As oil prices fall, investment opportunities emerge

Boon for MLPs, and a boost for holiday sales

For most people, the dramatic drop in oil prices over the past few months has been welcomed in the form of cheaper gasoline prices. But for investors, the story is less clear.
Beyond the obvious pain felt by energy producers as the price of oil drops closer to a production break-even point, there may be opportunities to remain exposed to energy through master limited partnerships, oil services companies and even less directly through consumer discretionary stocks.
“Right now we’re seeing a lot of winners and losers from the lower oil prices and, as an investor, you have to be careful,” said Douglas Cote, chief investment strategist at Voya Financial Inc.
“The safer bet is to focus on the end users of oil and look at the consumer discretionary sector,” he added. “We think there will be a bigger Christmas season because of dramatically lower oil prices, which is going to be an enormous benefit for fourth-quarter GDP.”
Crude oil is currently hovering around $75 a barrel, which is down almost 28% from $104 at the end of July.
Some analysts believe the commodity is still searching for a bottom, which has introduced a unique set of challenges and opportunities across the energy sector.
“Often when you see huge price moves in either direction, there is a supply-and-demand imbalance,” said Stewart Glickman, group head of energy research at S&P Capital IQ.
“Global demand for oil has been slightly negative, but the real big change has been supply,” he added. “The big change has been that U.S. production of crude oil has been really ramping up over the past four years, because everybody has gotten more prolific about getting oil out of the ground.”
Investors who have already seen share prices of energy-and-exploration companies fall between 20% and 40% as oil prices have declined, don’t have a realistic bottom in sight, according to Mr. Glickman.
The most recent indication that oil prices could continue to slide is the October selling price report from Saudi Arabia, which had lower prices for every region of the world.
“In the past, Saudi Arabia would try and defend the price levels by cutting back on production, but now it looks like they are trying to defend their market share,” Mr. Glickman said. “That pretty much takes the floor out of the price.”
But far from suggesting any kind of extreme price drop from here, S&P Capital IQ is already predicting an average price of oil for 2015 of $80 per barrel, which implies some upward movement from current levels.
With price volatility in mind, Mr. Glickman acknowledged the logical play of investing in infrastructure through master limited partnerships that contract to transport the commodity, regardless of the per-barrel price.
“It doesn’t matter to the pipeline what the price of oil is, because they are getting fees for volume and clearly the volumes are high,” he said.
Mutual funds investing in MLPs have gained 14% this year through Nov. 17, according to Morningstar Inc.
By comparison, equity energy sector funds have declined by an average of 5.8% over the same period.
“The play here is oil and gas production in North America, which is probably the most certain growth story in the world right now,” said Quinn Kiley, co-portfolio manager of Advisory Research Inc.’s MLP & Energy and Income Fund (INFIX), as well as the ARI MLP & Energy Infrastructure Fund (MLPPX).
Mr. Kiley, who invests primarily in MLPs for his funds, acknowledged a potential short-term negative impact on MLPs if oil prices decline to a point where production slows dramatically. But he likes MLPs because they are securing long-term contracts from users at both ends of the infrastructure.
“The oil producers are locking in contracts at one end and on the other end you’ve also got utilities locking in multi-year contracts,” he said. “Long-term, as long as we have prices that support production, slightly lower crude oil prices are a positive for GDP growth and a positive for consumer spending.”
Of course, MLPs are far from a sure thing, as Mr. Glickman explains.
“Most of the pipelines that are structured as MLPs are seen as yield plays, which means if interest rates go up the MLP yields might become less attractive to investors,” he said. “Also, a lot of MLPs, because they are currently investing so much in pipeline construction, are highly levered, which means the expenses go up if interest rates go up.”