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Energy Stocks Will Be a Steady Source of Dividends

U.S. News & World Report - Money logo U.S. News & World Report - Money 7/13/2017 Jeff Reeves
Oil refinery at twilight sky: For investors who can wait it out, experts say several factors offer big potential in the energy sector in the coming months.© (Getty Images) For investors who can wait it out, experts say several factors offer big potential in the energy sector in the coming months.

It's been rough for the energy sector in the last few years. As crude oil prices have crashed from the $90 range in mid-2014 to the $40 range this summer, big-name stocks in the industry have taken it on the chin.

Here's how some of the biggest names in energy have fared lately:

--ExxonMobil Corp. (ticker: XOM) is down 14 percent in the last year and 22 percent in the last three years.

--BP plc (BP) is down 4 percent in the last year and 35 percent in the last three years.

--Royal Dutch Shell (RDS.A) is down 3 percent in the last year and 36 percent in the last three years.

--Chevron Corp. (CVX) is down 1 percent in the last year and 21 percent in the last three years.

By comparison, the Standard & Poor's 500 index is up 15 percent in the last year and is up 22 percent in the last three years, dating back to July 2014.

So is the oil industry doomed, and should investors dump their energy stocks?

Not so fast, says Shawn Reynolds, portfolio manager for Natural Resources Equity Strategy with investment manager VanEck.

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

"It's cyclical; it happens." Reynolds says. "In my career, I've seen the death of the oil industry at least three times."

In reality, the energy market often corrects itself via supply and demand trends. Consider recent overtures from OPEC that production cuts will continue into 2018, or news that major oil companies cut capital expenditures by $54 billion, or about 40 percent in 2016, as cheap oil prices made it counterproductive to bring more crude to market.

These reductions in supply are occurring even as demand marches slowly and steadily higher, and experts agree that these trends will have a stabilizing force in the long term even if energy stocks could still face near-term volatility.

For savvy long-term investors who can stomach some more ups and downs in the next few months, a combination of factors are pointing to big potential in the energy sector – both for investors looking to capitalize on the impressive growth of shale oil drillers, and for investors looking for stable income investments trading at a fair price.

Technology has redefined the energy sector. The first thing investors should understand, says Reynolds, ishow horizontal drilling and hydraulic fracturing technology has revolutionized the energy industry.

It used to be that oil companies were primarily explorers hunting for oil pockets they could tap and bring to market, and the potential of those fields was limited by the price of oil.

"The fields were discrete, so if there was 100 million barrels there would always be 100 million barrels," Reynolds says. "The value of that discrete field was simply calculated based on the price of oil."

The result was that oil companies were always on the hunt, spending billions each year in pursuit of the next oil field. Reynolds says the industry got a reputation for "destroying capital" as a result, since expensive deepwater exploration "didn't have high enough success rates to make for sustainable companies" and the high cost of extraction relied on perpetually high energy prices.

Now, technological advances like fracking allow oil companies to access massive onshore shale oil fields with greater ease and much lower investment. The volatility in energy prices will never go away, Reynolds says, but now "the only thing these guys need to worry about is getting the cost of getting that oil out of that shale lower and lower – and over the 10 years this (fracking) industry has really existed, that's all they've done."

As a result, many investors are expecting North American shale companies to "grow 20 to 30 percent, or even more," Reynolds says. And since risk is lower than conventional oil companies thanks to cost controls, these shale companies look particularly attractive right now.

The dividends aren't there in fracking yet. Income-oriented investors may notice these fracking stocks don't really pay substantive dividends now. However, it may only be a matter of time as the consistent cash flow causes investors to demand a return of capital and consistent dividend growth.

Reynolds points to Pioneer Natural Resources (PXD), a low-cost shale oil producer that yields less than 1 percent currently but is a case study in up-and-coming energy stocks that could offer big dividend growth.

"These stocks are going to start paying a good dividend," he says. "Not in 2017, 2018 or 2019, but by 2020 a lot of these large (fracking) companies will emerge into this dividend business model that the oil majors have held onto for so long. That will expand the investor universe greatly for energy and dividend investors."

Reynolds says he's not overly concerned with oil majors in the next five years or so, because "their dividend is their No. 1 priority" and institutions and investors find that attractive. But when this new generation of frackers come into their own, it could "change the investing universe" as income-oriented investors move out of names like Exxon and Chevron with a higher cost of production and into more stable plays like Pioneer – particularly if big oil companies continue to shortchange exploration budgets now, leading to smaller future reserves.

For long-term investors, then, now may be the perfect time to consider a transition out of old dividend stocks in the oil patch and into the next generation of energy companies.

Energy infrastructure plays offer stability and value. Admittedly,it's hard to predict what the future holds for frackers and oil prices. And the current dynamic seems mighty unfavorable to oil majors like Exxon and Chevron; these companies are hamstrung by a current unwillingness to spend aggressively on finding future reserves and persistently low oil prices limiting the value of their existing oil fields.

So if you're interested in energy but want to limit your risk, a good strategy may be to focus on infrastructure plays, says Rich Steinberg, managing director and partner at HSW Advisors at HighTower.

"While (low prices) may not be great for those who are selling the commodity, it's not bad for the ones who move it and store it and process it," Steinberg says.

Furthermore, energy output is remarkably consistent and can deliver reliable revenue streams for these infrastructure plays to fuel big dividends. Steinberg points to stocks like Enterprise Products Partners (EPD), which yields north of 6 percent thanks to consistent cash flow from its pipelines.

And best of all, he says, you can often snap up stocks like this at a bargain when oil is cheap because many investors tend to discount these pipeline and storage names with the rest of the sector. A savvy investor who delves into the specifics of a company can often find value that isn't evident when looking at broad trends for the diverse oil and gas industry.

[See: 10 Energy ETFs That Will Clear Your Conscience.]

"The energy sector tends to trade in a homogenous fashion, but they're not all the same," Steinberg says. "There are plenty of pockets of value if you know where to look."

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