By now, most advisors are aware of the new U.S. oil and gas boom. As reported by John Sullivan (see "One of the Most Underreported Facts of 2012," ThinkAdvisor.com, Feb. 4, 2013), "2012 saw the greatest increase in domestic crude production ever. Even better? 2013 is already on track to beat it."
Perhaps best is that U.S. production of natural gas has shot up almost in lock-step with oil: According to the U.S. Energy Information Agency, from Jan. 1, 2007, until the beginning of August, U.S. oil production has increased 40%, from 5 million barrels per day (bpd) to 7 million bpd, while natural gas production jumped 25%, from 2 million cubic feet per day (cfd) to 2.5 million cfd.
To put these increases into historical perspective, U.S. oil production peaked in 1970 at 9.6 million bpd, falling to the 2007 low. In contrast, natural gas production had stagnated at the 2 million cfd mark since 1980 until the current boom. On June 10, the EIA released a report showing that the recoverable oil and gas reserves in the United States—now at 58 billion barrels and 665 trillion cubic feet of gas—is up 35% since 2011.
In the past 10 years, oil companies have figured out how to drill wells that run horizontally rather than straight down through the rock formations under them. That means the producing portions of these wells can be miles long, compared with a few dozen feet in most traditional wells. It also means that hard-to-reach, oil-rich rock layers — particularly shale — are now readily accessible. Virtually the entire 35% increase in U.S. oil and gas reserves comes from shale drilling. I've read reports that U.S. shale oil reserves will eventually be found to be larger than those in the Middle East.
Having worked for an oil and gas drilling company many years ago (before I discovered it was a lot more fun to write about investing), I've been following the "shale drilling boom" with great interest for the past few years. Having also begun my journalistic career writing about the imploding oil and gas investment partnerships during the mid-1980s, I'm well aware of the pitfalls involved in trying to make money from passive oil and gas investments. So, I've been keeping an eye out for a way that advisors' clients might make reasonable returns from the new boom, without taking the ridiculous risks that usually accompany non-insider investments in oil and gas exploration. I think I may recently have found it.
Before I get to that, I hope you'll indulge me one more historical set up. About a decade after I left the oil business to become a financial journalist, I had the privilege of working with the legendary Peter Lynch (who managed the Fidelity Magellan Fund as it grew from $18 million to $14 billion and eventually retired as vice chairman of Fidelity Investments) on his column in Worth magazine. One of Lynch's strategies that I've managed not to forget is to avoid investing in "booms" and instead invest in the suppliers of boom companies. One of his favorite examples was one of the only companies to profit from the California Gold Rush of 1849, the Levi Strauss Company, which supplied sturdy britches to the gold miners. Levi Strauss is, of course, still booming today—some 164 years later.
I was reminded of Lynch's "rule" when I was recently introduced to MLPN, Credit Suisse's exchange-traded note (ETN) based on the Cushing 30 MLP Index. It's an investment vehicle that delivers the returns—and dividend distributions—of the 30 "mid-stream energy companies" that comprise the Cushing MLP Index. These companies, formed as publicly traded master limited partnerships, are all involved in the gathering, processing, transporting and storing of crude oil and natural gas; that is, they are mostly oil and gas pipeline companies. Pipelines typically lock in their profits with contracts and inflation clauses.
