Crude oil prices are going back to $100 and then $120 per barrel.
That’s what the portfolio manager of Smead Capital Management told Bloomberg recently. And I think he’s right.
It’s easy to forget that oil hit a 10-year high above $130 a barrel back in March of last year. But economic weakness and recession fears helped walk oil back down from that high.
And then the US government jumped in.
The Biden administration drained the Strategic Petroleum Reserve (SPR) to dump 180 million barrels of oil on the market. This was the largest SPR release in history.
The SPR is simply the US government’s emergency stockpile of crude oil. Congress established it back in 1975 in response to the Arab Oil Embargo which led to shortages across the US.
The current administration drained the SPR to push the price of oil lower. They got it back down into the $70s and $80s. That’s where oil’s traded for most of the year.
But here’s the thing… the rubber band always snaps back. When you push something in a direction it wouldn’t otherwise go in, sooner or later it’s going to come back.
And that’s especially true of oil when you have wars in Eastern Europe and in the Levant… and you have crazy people trying their darndest to escalate those wars into something bigger.
Meanwhile, the Environmental, Social, Governance (ESG) movement shifted nearly $2.2 trillion in investment into renewable energy development. All in just the last seven years.
The problem is, those projects aren’t economical. As we discussed last week, solar and wind cannot produce enough energy to power our grid.
So that money should have gone towards traditional energy production (oil, natural gas, and nuclear power). Instead, annual investment in oil & gas plummeted.
Oil investment here in the US peaked at $205 billion in 2014. Investment has floated between $83 and $124 billion each year since.
The story for nuclear is even worse. We’ve only invested $6-8 billion a year for maintenance and minor upgrades over the last seven years.
So we’ve been underinvesting in traditional energy production thanks to the false promises of ESG.
At some point we’ll admit that was a mistake. And then we’ll see a tidal wave of investment dollars pour back into oil, gas, and nuclear.
That means we are going to experience an energy renaissance in this country and around the world. It’s inevitable if we want to maintain our current standard of living.
So let’s get out ahead of what’s coming…
Simple Moves to Make Today
The easiest way to get exposure to oil and gas is to buy the SPDR S&P Oil & Gas ETF (XOP). It’s an exchange traded fund (ETF) that tracks nearly 60 stocks in the oil & gas industry.
And the easiest way to gain exposure to nuclear is to buy the Sprott Physical Uranium Trust (SRUUF). It’s an investment fund that buys and stores physical uranium—the fuel that powers nuclear reactors.
As I write, SRUUF owns over 62 million pounds of uranium. That stockpile is worth nearly $4.7 billion at current prices.
This gives SRUUF a net asset value of $18.42 per unit. Yet we can buy it today at $17.59. That’s a 4.5% discount. That means SRUUF is on sale right now.
I suggest allocating some money to both XOP and SRUUF at current prices. But please know they aren’t going to go straight up. We should plan to hold these investments for several years as the energy renaissance plays out.
Then if we want to super-charge our energy investments, we need to know the secret of master limited partnerships (MLPs). These are often called “energy royalty” companies.
The Most Efficient Energy Investments
A gentleman by the name of T. Boone Pickens created the first publicly traded MLP back in 1979.
If his name sounds familiar, Pickens is an absolute legend in the energy space. He’s also well respected out in Oklahoma. Oklahoma State University’s football stadium is named Boone Pickens Stadium in his honor.
Boone, as his friends called him, had a brilliant insight. He realized that if he could move the income from his oil & gas production sites to a separate entity, his company Mesa Petroleum wouldn’t have to pay corporate taxes on that money going forward.
So Boone took the assets of his company’s huge oil and gas fields in Colorado, Kansas, New Mexico, and Wyoming and spun them off into a new entity called Mesa Royalty Trust.
But he didn’t set up Mesa Royalty as a new corporation. He structured it as a master limited partnership.
Doing this gave Boone the ability to manufacture stable, predictable cash flows in what has always been a highly volatile industry. I’ll explain…
Oil and gas production sites can cost billions of dollars to develop. Then once they are up and running, it typically costs between $5 and $20 per barrel of oil equivalent (boe) to maintain these sites.
Those expenses are relatively stable year after year. That makes them predictable.
The problem is that an oil & gas development company’s income is not predictable. Because it is tied to the market price of the underlying commodities.
When the price of oil and gas goes up, these companies make a killing. But revenue falls dramatically when commodity prices drop.
And as we know, many political and geopolitical factors impact the price of oil. These are factors completely outside of the industry’s control.
So Boone identified two problems back in the 1970s. Both are true of all oil & gas development companies…
Boone realized that if he left the income in Mesa Petroleum, he would be on the hook for massive corporate tax bills. Especially during commodity booms.
And when commodity prices fell, Mesa Petroleum’s cash flows would plummet. That would make it hard to pay out consistently high dividends. Thus, the market would likely punish the stock price.
The master limited partnership structure solves both of these problems.
MLPs are pass-through entities. They aren’t subject to corporate taxes.
And if an oil & gas development company transfers its logistical infrastructure to a MLP – it’s pipelines, storage, and processing facilities – it can shift as much of its revenue to the MLP as it wants.
The development companies do this by paying the MLP fixed fees for transporting and storing their oil & gas. This reduces the development company’s net income, thus bypassing corporate taxes. And it creates consistent, predictable, tax-advantaged income for the MLP.
That allows the MLP to pay higher distributions (similar to dividends) to investors. And the best MLPs can raise their distributions over time thanks to their stable income. The market loves that.
And here’s the kicker – the oil & gas development companies often maintain a controlling ownership interest in the MLPs they create.
This ensures the two entities are aligned on operational matters. It also aligns the company’s interest with that of investors… because they are large investors in the MLP as well.
It’s brilliant. Everybody wins.
And for investors, owning the best MLPs allows us to build exposure to the coming energy renaissance and collect massive distributions at the same time. We can reinvest these distributions right back into the MLP to put the power of compounding interest on our side.
The key is, we only want to own the best MLPs. Not all are created equal.
To identify the cream of the crop, we need to analyze five key metrics. They are:
- Free Cash Flow (FCF) Margin
- Return on Equity (ROE)
- Return on Invested Capital (ROIC)
- Price to Distributable Cash Flow (P/DCF)
- Enterprise Value to EBITDA
These metrics allow us to assess a MLP’s performance relative to others in the industry.
They also inform our valuation analysis. As with any investment, we must buy at the right price if we want to make money.
Friends, the energy renaissance is coming.
Funds like XOP and SRUUF are simple ways we can get ahead of it today. Then we can use energy legend Boone Pickens’ great MLP innovation to kick our energy returns into hyperdrive in the years to come.
-Joe Withrow
P.S. We are actively tracking these themes inside our investment membership The Phoenician League. We take this insight and help members build a robust investment portfolio with specific suggestions.
If you’d like to learn more about what we’re doing and why we’re doing it, you can get more information at: https://phoenicianleague.com/secret