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Is It Time to Dump Fossil-Free Funds?

Jeff Brown

Maybe fossil fuels aren't dead after all. President Donald Trump has moved to spur coal mining and wants more oil drilling and less environmental regulation.

So is it time to pile into coal and oil stocks?

Many experts are encouraged, somewhat, by recent oil price increases, but warn it's still a risky sector beyond the government's control. Oil is trading for around $53 a barrel, up from around $37 a year ago but still well below past highs due to a glut. The coal industry is being hammered as electricity producers switch to cheap natural gas, a trend unlikely to change.

[See: The Best Energy Stocks to Buy for 2017.]

"Investors should have a diversified portfolio with some exposure to high-quality energy companies," says David Yepez, energy analyst and portfolio manager at Exencial Wealth Advisors in Oklahoma City. "For the more aggressive investor, having a slight overweight exposure seems suitable. For the conservative investor, an equal-weighted exposure to the sector appears appropriate."

He and other experts note that policies encouraging fossil fuel production won't enrich investors if gluts depress prices.

"The energy sector has been the second worst-performing Standard & Poor's sector in the last 10 years," he says, blaming regulation and low prices.

While Trump wants to spur coal production and jobs, that industry already employs far fewer than the solar and wind power industries, and easing coal regulation will not change the fact that natural gas is cheaper and renewables like wind and solar are getting cheaper.

Oil may have better prospects than coal. Low prices have forced the better companies to become more efficient, which could help them thrive even if prices do not soar, says Jody Team, a planner with Team Financial Strategies, an energy investment advisor in Abilene, Texas.

"As oil moves back toward $60 per barrel there could be opportunity and value in service companies as production continues to come back on," Team says, referring to firms like drillers and testers that serve oil producers.

But low prices don't make for high profits, says Joshua Hall, owner of True Vine Investments in Williamsport, Pennsylvania.

"At current oil prices, very few U.S. oil producers are generating free cash flow," he says. "By this I mean, that few have any excess cash left over after they reinvest in the drilling, etc., required to simply maintain their current production levels."

While production costs have fallen, Hall says that's largely due to price cuts by service companies that will charge more as oil prices rise. "Even if oil prices rise further, U.S. producers will still struggle because of the increased cost pressures," he says.

That said, he likes Baker Hughes (ticker: BHI), a low-debt leader in technology that could benefit from a pending merger with General Electric Co. ( GE).

Exencial Wealth Advisors prefers firms with strong balance sheets, vertical integration and good growth prospects for five or 10 years. The firm avoids those with lots of debt and low growth, Yepez says, recommending Pioneer Natural Resources ( PXD) and EOG Resources ( EOG).

While easing of regulation could benefit the oil industry, other trends might be more important, says Robert R. Johnson, president of the American College of Financial Services in Bryn Mawr, Pennsylvania.

[See: Oil ETFs: 8 Ways to Invest in Black Gold.]

"I think it is a terrific time to invest in energy stocks," he says. "Historically, energy stocks have been among the best-performing stocks in a rising-rate environment," citing research he did with Gerald Jensen of Creighton University and Luis Garcia-Feijoo of Florida Atlantic University.

They found that from 1966 through 2014, energy stocks were the best performing sector when rates were rising, gaining an average of 11.2 percent annually during those periods, versus 8.1 percent for consumer goods, 7.9 percent for utilities and lesser gains for steel, food and financial stocks.

Rather than pick and choose among individual energy stocks, small investors should buy index funds that offer diversification and low fees, Johnson says.

"Two great, low cost, passive alternatives for investors wanting exposure to the energy sector are the Energy Select Sector SPDR Fund ( XLE) and the Vanguard Energy ETF ( VDE)," he says.

Another option is to invest in oil infrastructure like pipelines, refineries and storage facilities, which are used even if oil and gas prices slump, especially if production increases. Master limited partnerships, a kind of fund traded like a stock, make these bets easy and can pay handsome income.

"We are optimistic of the fundamentals for the midstream companies," Yepez says, referring to MLPs that gather, process, store, and transport energy. "MLPs will benefit from less regulation, more pipeline approvals and increases in crude oil volumes through the pipelines. The current dividend yield for the average MLP company continues to be attractive."

Many yield in the high single or low double digits.

If oil and coal look risky, what about renewable energy like wind and solar? Again, views are mixed.

"Renewable-energy companies will have an uphill battle to get subsidies from Washington" in an Republican-dominated era, Yepez says, referring to benefits that have made renewables competitive with fossil fuels.

"One way to have exposure is to find companies with diversified businesses that have some exposure to alternative energy investments. General Electric fits this criteria very well," he says.

But Garvin Jabusch, co-founder of Green Alpha Advisors, an asset manager that focuses on clean energy stocks, thinks renewable energy is a better bet than fossil stocks despite Trump Administration support for the traditional fuels.

Jabusch says fossils will have trouble competing as renewables grow cheaper. He likes 8point3 Energy Partners LP A ( CAFD) and Vestas Wind Systems.

[See: The 10 Best Energy ETFs for an Eventual Bounce.]

"Solar module costs have fallen 80 percent since 2008, and solar power can be generated for as little as 2.42 cents per kilowatt-hour, less than half the price of fossil-based electricity," he says.

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