Enterprise Products Partners, Linn Energy: Petroleum Profits Without the Drama

Crude oil is up big one day and down big the next. Here's how to pump the profits without trying to predict the future or taking a white-knuckle ride.

If the oil market is supposedly doing so well - why are the biggest oil companies doing so poorly this year?

Year to date, crude oil spot market prices are up some 49 percent yet for the trailing 12 months, yet the biggest oil companies, such as ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX) are down hard by over 10 percent and nearly 8 percent respectively so far this year.

Moreover, ExxonMobil and others have begun to roll out their latest quarterly reports and the news isn't getting any better for shareholders.

ExxonMobil saw its smallest levels of petrol production since its merger to form the current company. Demand is still very much sinking: Revenues are down and you can only make so much with so little. The company did manage a bit of a profit at just shy of $4 billion - but that's down by some 67 percent from last year at this time.

And if you look at the other big oil companies, even the Europeans such as Royal Dutch (RDS.A) or BP (BP), you'll see pretty much similar stories with profits down by 67 and 53 percent, respectively, from levels last year.

No wonder that these companies' shareholders aren't too happy. They're down from last year and even with some positive blips in the general stock market indexes, the oil companies are still losing even more money this year.

This isn't news to me. For despite all of the mania over energy coming at us from the talking heads on cable, along with newsletter gurus touting oil, oil and more oil for me it just didn't make any sense.

Petroleum Econ 101

Perhaps too many of the gurus either have other agendas when making their pitches, or maybe they just didn't take the time to show up for Econ 101 when the professor was lecturing about good old supply and demand.

We've continued to see the numbers from the IEA (International Energy Agency) that keep showing the ramp up in supply that has begun to outpace demand. The "deficit" that so many folks were touting last year is now actually running at a surplus on a daily barrel rate around the planet.

And as we're now seeing in the big oil quarterly reports, the guys that make calls based on what they're actually seeing first hand, rather than guessing and hoping, were right, as consumers from industrials to ordinary households are using and demanding less.

That doesn't stop markets from regularly getting out of synch with reality, which is what's been going on recently with crude oil.

And if you happen to trade futures, congratulations if you managed to make a couple of bucks in the bounce this year. But that's not how I expect you to repair your 401k and other retirement accounts.

Guessing and hoping that the greater fool theory will keep working with oil will more likely only end up in more distress. And for additional evidence, all you had to do is look at the companies that provide the equipment and services in the oil fields.

Oil companies generally aren't run by morons. Most of the successful executives tend to know a bit about the oil market. So if real market conditions, rather than just spot market moves in futures, aren't supporting more investment to produce more, then the smart oil guys slow down investment.

It's better to keep the oil in the ground as reserves on the balance sheet, rather than shell out more to pump it out of the ground. And it also makes little sense to bet big on exploration unless the longer-haul market conditions really justify it.

That's why, again, we can look to the oil services companies which reflect this reality, as we've been seeing from the quarterly reports, including from the biggies such as Schlumberger (NYSE: SLB) which detailed that demand for its services was down sharply, resulting in a cratering of revenues and profits.

And given that the big oils, and even many of the smaller ones, are reducing capital expenditures (capex), it doesn't look good for these companies in the near term either.

Pump the Profits Another Way

Those who have been reading and following my recommendations in the petrol sector know that I really don't care what the price of oil might be. And if you ask me for my prognostication right now, it would be a complete guess! But at the same time, you can invest in the petrol market and make money regardless of whether we see crude oil trading back above 80 or down into the 40s or well below.

Back in the early part of this decade, I spent some time studying the petrol market prior to taking the helm of what was one of the biggest newsletters in the publishing business. Back then, as now, plenty of folks liked to invest in petrol. And I would watch as they would follow gurus who were always bullish on energy.

Like anybody who makes the same calls year in and year out, eventually they're right. But as you and I both know, petrol doesn't go in a straight line. It goes up, it goes down and then it keeps going up and down.

Rather than just giving profits back when petrol prices fall, or trying to time the markets, which never works consistently, I wanted to find a way to cash in on this crucial industry and market segment without the drama and the losses.

I came up with a group of companies that were based in Canada, called income trusts. And after stress testing them for high and low gas and oil prices, as well as high and low interest rates, I had a nice group of securities that managed to make money for investors regardless of petrol market conditions.

