Petrol is a big part of the U.S. and global economy, and that’s why I have maintained a collection of up-, down- and midstream petroleum companies inside the model portfolios of my Profitable Investing. And like most market segments, the market for petroleum and the underlying companies and their stocks never moves in a continuous straight line.
Source: SarahTz Via Flickr
The key to successfully investing in petrol is not just placing bets on higher prices, but treating it as an industry with many different participants that don’t all rely on soaring prices. That said, the current higher prices for crude are indeed a general boost for many in this vital industry. And those prices may well continue to be supportive.
But to start, the current bubbling up in petrol pricing shouldn’t be viewed as a surprise. It’s a product of some major overriding developments that favor profitability, particularly for U.S. petroleum companies.
And to start, all it takes is to look at price of U.S. West Texas Intermediate (WTI) crude oil. Since 2016, the market for U.S. crude oil has gone from a low of $35.70 to a current level of $65.83 a barrel for a gain of 84.4%.
US WTI Crude Oil Price Source Bloomberg
The price, of course, was higher in October, before oil slipped to a near-term low on Dec. 24 along with the sell-off in the general stock market.
But like for stocks, the realities of a growing U.S. economy and profitability of U.S. oil companies at even lower crude prices has been supporting the underlying market. And note, the much-lower crude oil prices five years and more ago worked to drive U.S. producers and related companies to increase technology in the fields in order to drive down lift costs for crude.
This means that U.S. companies can pump crude at lower costs, so margins at sale can be positive even with lower market prices. This means that you can invest now with more certainty of profits — even with lower prices.
The tested, lower-cost producers in the U.S. have been leading to a continued upward march in U.S. production, which since 2016 has soared by more than 33%.
US Crude Oil Production Keeps Climbing Source Bloomberg
And according to the U.S. Energy Information Administration (EIA), this continued climb in production should result in that the U.S. will be a net oil exporter by 2021.
Adding to the positive market developments are that the Organization of Petroleum Exporting Countries plus Russia and other nations (OPEC+) continue to largely adhere to production cuts, resulting in the proven data from shipping records of December 2018 showing production cuts of 1.2 million barrels per day (MBPD) with only Russia and Iraq showing some slippage in their cuts.
More Crude on the Move
One of the big limitations has been the infrastructure to move crude to refineries and marine terminals for export. But the approval process for additional pipeline capacity has been stepped up, with pipeline companies continuing to add capacity to move stuck crude to the market.
This now is showing up with the periodic drops in U.S. stockpiles of crude, as tracked by the EIA. The stockpiles on given weeks shows lows not seen since last June, and they may well head lower with the further developments in transportation.
US Crude Stockpiles Down West Texas WTI Up Source EIA, Bloomberg
The periodic drawdown in stockpiles is showing up in the export market. And what is particularly interesting is how much more U.S. crude is being shipped to Europe. Over the past five years, U.S. crude exports have gone from zero to nearly 1.4 billion barrels according to records from the U.S. Census Department.
US Crude Exports to Europe Source US Census, Bloomberg
This surge in U.S. crude in Europe is now affecting European crude markets. For North Sea crude prices set at ports in the Netherlands, Argus Media (Private), a business intelligence analytics company, is stating that one third of the time, U.S. crude imports in Europe are driving the prices for European crude oil.
That puts U.S. producers further on the way to narrowing the price discount of WTI to the currently higher Brent crude prices. That discount now at $8.61 per barrel is down from recent highs by 23.65%. And this in turn, should help to increase the margins for U.S. producer and related companies.
WTI (White) vs Brent (Green) Crude Oil Prices Source Bloomberg
Globe Takes More than Makes
Now, OPEC+ isn’t going to limit production forever. However, there are some reasons to see limits in their capacity to bring significantly more crude oil to the market. First, Iran remains under U.S. sanctions with no daylight in negotiations in sight — and waivers are set to end on May 2. And with more availability of U.S. exported oil, it favors U.S. producers.
In addition, even if other major former producers get sorted out politically, they will take years to get back into the oil business. This includes the imploding nation of Venezuela, the broken-apart Libya and the very unsettled West African nations, including Nigeria.
Then there’s the problem with Saudi Arabia and Russia, which are both post peak in production with the major fields in Saudi Arabia being drained with dropping reserves.
Meanwhile, the globe’s demand for crude oil remains firmly on the ascent. And even with rising U.S. production and exports, there continue to be shortfalls in supply against global consumption of crude oil. The EIA tracks overall supply and consumption, and as the graph shows, consumption keeps peaking over supply.
Add in the U.S. drop in stockpiles and the supply-and-demand statistics favor supported crude oil prices.
