[Editor's note: In honor of the New Year, we at StreetAuthority thought it might be worth looking back at some of our most popular articles of 2012. This article was originally published on Nov. 15.]
With the drama of the presidential election behind us, it's time for investors to focus on the real task at hand: How investments will pan out next year, particularly in the energy sector. After all, energy has a role in just about every good produced and service rendered in this country.
Being the contrarian investor that I am, I think 2013 could mark the end of triple-digit prices for oil. The good news is energy investors don't have to panic. There are plenty of opportunities to profit from cheap oil.
Black gold's last "hurrah..."
From its 2008 peak near $133 per barrel, oil has settled back to around $90 per barrel -- a nearly 34% drop. But the best way to track oil prices is by following the performance of the United States Oil Fund ETF (NYSE: USO), which tracks the minute-by-minute fluctuations of West Texas Intermediate (WTI) crude.
Take a look at the chart below...
Since the steady climb in 2008, USO has been in a clear downtrend. Yes, oil has rallied somewhat here and there this year thanks to geopolitical tension in the Middle East and the Federal Reserve's quantitative easing (inflation supports commodity prices, deflation softens them, and the Fed has definitely had an inflationary posture). But the fact is that oil is headed down below $90 per barrel and possibly lower in 2013 and the next several years.
Increased domestic production -- I may sound like Captain Obvious as I talk about the huge wealth of fossil fuel resources currently being tapped in the Bakken and Eagle Ford deposits. But the underlying numbers the nation has to look forward to are downright epic. The United States will likely be producing nearly 11 million barrels of oil per day domestically by 2015, according to the National Association of Business Economists. By 2020, that number could jump to 14 million barrels per day. This brings the country pretty close to energy independence. In fact, U.S. Department of Energy data shows that for the first time since 1949, the United States exported more petroleum products than it imported in 2011.
The days of U.S. dependence on foreign oil are dwindling and the country will enjoy this bonus in the form of lower energy prices, a stronger domestic economy, as well as a tamer geo-political climate. Oil exploration and production will likely continue to grow in the country as the federal government crafts new and definitive energy policies in the next few years.
1. Tensions easing in Iran -- The United States is not dependent on crude oil from Iran, but it does pose a real threat to the security of the global flow of oil. Its close proximity to the Strait of Hormuz -- the only open passage from the Persian Gulf to the open ocean -- along with its belligerent relationship with Israel and its advanced pursuit of nuclear weaponry keep global financial markets on tender hooks. But expect to see some form of resolution in tensions with Iran. Even if an airstrike is carried out, expect oil prices to spike only temporarily.
2. Softer global demand -- While the U.S. economy seems to be muddling toward improvement, the fiscal and economic problems in Europe continue to cloud the global economic outlook with uncertainty. Germany is showing visible signs of slowing and France is heading into a recession. And the troubles in Spain, Greece and Italy have been well-documented at this point. In light of all this, the Paris-based International Energy Agency projects crude oil demand in Europe to contract 2.5% this year.
To the East, some pundits argue that the Chinese economy may be getting tired. If this is the case, then look for global oil demand to weaken steadily. In addition, China also needs a lot of petroleum byproducts for manufacturing, primarily for the injection-molded plastic required for many manufactured goods. But as more manufacturing returns to the United States, companies like General Electric (NYSE: GE) are moving manufacturing operations from China back to the United States, and the demand for Chinese cheap goods will likely shrink as will China's need for the raw materials to manufacture them.
Going into 2013, look for these three factors to influence the price of oil on the down side. Currently, West Texas Intermediate crude trades at around $86 per barrel. While we may see prices fluctuate as high as the mid-$90s, the higher domestic supply and global weak demand for oil will probably keep prices within a trading range in the upper $80s to the mid-$70s per barrel.
So how can investors take advantage of this opportunity?
One way is through energy master limited partnerships (MLPs). Energy MLPs are typically in the transportation business, so demand for their services are determined by energy volume, not prices. In other words, these pipeline companies get paid to pump and transport oil and gas whether oil is at $150 or $15.
The irony is that MLP unit prices typically move in tandem with oil prices, but MLPs can still turn out to be profitable investments. This is because they are also one of the best-yielding investments out there, so as their unit prices go downward along with oil prices, their yield goes up. And that's when it's usually time to buy.
One of my favorite MLPs currently is Buckeye Partners LP (NYSE: BPL). With a generous 9% yield, it's currently trading at a compelling 31% discount to its 52-week high of about $45 per unit. Buckeye is one of the largest domestic movers of crude and refined oil in the nation.
Risks to Consider: While the empirical evidence for this forecast is quite substantial, keep in mind that when it comes to investing -- especially in energy -- the only thing certain is uncertainty.
Action to Take --> Rather than capitalizing on the movement of oil prices -- which can turn out to be quite volatile and stressful -- focus on high-quality companies that are well equipped to make money regardless of the price of oil. Buckeye Partners is a great example of this -- it offers a superior business model with an attractive and reliable income stream.