Though we’re barely more than a quarter of the way through 2019, we’ve already seen a few big investing surprises.
On the upside, the S&P 500 SPX, -0.45% is up a stellar 15% in the last three months after a rocky December caused many market observers to wonder whether the bull market was finally on its last legs. And on the downside, the highly anticipated IPO of ride-sharing service Lyft Inc. LYFT, -3.55% is trading well below its offer price of $72.
Another surprise has been the resilience of the energy sector and steadily increasing crude oil prices. After starting the year around $43 a barrel, oil CLK9, -0.89% has jumped roughly 40% to the mid $60s per barrel — and the flagship Energy Select Sector SPDR Fund XLE, -1.24% has jumped almost 20% in the same period as a result.
And to hear some say it, the party is just getting started. Analysts at JPMorgan just told Barron’s that if oil can hold the line at $60 in the coming months, the sector can really break out.
Read: The start of a new rally for oil prices? Not so fast, says this strategist
If you’re looking to play the current rally for crude, you can always go with broad and liquid ETFs like the Energy Select Sector SPDR Fund, which boasts about $14 billion in total assets and is the No. 1 energy sector ETF by market value. But different slices of the energy sector offer different risks and rewards if you want to get more tactical with your trades.
Here are three ways to play the rally in oil right now, based on your risk tolerance:
Fracking stocks
In perhaps one of the more aggressive ways to play the oil patch, firms involved with hydraulic fracturing for shale oil and gas were hard hit at the end of 2018 by falling energy prices. After all, the appeal of fracking is that these companies access oil that is a bit pricier and harder to extract, but amazingly abundant in the continental U.S. When oil is cheap, the cost structure just isn’t as attractive and the incentive to pump dries up.
At the end of 2018, as oil approached $40 a barrel, fracker PDC Energy Inc. PDCE, +1.65% plunged almost 39% in three months. Related service stocks were equally hard hit; specialty sand and chemicals provider U.S. Silica Holdings SLCA, -1.49% skidded about 43% in the last three months of 2018.
Now, both have come roaring back. Year-to-date returns for PDC Energy are nearly 50%, and U.S. Silica stock has tacked on an amazing 70% or so since Jan. 1.
These smaller fracking-specific investments are admittedly much higher risk. They don’t have the deep pockets of the major oil companies, and even with technological advancements they can simply wind up on the wrong side of a math equation when production costs are too high and oil is too cheap. However, both PDC Energy and U.S. Silica are expecting a massive swing back to profitability this year on higher oil prices, and investors who are comfortable with volatility may want to hang on and enjoy the ride.
Major oil companies
Of course, while the smaller and more agile small-cap frackers are the quickest to ramp up production, don’t think the majors have been left out altogether. Big Oil giant Exxon Mobil Corp. XOM, -1.24% has surged 20% year-to-date to significantly outperform the broader stock market on the heels of a big earnings beat in February.
What’s more, pessimistic investors continue to lowball Exxon stock; shares have a forward price-to-earnings of about 15 even after this run, while the broader S&P 500 has a forward P/E of almost 18. Exxon offers a decent dividend of around 4% to further sweeten the pot. With unrivaled scale that threw off $16 billion in free cash flow last year and a war chest of $3 billion in the bank, neither this company nor its dividend are in danger anytime soon. And after a few years of poor performance and pessimism, now may be a decent time to consider this stock if you’re confident higher oil prices will stick.
The real Big Oil play in my mind, however, is BP. After forking over about $65 billion in penalties relating to the 2010 Deepwater Horizon disaster in the Gulf of Mexico, BP has been a laggard for nearly a decade; shares were in the mid-$40s by 2011 and after some modest ups and downs are still in that price range. But with the penalties for the giant oil spill finally tallied — and with oil prices at long last back above $60 a barrel — now is the time to consider BP. The stock yields an amazing 5.5%, but is only paying out about two-thirds of earnings.
There is always risk that slumping energy prices will take a toll, even on entrenched Big Oil names. However, they are a more stable way to play energy and generate a bit of extra cash via dividends along the way.
Read: Gasoline prices up 8 straight weeks, with California on track to pay the most in nearly 5 years
MLPs
Of course, if you really want dividends, then go straight to the energy sector’s most generous players in master limited partnerships, or MLPs. These firms are a special class of company that gets preferential tax treatment and in fact aren’t stocks at all in the strictest sense. As the name implies, they are partnerships — and as such, give investors a direct slice of the profits via regular and generous paychecks.
MLPs are typically pass-through entities. The “general partner” is typically a bigger name in energy, and the “limited partners” are people who own a piece of the company and make most of their money via distributions instead of share appreciation. It’s a win-win: MLPs reduce the cost of capital for energy companies, and individual investors get tremendous yield.
One of the largest MLPs is oil transportation giant Plains All American Pipeline LP PAA, -2.13% a $18 billion partnership that yields about 4.9% at present. Shares have been much sleepier than the rest of the energy sector in the last 12 months, with a more shallow dip in late 2018 and a more modest recovery in 2019, but that’s the nature of stocks like this.
However, Plains All American Pipeline’s yield is actually quite modest when you look at other names in the space. Buckeye Partners LP BPL, -1.59% is a midstream petroleum transportation and terminal operator that has jumped 17% year-to-date and yields a phenomenal 8.6% at current pricing.
Now, there is no free lunch. If and when oil prices roll back, their operations may suffer — and so would your payouts. Midstream operators that are largely toll collectors on pipelines or storage facilities are much more insulated from month-to-month oil price volatility. If you don’t necessarily want big share appreciation and instead prefer to chase long-term income, MLPs are looking very good right now.
Now read: Why energy sector stocks aren’t keeping up with soaring oil prices
