Capture High Yields From the Bull Market in Oil

If you were paying close attention last week, you might have noticed some of the world’s most powerful groups — who each have the power to move markets by themselves — all said the same thing… albeit in different language.

  • Last Tuesday, the Federal Reserve announced that it will keep interest rates unchanged and at record lows — a sign that, according to the Associated Press, reassures investors that the U.S. is committed to spurring economic recovery: “Oil and gas demand is expected to increase as economies recover and businesses hire more workers.”
  • Then, last Wednesday, OPEC made the announcement that it will not increase output.

Translation: There’s a bullish case for oil. It’s not often all of these market movers make similar announcements within such a short time period. That’s why I think it’s so important to listen.

After rocketing to nearly $150 a barrel… and then falling all the way back to $35… the price of oil has been in a picture perfect bull market, rising past $80 per barrel. And it’s no wonder:

  • Emerging markets like China — whose economy is expected to expand a sizzling +9.6% in 2010 — are industrializing at an explosive pace and spurring huge new demand for oil.
  • Developed markets like the United States — the world’s largest consumer of crude — are recovering from the economic downturn, which is likely to cause “rebound” demand for oil.
  • Meanwhile, the global supply of petroleum is shrinking fast: New sources of oil are increasingly difficult to find and the Earth’s 1.3 trillion barrels of proven reserves are only enough to last us the next 40 years at current rates (and far less if the uptrend in the world’s appetite continues).

In short, all of the factors that helped push oil to nearly $150 per barrel in 2008 are still with us today… even after a nasty recession.

Of course, we’re income investors, not commodity speculators. Income is everything to us, and oil prices are notoriously volatile, even if I think they’re likely to rise. By earning a stream of dividends we can offset some of the damage if the price of oil doesn’t go our way, while also enjoying fat dividend checks.

That’s why I’ve been hunting for plays that should gain on rising oil prices… but also pay healthy yields.

I’ll be honest, most traditional oil stocks leave much to be desired. The best choice is French oil giant Total SA (NYSE: TOT). It pays a solid 5.5% right now, but the company only makes two dividend payments per year.

I think investors can do better.

You see, there are plenty of oil companies paying frequent — and high — yields. But you’ve likely never heard of them. That’s because these high-yielding oil plays are in the ranks of small producers.

I’m talking oil producers with market caps of roughly $3 billion or less. In other words, businesses that are just 1% the size of ExxonMobil (NYSE: XOM). A quick screen pulls up 13 small oil producers yielding above 7%. Some have market caps as small as $300 million.

Many of these high-yielding businesses, such as Pioneer Southwest Energy Partners (NYSE: PSE), are set up as master limited partnerships — a tax-advantaged status that means more cash is available to pay distributions. This structure is one of the reasons they’re able to pay such high yields.

Most also have other segments of their business besides production, such as the processing and shipping of crude and/or natural gas. While this diversification does mean the units won’t move in lockstep with rising crude prices, I think you’ll find their high yields are certainly worth the trade-off.

P.S. – I’m not the only looking for high yields from small producers. StreetAuthority’s foremost income expert, Carla Pasternak, recently featured a tiny oil company as her “Stock of the Month” within High-Yield Investing.

The jewel she found has never missed, slashed or cut one payment in its history. And in the past year, when the price of oil has leapt from about $40 a barrel to $80 a barrel (a +100% increase), this oil investment delivered +177.5% total returns… yet still pays 10.2%.

Follow this link to learn more about Carla’s “Stock of the Month.”