investing

How Investors Can Prosper From High Gas Prices

The best approach is to invest in large, high-quality energy firms run by experienced managers.

When prices at the pump shot up four years ago, I suggested that you move some savings to high-yielding oil royalty trusts and master limited partnerships, then use the dividends to pay for gas. It’s time to relaunch this plan.

My original cash-for-gas scheme stalled late in 2008 because the recession pummeled the price of oil. West Texas Intermediate fell from $145 to $30 a barrel. Shares of BP Prudhoe Bay Royalty Trust (symbol BPT), a key driver of my plan because the trust passes along dividends directly from the sale of Alaskan oil, went off the road, plunging from $106 in July 2008 to $50 in March 2009. It’s true that gasoline prices also fell—but except for Treasury bonds, all your other investments got totaled. I bet you’d have preferred to continue paying $4 a gallon rather than losing half your retirement savings.

Don’t expect a big drop in oil prices anytime soon. Even if tensions with Iran ease, you can’t count on economic weakness to bring down the price—the U.S. is growing, and demand for oil is brisk everywhere. The Chinese, for example, have bought 50 million cars since 2008. Moreover, the cost of finding, producing and transporting oil has been rising sharply. And the depressed price of natural gas is having no dampening effect. No wonder West Texas crude was parked near $100 a barrel in mid March.

I concede that my cash-for-gas plan is not for everyone. If you spend $100 a month for fuel and assume that you can collect 6% annually on your investments, you must front $20,000 to drive “free” for a year (and that doesn’t take into account taxes on your dividends). Because this strategy involves some risk, you wouldn’t want to use 20 grand that’s designated as the family emergency fund or reserved for a down payment on a home.

Not surprisingly, the oil-soaked Texas advisers I talked to liked my plan. (When do Texas oil guys ever say anything bad about the black stuff?) Their major concerns are that too many unsophisticated investors are piling into income-producing energy investments and that some questionable exploration companies and royalty trusts have gone public recently. Some of these will fail regardless of the path energy prices take.

Best ideas. The best approach is to avoid the unfamiliar and stick with large, high-quality firms run by experienced managers. Because BP Prudhoe Bay is a pure play on the price of crude, it should be the cornerstone of your energy portfolio. Although the stock has rebounded to a near-record $124 a share, it still yields 8.1% (all prices and yields are as of March 9).

Jerry Swank, head of Cushing MLP Asset Management, in Dallas, is a fan of BP Prudhoe Bay. But he says the best income choices are pipeline networks, such as Plains All American Pipeline (PAA) and Magellan Midstream Partners (MMP), both set up as master limited partnerships. Plains moves crude around the central part of the U.S., and Magellan carries refined products, so the two firms don’t compete with each other. At $80, Plains yields 5.1%; Magellan, at $72, pays 4.5%.

To diversify more, Swank suggests blending in proven producers. He likes Linn Energy (LINE), which explores for both oil and natural gas. Much of its gas is in the form of “liquids,” such as propane, which is more profitable than natural gas. Swank also favors Vanguard Natural Resources (VNR), whose output is two-thirds oil-and-gas liquids and one-third natural gas, one of the highest liquid-to-gas ratios in the group. Vanguard, selling at $29, yields 8.2% and LINN, at $39, yields 7.1%.

James Shelton, of Kanaly Trust Company, in Houston, is less ebullient than Swank because he thinks these energy stocks are getting too pricey. “We continue to like the MLPs, just not as much,” Shelton says. He advises yield hunters to start with energy stocks but to add some high-yield and emerging-markets bond funds. That makes sense. Investors, start your engines.

ORDER NOW: Buy Kiplinger’s Mutual Funds 2012 special issue for in-depth guidance on the only investments you need.

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