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October 30, 2014

Energy Sector: Down But Not Out

By MIchell Clark B.Comm for Profit Confidential

The big news so far this earnings season isn’t corporate financial results but the price of oil, which continues to be under pressure.

Domestic production has finally caught up to spot prices and combined with reduced expectations for the global economy, oil prices continue to be vulnerable.

Resource investing is inherently volatile; risk related to commodity-based investing is always higher. But as oil prices have given oil stocks a well-deserved buzz-cut, value is appearing, which is not a common trait in today’s stock market.

There are countless growth stories in domestic oil and gas production. The smaller-cap growth stories have been expensively priced for a considerable period of time. They just got a big haircut as well, and all of a sudden, they are much more fairly priced.

For quite some time, oil prices held firm just over the $100.

Some of the best opportunities when oil bottoms, I believe, will be in the large-cap space, but it’s important to consider that the price of oil is currently in “turmoil”—it can’t, in a sense, be counted on near-term.

One company that’s a standout in the current environment is Kinder Morgan, Inc. (KMI), which is going through a major corporate reorganization. Acquiring its related master limited partnership (MLP) entities, it is now the fourth-largest domestic oil company by market capitalization.

This corporate reorganization is a rejection of the MLP business model, but also an opportunity for management to shed non-core assets.

What I like about Kinder Morgan is that the company has substantial hydrocarbon pipeline and storage assets. These are good businesses that aren’t so directly affected by the current spot price of either oil or gas.

Oil-related investments certainly don’t have to be part of an investment portfolio, but they’ve proven to be profitable in the past and very good at increasing dividends paid to shareholders.

As the wind was taken out of the business model for gold producers, oil stocks will continue to be under pressure, so long as the price of the commodity is falling.

In the past week alone, many fast-growing junior oil producers recovered nicely on the stock market as oil prices stabilized—but then they retreated again as the marketplace reacted to rising crude stocks.

The dramatic price action in oil is a good reminder that resources stocks are, for the most part, high-risk securities. There’s a double-whammy of risk with a junior producer because no one can predict what will happen to the underlying commodity and its weakness directly affects the company’s business model.

So now is the time to be perusing oil stocks for opportunity as the spot price looks to have more near-term downside.
There are still strong growth stories in domestic oil and gas production, and the sector will continue to be a strong economic contributor in an otherwise stagnant environment.

Courtesy Profit Confidential, a daily publication for Lombardi Financial customers.  (EconMatters author archive Here)  

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Item Reviewed: Energy Sector: Down But Not Out Rating: 5 Reviewed By: Econ Matters