Global Oil Supply (White) Global Oil Consumption (Gold) Source EIA Bloomberg
My Way to Profit from Petrol
As I started, the way to invest in petrol is to own a variety of companies, from downstream refiners to midstream transportation companies as well as upstream producers. This treats the petrol market as an industry and not just a one-way bet.
Starting downstream in the refinery market, look at Marathon Petroleum (NYSE:MPC). This refiner is well-placed to capitalize on U.S. crude supplies thanks to its takeover of Andeavor last year. It has revenues up 29.1% over the trailing year and the stock is valued at a 70% discount to its sales, making for a bargain.
Then move up to the midstream with a collection of pipeline and marine terminal companies. Some of the best include Enterprise Products Partners (NYSE:EPD), Kinder Morgan (NYSE:KMI), Buckeye Partners (NYSE:BPL) and Plans GP Holdings (NYSE:PAGP). What these have in common are long histories of being successful toll-takers in transporting petrol. And in turn, they pay out big distributions, providing ample dividend yields. And they are in part shielded from petrol pricing risk which provides balance in a properly invested portfolio of the petroleum market.
But you’re reading this because the market for crude oil is up recently, and I believe that trend is well-supported for some time to follow. So, upstream is where the bigger gains are being found right now. And in particular, you should be focused in the heart of the U.S. petroleum production market — the Permian Basin.
And the company that is right at the source of all of this additional U.S. production of oil and gas is Viper Energy (NASDAQ:VNOM). And it is unique in that it doesn’t drill or lift crude oil or natural gas.
Viper Energy is instead the leading landlord of the petroleum patch primarily in the Permian Basin. As a landlord, the company leases out its land for exploration and development companies (E&P) for fee income and royalties on the oil and gas that gets pumped out of its land.
This means little capital is needed beyond the land. And it means that the company doesn’t have to worry as much about the price fluctuations in oil and gas for its operations. But of course, the higher the price of crude and the higher the price for natural gas, the higher the royalties and the higher the income.
It has a large collection of operators on its land including Devon Energy (NYSE:DVN), BP (NYSE:BP), XTO Energy, EOG Resources (NYSE:EOG), ConocoPhillips (NYSE:COP), Occidental Petroleum (NYSE:OXY), Anadarko Petroleum (NYSE:APC) and many others. Each continues to develop leased properties.
Since coming to the public market in 2014 through a drop-down of assets from Diamondback Energy (NASDAQ:FANG), the proven developed reserves of petroleum have climbed by 764%. And royalty income per acre of its land has grown by 368%.
Overall oil and gas produced on Viper’s land was up 63% in 2018. And the company is projecting that on an organic basis (meaning existing land statistics and not counting additional land and land development), that production will climb at least by 24% for 2019.
In addition, Viper completed an additional share sale recently. That additional cash is going to expand its land properties. And with Diamondback having much more land in its existing assets, there is more room for a further drop-down for more productive petroleum land in its portfolio. This will mean more growth potential for leases and royalty income.
Venom for Better Return
Total Return for Viper Energy Source Bloomberg
Viper Energy has been a good performer. Over the past two years, the stock has generated a total return of 125.4% including its ample and rising dividend. And this even includes the slip with the general stock market in the fourth quarter of last year.
But since Dec. 24, 2018 (the market low for U.S. WTI) to date, Viper has soared by over 50% in total return, reflecting the realities of the economy and the market for high and rising royalty income from its leased lands.
Viper by the Numbers
Viper, as noted above, is working well as a landlord. Revenues for the trailing year are up by 67.9%. And since it doesn’t drill or pump oil, its operating margin is a whopping 70.3%. This in turn drives a great return on shareholders’ equity of 20.6%. It has gobs of cash and its debts are at a minimal 24.8% of its valuable assets, so its credit is very good.
Then we come to that nice dividend. The current distribution is at 51 cents which has been climbing over the last three years by an average annual gain of 37.32%. That distribution equates to a yield of just under 6%. And I’m expecting a dividend distribution hike to be declared on April 30 by around 10%, making for an even better yield.
And even though Viper changed from a passthrough to a taxable entity effective on May 10, 2018, the give up of the tax-shielding of its distributions is made up for by the ease of ownership by more investors seeking to avoid K-1 tax forms in favor of 1099-DIV reporting.
The stock has been performing and paying well. And yet, the shares are reasonably valued with a price to book at 3.23 times. This is down from over 4.5 times book seen earlier last year. And more important, the underlying book value per share has climbed over the past year by 36.36% meaning that the underlying value of the book of assets is up and growing and not just the stock price.
Now that the additional shares have been placed in the market successfully earlier this year, the stock makes for a good buy for growth from the upstream of the petrol market and lots of income that will complement the midstream and downstream companies in a balanced petrol portfolio.
Neil George is the editor of Profitable Investing and does not have any holdings in the securities mentioned above.
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