The key was that they were low cost, steady producers that paid investors to own them with big, high-yielding dividends.

That worked for a long time until some disagreeable political events brought tax changes that helped local Canadian investors while penalizing US and other foreign investors.

But I wasn't put out. I simply adapted. I took the time to look at similarly structured companies in the US that followed the same business approach, including cutting stockholders in on the profits with big dividends.

My two long-standing petrol recommendations that keep rewarding shareholders are Linn Energy (NASDAQ: LINE) and Enterprise Products Partners (NYSE: EPD) .

Linn has generated profits for investors of over 58 percent so far this year, while it keeps pumping out the dividends, currently yielding over 11.5 percent.

And Enterprise Products has delivered profits of 44 percent so far this year, while paying investors who own a nice 7.8 percent dividend that keeps rising by an average annual rate of over 6 percent.

The key in both of these companies, and plenty of others that I follow and will be rolling out for readers in the coming weeks and months, is that they focus on controlling costs and maintaining margins that make the dividends work.

Linn produces low cost gas and oil - and is focused not on new discovery, but just making the most of existing field production.

Enterprise is in the pipe and distribution business. So prices matter even less for it, because it's just a toll taker.

And while demand for oil might be down - the interesting thing for Enterprise is that demand for piped gas is actually developing on the positive side.

With newer, lower cost fields in Appalachia and other key areas close to consumers, gas is finding demand from utilities seeking to reduce pollution.

And with further constraints coming on greenhouse gases and other pollutants, as well as the big cost advantage over coal, look for more piped gas demand literally in the pipeline.

I own these myself, and if you really want to make some money in the energy market, forget the vagaries of ETFs and the futures markets and instead focus on stocks that pay you, like Linn and Enterprise.

Disclosure: Long both LINE and EPD

Comments

[jerdawg:]

Nice article. Are LINE and EPD OK to hold ir IRAs?

Aug 03 09:20 AM

[SLW:]

HI, Neil,
Glad to see you are still alive and kickin'. I sort of miss your ranting and ravings and the "show me the cash" mantra in your former endeavor. I don't care much for the new look and direction, though Roger still maintains some of the old.

I like to see the cash. I figure my kids will eventually get the principal anyhow so as long as I can live on the income I'm not greatly concerned about volatility. EPD/TPP and LINE are two great examples which have helped soften the blow from a few "wrecks" like Thornberg and Acrtic Glacier (though the latter isn't down for the count just yet). What else is up? (or down and going up?)

Aug 03 10:03 AM

[macsmart:]

Before you buy any MLP, check on what can happen if you own them in an IRA. I'm not a tax accountant, so I'm not the one who should explain it. It is very easy to find out why you should not hold an MLP in an IRA....just google it and do a little research on your own.


On Aug 03 09:20 AM jerdawg wrote:

> Nice article. Are LINE and EPD OK to hold ir IRAs?

Aug 03 11:16 AM

[Bobhjon:]

jerdawg..
I don't know about PD but much of LINE's dividend is classified as Return of Capital and not taxed. So get it out of your IRA and replace it with LGCY which is also hedged well into the future. In fact, it's smarter to hold high div stocks like these in a Roth, if you've got one or can get one.

Aug 03 11:16 AM

[Mmarrkk:]

300375:

LGCY is also a LP and hence shouldn't be in an IRA. Worse case scenario is it spins off too much of those passive gains which can become a taxable event if large enough. Even if it doesn't, you are tax protecting something that is tax protected (as you pointed out). Just don't think replacing LINE with LGCY fixes the problem, if in fact there is one. They are similar vehicles.

I own both and are very happy with the management of both. I know one personally and he's top notched. The second is one I've met professionally and he too is a great manager.

Aug 03 11:35 AM

[Dotcom:]

jerdawg - I have EPD, ETP and OKS in my IRA. I'm very happy with the yields.

Aug 03 11:49 AM

[mplaut:]

There are Closed End Funds that invest in MLPs and their main reason for being is that they are ok for IRAs. I have not researched them and cannot recommend any. In regular accounts you are better off with the MLPs themselves.

