How to Play the Oil Rally

Sean Brodrick
by Sean Brodrick, Resource Strategist

Have the mainstream media yahoos who keep screaming about “the death of the commodity bull market” filled up their gas tanks lately? The price of gasoline is going up. And yep, crude oil is in a big bull market, the kind that just gushes potential profit opportunities.

Looking at the chart, you can see that crude oil has broken out. While it might retest its breakout, the likely path is higher, probably to test overhead resistance from 2011.

West Texas Intermediate (CME: WTIC), the U.S. crude oil benchmark, used to trade at a discount to international benchmark Brent Crude. That’s over. Now, new pipelines and rail are carrying more U.S. crude to refiners on the coasts, relieving a storage surplus. At the same time, U.S. refiners are able to export more refined product to eager customers overseas.

And remember, this is happening while the global economy sputters along in second gear.

Here’s a list of forces that could send the price of U.S. crude even higher…

U.S. Crude Oil Stockpiles Are Dropping. U.S. commercial crude stockpiles fell for the fourth week in a row, dropping 2.8 million barrels to 364.2 million barrels last week. That’s a drop of nearly 30 million barrels in a month - the largest drop since at least 1984.

Sure, stockpiles are still over the five-year average, but the trend is looking pretty darned bullish. Gasoline stockpiles are down, too, dropping 1.4 million barrels in the most recent week, when most analysts were expecting a build. If you think that doesn’t affect you, keep an eye on prices at the gas pump. They’re likely to go up.

Peak Hurricane Season Looms. August is around the corner, and that’s peak hurricane season. We’ve been lucky so far, but you can’t count on luck when the winds start to blow. If a major hurricane hits “Energy Alley” in the Gulf of Mexico, companies such as Shell and ConocoPhillips typically shut down offshore production rigs, refineries and pipelines, and evacuate workers. And wholesale fuel prices see it coming - they typically go up a week before a hurricane hits.

Emerging Markets Are Thirsty for Crude. The International Energy Agency (IEA) is jacking up its demand forecast this year by 215,000 barrels per day. That takes total consumption to 90.8 million barrels per day. Why? Because the rest of the world wants to drive like Americans!

What’s more, the IEA now estimates that in 2014 emerging economies will drive demand to a record 92 million barrels per day.

So how can you play this energy boom? Take advantage of the fact that America’s energy companies are trying to squeeze more and more product through the same pipes.

Energy producers are pumping out so much oil and gas that it’s putting a strain on America’s energy infrastructure. The EIA recently reported that U.S. transport of crude oil by rail, truck, and barge has soared by 57% between 2011 and 2012, surpassing 1 million barrels per day.

Holy mackerel – look at that surge in 2012!

So, who makes money in that situation? Pipelines, for one.

And many of these companies pay you to own them... plenty with yields over 5%. Longer-term investors will find such companies the smart choice.

Why I Like MLPs

Pipeline companies are usually structured as master limited partnerships (MLPs), which usually pay out a hefty share of their profits as dividends, though MLPs call them “distributions.

Many great pipeline companies, energy producers, drillers and others in the oil business are organized as MLPs. Although not corporations, MLPs trade on major stock exchanges and are included in exchange-traded funds (ETFs).

Alerian MLP ETF (NYSEMKT: AMLP) is an ETF that tracks a basket of 25 of the leading U.S.-listed energy MLPs. It has a market cap of $7.3 billion and daily volume of more than 2.7 million shares. So it’s big, liquid and easy to trade. And it sports a distribution yield of 5.72% - not too shabby.

It’s obvious AMLP is in a strong uptrend that might even be accelerating. Pullbacks can be bought. And if it pulls back deeper than your original buy price, well, you’ll be paid a nice 5.7% yield to wait it out.

For now, the global economy is improving, if slowly, and it’s likely we’ll see continued expansion. That means higher prices for oil - and energy MLPs.

Good investing,

Sean

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