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Plummeting energy prices shocked the stock market and sent shares of energy companies reeling. The Energy Select Sector SPDR ETF (NYSE: XLE) lost roughly 15% in the past three months as the market seemed to lose faith in global economic growth.
But not all energy stocks have suffered. In fact, today's pick is up 9% in the past three months. What's more, it has a hefty annual dividend of 6.1%, but I have found a way for income traders to boost that annual cash to an almost 15%.
An Energy Company That Benefits From Lower Oil Prices
Energy Transfer Partners (NYSE: ETP) is a master limited partnership (MLP) that owns pipelines and energy storage facilities. The partnership is managed by Energy Transfer Equity (NYSE: ETE), which collects a fee and sells assets into the partnership.
On Tuesday, it was announced that Energy Transfer Partners entered a joint venture with Phillips 66 (NYSE: PSX) to build two pipelines to move crude oil from the Bakken Shale and Three Forks formations in North Dakota to refineries and rail terminals around the country.
The 1,100-mile Dakota Access Pipeline is expected to deliver 450,000 barrels of oil a day to Illinois, and the Energy Transfer Crude Oil Pipeline will connect Midwest storage hubs to Texas. ETP will have a 75% interest in both pipelines, which are scheduled to be completed by the end of 2016.
It costs roughly $10 per barrel to ship crude by rail from the Bakken formation to Illinois, compared with about $6.50 to ship it by pipeline. With limited pipeline capacity from North Dakota, oil producers have had no choice but to pay higher rates to ship crude by rail.
Bakken producers need crude prices between $70 and $80 a barrel to meet return targets. If prices continue to drop, oil producers in the region may decide to lower production volume over the short term rather than continue to pay high rail costs. Lower near-term production will stretch out the lives of fields in the region. This is important because unconventional shale fields deplete quickly. A shift in production to later years when pipeline capacity will be higher could benefit ETP.
Not only does the company stand to benefit on its future Bakken pipeline, but it is also well-positioned for the developing natural gas export story in the United States. Surging production has driven U.S. natural gas prices to less than a third of the price in Asia, and massive export growth could be just around the corner. The MLP's existing assets allow for transportation to both the East Coast and Gulf Coast.
Energy Demand is Higher, Even If Prices are Not
Whether energy prices head higher or lower from here, volume demand is on a one-way path. In its 2035 Energy Outlook, BP (NYSE: BP) forecasts demand for crude will rise 10.5% by 2025, and natural gas consumption will jump 21.5% over the next decade.
Even as the Federal Reserve pulls back on its monetary stimulus, the European Central Bank has committed to inject up to 1 trillion euros (roughly $1.27 trillion U.S.) into its financial system. The Bank of Japan will continue its own monetary stimulus program through 2015, and China's GDP is expected to grow at least 7% next year. With the developed world firmly bent on kick-starting growth, demand for energy products will remain high regardless of where energy prices go.
As a pipeline transportation company, ETP makes its money on the volume of crude and natural gas that it transports. The partnership focuses on fee-based revenue, and management looks to hedge up to 75% of its commodity price exposure.
A Double-Digit Cash Return and Strong Upside Potential
ETP pays an annual distribution of $3.90 per share for a yield of 6.1%. The distribution has increased at a compound rate of more than 10% annually over the past 10 years, and strong cash flow should drive growth going forward.
But you can boost your cash return to double digits and still benefit from upside in prices with a covered call strategy.
With ETP trading at $64.11 at the time of this writing, we can buy 100 shares and simultaneously sell an ETP Jan 70 Call, which is trading around $1.20 ($120 per contract) for a net cost of $62.91 per share.
If ETP is above the $70 strike price at expiration on Jan. 17, our shares will be sold for that price. In this case, we will make $5.89 in capital gains plus the $1.20 in options premium for a total profit of $7.09 per share in 80 days. That is an 11.3% return over our cost basis. If we were able to make a similar trade every 80 days, we could earn a 51% rate of return in a year.
I like the trade as long as you can get in for a net cost of $63.50 or less, which still leaves you with a gain of more than 10% in less than three months if the shares are called away.
If ETP fails to rally to $70 by expiration, you keep the shares and the premium and have the opportunity to sell additional call options to generate more income and lower your cost basis further, while still collecting dividends.
If you were able to generate $1.20 in income every 80 days on this stock, that would add up to about $5.47 a year. Combine that with the $3.90 dividend, and you now have a yield of 14.6% at current prices on an MLP that has a strong future.
Energy Transfer Partners should remain relatively protected from the sell-off in energy prices because of its fee-based revenue structure and strong assets positioned to take advantage of U.S. energy export growth. It should also benefit over the next several years as capital spending brings new pipelines in service, especially in the Bakken formation. A covered call strategy can boost your cash return while still benefiting from longer-term price appreciation.
Note: Selling covered calls is like collecting "rental income" on the stocks you own. If you're not renting out the stocks in your portfolio, you may be missing out on the easiest income around. See how you can collect $1,200 or more each month by clicking here.
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