Despite the tepid growth in the economy, one of the most encouraging developments for the future is the abundance of energy in the United States, particularly oil and gas. Due to enhanced technology that allows for the extraction of formerly inaccessible reserves as well as new discoveries, the United States is on course to overtake Saudi Arabia and become the world’s biggest oil producer before 2020. It is projected that we will become both energy independent and a net exporter of oil by 2030.
The story is equally sanguine for natural gas. It is estimated that natural gas reserves have increased 22.1% since 2010 according to a study conducted by the Colorado School of Mines. At current consumption levels, there is sufficient recoverable natural gas to supply the United States for the next 105 years. Furthermore, the International Energy Agency estimates that the United States will replace Russia as the world’s largest producer of natural gas in only two years.
Obviously, there are environmental issues that need to be addressed concerning the impact of fracking. Congress is expected to complete and release a report sometime next year that will deliver the results of a long awaited study.
There is no lack of opportunities for all investors with different objectives and risk tolerance levels. Investors who are seeking potential tax sheltered cash distributions with commensurate tax benefits might consider investing in an oil and gas drilling program where drilling is concentrated in areas of producing fields, with the objective being to enhance the success rate. Projected early year distributions would generate a high percentage of tax free income sheltered through the oil depletion allowance while also benefitting from a substantial tax deduction resulting from intangible drilling costs. These types of investments should only be considered by high net worth investors who are able to sustain the inherent risk.
A big opportunity exists for investors who are in search of possible income sources other than bonds. As a result of the prevailing low interest rate environment and the opportunity to benefit from current average distributions of 6% as reported by Barrons on August 10th, master limited partnerships or MLPs have generated very high investor interest. MLPs are pass through entities that are engaged in the infrastructure of the energy business or so-called midstream companies. These companies gather, process, store and transport oil and gas.
They own pipelines, gathering systems, gas processing plants and liquefied natural gas facilities. Since they are not involved in extracting, refining or distributing oil and gas, historically, they have been minimally impacted by the volatility that fluctuating energy prices has on upstream and downstream companies in the energy sector. Additionally, a high portion of the distribution is deemed return of principal resulting in tax free distributions.
For investors who desire both growth and income, there is another way to participate in the growth of the energy sector. There are approximately 15,000 private energy companies and only 300 public companies. Since public companies such as ExxonMobil and BP need to constantly replenish depleted energy supplies, they are continuously on the prowl for possible acquisitions of smaller companies with rich reserves. Upon sale, the equities of these smaller asset rich companies generally sell at a premium, boosting capital gains for fortuitous investors. There are various vehicles for investors to position themselves to take advantage of this potential growth opportunity.
While controversy continues to swirl around the environmental issues, there is little doubt that oil and gas will remain the major supplier of our energy needs for years to come and that exploration and extraction will continue to accelerate. It is my opinion that the energy sector offers investment possibilities for all investors and should be considered as an asset in all portfolios.
Clifford L. Caplan, CFP®, AIF®
In the News: I was quoted in the July 19, 2013 edition of the Boston Business Journal in an article titled “Advisors Plot Varied Path as Fixed Income Markets Tremble”. The article discussed reactions to the sudden decline in bond prices as a result of Ben Bernanke’s May 17th comments to Congress. I was also quoted in an Associated Press article in May titled “How Much Risk to Take? Assessing Fund Volatility” that discussed measuring risk and conveying that message to clients.
Links for these articles can be accessed on my website.
Investing in alternative investments may not be suitable for all investors and involves special risks, such as risk associated with leveraging the investment, potential adverse market forces, regulatory changes, and potential illiquidity. There is no assurance that the investment objective will be attained.