable cash flow ratio of 1.4x future dividend.

Enterprise Products Partners LP

Market Capitalization: $51.4 Billion

Dividend Yield (Fwd): 7.65%

Enterprise Products Partners LP (NYSE:EP) is the largest carrier of natural gas liquids (NGLs) and also has the most NGL fractionation capacity in the United States, as well as dock space for export. Enterprise Products is the country’s largest midstream MLP.

Enterprise has clearly read the signs of the times and has begun to work with partners to reduce project backlog. In the past, EP has been able to weather normal industry headwinds thanks to robust cash coverage and manageable leverage. Sadly, Covid-19 has been anything but your average downturn, and EP has been forced to make some serious cuts to Capex.

After spending $17 billion on capital projects in 2015-2019, including new oil pipelines, NGL and LPG pipeline and export facilities, and NGL fractionation plants, the massive MLP now plans to total $4 billion in 2021-22. to issue.

These dramatic cuts are expected to yield much in increased income and benefits.

Philips 66 Partners

Market Cap: $8.4B

Dividend Yield (Fwd): 9.56%

Philips 66 Partners (NYSE:PSX) is a midstream company founded in 2013 as a subsidiary of Philips 66 (NYSE:PSX).

Phillips Partners owns 75% of the restricted shares of its MLP, which is crucial

revenue and financing support. Indeed, PSXP has one of the strongest balance sheets of the refining-sponsored MLPs, with a huge dividend that seems well-backed.

The main risk in investing in PSXP depends on whether the Dakota Access Pipeline (DAPL) will eventually be closed after a licensing dispute. But with states and municipalities starving for tax revenue and jobs amid Covid-19, this doesn’t seem like something likely to happen anytime soon. In July 2020, a district court judge issued a ruling to shut down the pipeline and drain the oil pending a new environmental assessment. The temporary closure order was overturned by a US appeals court on Aug. 5, although the environmental review is expected to continue.

Back in May, Reuters reported: that the US Army Corps of Engineers said it does not believe a judge should allow the Dakota Access oil pipeline to be closed while the environmental assessment continues.

Master Limited Partnerships

For decades, master limited partnerships, or MLPs, have been a source of reliable, high-yield income for energy investors. An MLP is required by law to obtain at least 90% of its cash flow from commodities, natural resources or real estate. They, in turn, distribute cash to shareholders instead of paying dividends as a typical corporation would. MLPs combine the liquidity of publicly traded companies and the tax advantages of private partnerships because profits are only taxed when investors receive distributions.

Related: Mexico’s Drug Cartels Steal Oil Again

The main appeal of MLPs is that they are considered pass-through entities under US federal tax law. While most corporate income is taxed twice (first through income and again through dividends), the pass-through status of MLPs allows them to avoid this double taxation because income is not taxed at the corporate level. Another key benefit: Midstream MLPs act as toll collectors for the utility companies using their pipelines. As such, their cash flows are protected by long-term take-or-pay agreements, meaning they are less sensitive to fluctuations in commodity prices.

It is therefore not surprising that MLPs typically pay the highest benefits in the energy sector. Here are some top payers.

MPLX LP

Market Cap: $28.8 Billion

Dividend Yield (Fwd): 9.85%

MPLX LP (NYSE:MPLX) is an Ohio-based crude oil and natural gas transportation and processing company.

MPLX has made good progress in reducing operating and capital costs and securing and developing joint venture growth projects. In addition, parent company Marathon Petroleum Corp. (NYSE:MPC) recently released the selling its Speedway assets for $21 billion, where the proceeds will be used to pay off debt and strengthen the company’s balance sheet.

Rattler Midstream LP

Market capitalization: $1.5 billion

Dividend Yield: 8.57%

Rattler Midstream LP (NASDAQ:RTLR) offers: water related services to oil and gas shale producers Diamondback energy (NASDAQ:FANG) in the Permian Basin in West Texas.

Rattler’s management has aggressively cut capital expenditures, helping to support continued free cash flow generation. Furthermore, Rattler Midstream is not present on Diamondback Energy’s entire business area, allowing it to grow its revenues at a time when Diamondback Energy has forecast a period of no growth.

Other highest paying MLPs are:

  • Plains All American Pipeline, LP (NASDAQ:PAA)–7.00% Fwd Return

  • Plains GP Holdings, LP (NASDAQ:PAGP) — 6.69% Fwd Return

  • Magellan Midstream Partners, LP. (NYSE:MMP)–8.87% Fwd Yield

  • Kinder Morgan, Inc. (NYSE:KMI)–6.22% Fwd Return

  • The Williams Companies, Inc. (NYSE:WMB)–6.52% Fwd Return

By Alex Kimani for Oilprice.com

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