Aug 03 01:24 PM

[Plaintalk:]

I received distributions from LINE in my IRA for the last quarter of last year. Had I known that there was a $1000 limit on distributions and taxed under a concept called UBIT (Unrelated Business Income Tax,) I probably wouldn't have put 4640 units in that account. "Low and Behold" when Schwab figured out the taxes due, (they are the custodian of my IRA and are required to calculate and pay taxes due from that IRA,) I ended the year with about a $200 credit toward tax year 2009 and no taxes due for 2008. This was because LINE's distributions, at least the amount I received, were tax advantaged. I have no idea what will happen in 2009, in that account, but I am super happy with LINE's performance and payments to me both for those units and 17,000 more in my regular Schwab account. I bought all of those after reading about them in Neil George's Personal Finance letter. He even took a call from me once when I first started my purchases because at the time I thought the then 18-20% distributions were too good to be true. I wish I could afford to go on one of those investor boat trips with Neil George and friends but they are too expensive. cz

Aug 05 06:06 AM

[Ronharv:]

I own Linn in my IRA but would not own it in a regular account. It's an MLP, not really a stock, and makes distributions instead of paying dividends. There's no 1099DIV involved, but there are two(!) migraine-inducing (even for accountants) K-1's instead. The distributions are tax deferred (NOT forgiven) and reduce your cost basis, ultimately to a minus position. Moreover, there's lots of supposed "income" which you never receive but which reduces your cost basis more rapidly than you'd expect. And there's a whole list of other complications that'll nail you down the road. So I like LINE, but only in an IRA.


On Aug 03 09:20 AM jerdawg wrote:

> Nice article. Are LINE and EPD OK to hold ir IRAs?

Aug 07 01:36 PM

[Ronharv:]

I own Linn in my IRA but would not own it in a regular account. It's an MLP, not really a stock, and makes distributions instead of paying dividends. There's no 1099DIV involved, but there are two(!) migraine-inducing (even for accountants) K-1's instead. The distributions are tax deferred (NOT forgiven) and reduce your cost basis, ultimately to a minus position. Moreover, there's lots of supposed "income" which you never receive but which reduces your cost basis more rapidly than you'd expect. And there's a whole list of other complications that'll nail you down the road. So I like LINE, but only in an IRA.


On Aug 03 09:20 AM jerdawg wrote:

> Nice article. Are LINE and EPD OK to hold ir IRAs?

Aug 07 01:36 PM

[Ronharv:]

Wrong. ROC reduces the cost basis, so taxes are simply deferred, and that includes lots of phantom income from MLP's ultra-complex K-1's. IRA's are perfect for MPL's, LLC's, etc


On Aug 03 11:16 AM 300375 wrote:

> jerdawg..
> I don't know about PD but much of LINE's dividend is classified as
> Return of Capital and not taxed. So get it out of your IRA and replace
> it with LGCY which is also hedged well into the future. In fact,
> it's smarter to hold high div stocks like these in a Roth, if you've
> got one or can get one.

Aug 07 01:40 PM

[Ronharv:]

With the small amount of units you own in your IRA you should never have to pay taxes on UBIT, which have nothing to do with distributions. Moreover, K-1 losses (Line 1, I think) can be carried forward. Don't trust a brokerage to know this.


On Aug 05 06:06 AM Plaintalk wrote:

> I received distributions from LINE in my IRA for the last quarter
> of last year. Had I known that there was a $1000 limit on distributions
> and taxed under a concept called UBIT (Unrelated Business Income
> Tax,) I probably wouldn't have put 4640 units in that account. "Low
> and Behold" when Schwab figured out the taxes due, (they are the
> custodian of my IRA and are required to calculate and pay taxes due
> from that IRA,) I ended the year with about a $200 credit toward
> tax year 2009 and no taxes due for 2008. This was because LINE's
> distributions, at least the amount I received, were tax advantaged.
> I have no idea what will happen in 2009, in that account, but I am
> super happy with LINE's performance and payments to me both for those
> units and 17,000 more in my regular Schwab account. I bought all
> of those after reading about them in Neil George's Personal Finance
> letter. He even took a call from me once when I first started my
> purchases because at the time I thought the then 18-20% distributions
> were too good to be true. I wish I could afford to go on one of those
> investor boat trips with Neil George and friends but they are too
> expensive. cz

Aug 07 01:44 PM