A few months ago, I suspected oil and gas pass-through securities were done with their amazing growth run. Tremendous appreciation in share prices of royalty trusts and master limited partnerships had knocked their current yields to their lowest point in years, sometimes below 7%. With energy prices peaking and other yields rising, I advised caution.

But yellow lights don't last forever. As I suffer the earliest onslaught of cold and snow in the Northeast that I remember in ages, I'm ready for another look. My verdict: The energy-trust sector is safe, and I have some recommendations for generous income. But I suggest that you diversify inside of the big tent called "energy."

Looking back

Some background: In summer, when oil and natural gas prices were dropping, so were the expectations for higher cash distributions from the royalty trusts and master limited partnerships. Because these are yield-oriented investments, lower-cost energy spells lower share prices. In less than two weeks in August, San Juan Basin Royalty Trust, which passes through income from domestic natural gas production, fell from $51 to $39. San Juan (SJT) is a bellwether for this group of stocks, so that was a jolt. Other royalty trusts and MLPs such as Sabine, Mesa, and Permian Basin lost around 10% of their value -- admittedly, most of these operations experienced 30%, 40% or even 75% run-ups over a year. San Juan is back now to $45, still way up from the mid $30s of last winter but well off its peak.

In all, the extended rally had cut the yields on many energy pass-throughs from 9% or 10% a few years ago to around 7%. If energy prices are peaking or falling, that makes them expensive. True, 7% is fine for a high-quality real estate investment trust or, better, as the taxable-equivalent yield on a high-rated municipal bond. But in an energy trust, 7% is low enough to be risky. Unlike rents and mortgage payments that feed into REITs, or ordinary bond interest, energy trusts' monthly income and cash distributions can swing dramatically. A 15% fall in gas or oil prices can result in a 50% cut in the dividend.

San Juan just distributed a 33.4-cent monthly dividend in December, which is almost as much as it has paid out in some quarters. That's its highest monthly payment since 2001. And with even colder months ahead and record gas prices, you'll get a few more hefty months.

The wild card

However, if you add up San Juan's last 12 monthly dividends, you get $3.17, and that works out to a 7% yield at $45. So we wouldn't pay more than $45 -- except there's a wild card: Wall Street apparently thinks natural gas reserves are going to be worth more. On December 12, the giant oil company ConocoPhillips offered a monster price to buy Burlington Resources, which has major gas reserves. Over the past four weeks, Fidelity's natural gas mutual fund is up 10%. U.S. Global Investors Global Resources, which invests in many gas trusts, is up the same percentage.

Now, why is this? Partly because it's cold, both here and in Europe. Natural gas in Britain is said to be the costliest fuel on earth. But it's also because of the sense that even if energy investments aren't the steals they were three years ago -- when you could get shares so low the yields were close to 10% with appreciation still to come -- the world's appetite for traditional fuels remains enormous. The shouts that $60 oil and $10-plus natural gas would send the industrialized world into a terrible recession also have proven to be far off the mark.

That said, you can and should diversify your income investments within energy. Besides royalty trusts and MLPs that pass through direct sales proceeds from oil and gas production, you can get high yields all over the field. Propane gas merchants such as Amerigas Partners (APU), coal producers such as Fording Canadian Coal Trust (FDG), and various pipelines, tanker companies and a few drilling service contractor companies that are now organized as income trusts all yield at least 6% and sometimes above 10%.

In my next column, I'll explore high-income opportunities in those fields and in shipping. Even if gas and oil prices back down soon or if January is as warm as December has been cold, there's sure to be big money exploring for energy and moving it around.

MORE: Kiplinger.com | Investing | Column

TOOLS:   E-Mail Article  |  Print Article  |  Reprint Article  |  Content Sales

E-MAIL ALERTS: Keep up-to-date with the latest Kiplinger has to offer

SAVE, SHARE & DISCUSS:    |   |   |   |   |   |   |   |   

ADD HEADLINES: