President Barack Obama recently remarked that oil is the "fuel of the past." As long as his "past" extends for 10 to 15 more years, I completely agree with him.
Right now, the oil and gas industry presents plenty of ideas for investors in need. There are so many options that really, entire portfolios can be built to reflect the process of extracting commodities from the ground and turning them into an end product that people use every day. While I'm not suggesting you actually do that, I am suggesting taking a closer look at energy from start to finish and evaluating the best stocks for your current portfolio.
This article will introduce you to each of the five main components of the energy sector. Over the next few days, I'll follow up with an in-depth look at each one, with specific investing ideas in each.
Exploration and production
The energy cycle begins here, as oil and gas companies travel to the ends of the earth and back searching for fat deposits of our two favorite commodities.
E&P is marked by two trends right now: the dearth of huge new discoveries of oil, and the abundance of huge new discoveries of natural gas. Unconventional production techniques have freed up some tremendous finds in the U.S. and abroad, and while some American companies are curbing natural gas production, overseas it's growing by leaps and bounds.
There are uncertainties about how long fossil fuels will continue to dominate the energy world, but in the near term, oil and gas stocks will continue to perform well.
Two E&Ps to start thinking about
The two companies below exemplify how diverse the American E&P game is right now, with both companies having seen huge growth lately. Forget Big Oil: The little guys are ramping up production, and there is still plenty of time to cash in.
2012 Target Production
Kodiak Oil & Gas (NYSE: KOG)
SandRidge Energy (NYSE: SD)
Source: Company statements.
Oil-field service companies handle a variety of tasks for oil and gas producers, ranging from taking seismic measurements of the seafloor to manning 24-hour hydraulic fracturing crews. The intricacies of exploration and production are so delicate that most companies hand them off to these experts.
The upshot of adding an oil-field service provider to your portfolio is that these companies are only going to become more necessary as E&Ps discover more oil and gas in very hard-to-reach places.
Two oil-field service companies to start thinking about
The two companies below represent the best the industry has to offer when it comes to offshore and onshore oil-field services, respectively.
Source: Yahoo! Finance.
There are 2.6 million miles of pipelines crisscrossing the United States right now. These toll roads are crucial components in the energy cycle, bringing the commodities to market. Aside from pipelines, the midstream category also includes storage and processing centers.
There are two upsides to adding a midstream company to your portfolio right now. First, these companies more or less escape the clutches of commodity volatility. Pipeline transmission rates are set by the Federal Energy Regulatory Commission and are not tied to the price of oil and gas. Second, American onshore E&P is booming, and we need many more miles of infrastructure to handle the supply.
On top of that, midstream companies are quite often organized as master limited partnerships. MLPs follow different tax guidelines and often offer very attractive yields.
Two midstream companies to start thinking about
We can find two of those very attractive yields with the companies below. Perhaps best known by their respective parent companies, Kinder Morgan and Enbridge, these two MLPs pass big chunks of their cash flow straight on to investors.
Return on Assets
Kinder Morgan Energy Partners (NYSE: KMP)
Enbridge Energy Partners (NYSE: EEP)
Source: Yahoo! Finance.
Refining is possibly the least popular step in the energy cycle right now, after many in the industry suffered fourth-quarter losses. The tide in this industry, however, turns quickly and things are already picking up. Seasonal effects and decreased capacity on the East Coast and in Europe will be contributing factors to refiners' success.
Adding refining to your portfolio now isn't a terrible idea. As we build out midstream infrastructure, capacity at U.S. refineries will increase, which is good for business. The risk in refining is that if demand is too soft, refiners will take a bath on tight margins.
Two refiners to start thinking about
The two refiners below are making the most of cheap oil from the middle of America, and boy does it show in their revenue growth.
Valero (NYSE: VLO)
Source: Company statements.
At times, it's hard to picture anything other than a fuel gauge when we think about the end result of the energy cycle. Gasoline, diesel, and jet fuel all power our vehicles. But natural gas is becoming more popular as a fuel, and it is even beginning to replace coal as the energy source for power plants. Utilities and chemical companies in particular are big buyers of natural gas.
Two end users to start thinking about
The companies below don't have much in common with the others we've covered so far, but they're dependent on the industry nonetheless. Whether it's buying the commodity to turn it into something else, or simply plugging in to our nation's power grid, these companies would be nothing without all the processes we've covered so far.
Dow is one of the largest buyers of natural gas. It converts the product into a variety of chemicals, resins, paints, aerosols, and plastics for everyday use.
Natural gas is quickly catching up to coal in the electricity-generation business. Charge your electric battery with the power of natural gas.
When I'm outside, I hug as many trees as I can, but for the next five to 10 years, my portfolio is going to have a lot of oil- and gas-related stocks in it. Every portfolio is different, however, and investors should take a moment to evaluate how best to convert energy opportunities into personal investing success.
Learn more about the energy industry in these articles from our energy investing series
Investors looking to shy away from energy for now should consider The Fool's special free report "Secure Your Future With 11 Rock-Solid Dividend Stocks" for a few more ideas.