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Playing The Expected Theme For 2018

Shale

There is, it seems, one theme that look likely to dominate energy investing in 2018, increased output. On some subjects it seems that the current White House has a problem iterating a consistent and coherent policy vision, but that is not the case on energy, where every word we hear talks about “unleashing America’s energy potential” or some other, similar cliché. And, so far, their actions have backed up their words. Vast areas of the country have been opened up for exploration and drilling, and environmental protections are being abandoned at what many consider to be an alarming rate.

That, though, is a double-edged sword for big oil and E&P companies. To date the relaxation has been accompanied by a big jump in oil prices, but at some point, as the new fields open up and U.S. production increases even more, it will put downward pressure on price. From here though, and with demand picking up nicely, that may not be too much of a problem, but it will cap the upside for many industry stocks. As I pointed out last week when I picked SLB as a stock for 2018, the expansion is good for oilfield service companies, and their reaction to price fluctuations tend to lag. That is why I am looking to midstream operations for other ideas for the early part of the year.

The obvious place to go is to Kinder Morgan Inc. (KMI). They are one of the biggest pipeline operators, and have a relatively stable financial position for a company in a capital-intensive business. That is important because the Fed has made it clear rate hikes are on the cards this year, so stock in over-leveraged companies that derive part of their value from their dividend will get punished at some point this year.

(Click to enlarge)

In KMI’s case, though, a lot of that punishment has been meted out in advance. The stock spent most of last year moving downwards, before hitting a bottom at 16.68 and beginning a bounce. Regular readers will know that is a pattern I like to trade, as the base gives a solid, logical level off which to set a stop loss order. In this case an initial stop around 16 would leave you looking at potential losses of around 20 percent, which is higher than I would like, especially given that that is roughly the upside to the trade if we see a good recovery. As the bounce is well underway in this case, however, I feel that a higher stop can be used: somewhere around 17.90 that is just below the last two lows.

Because of the interest rate and other risks, this is a long-term trade that should be run using strategies normally applied to short-term positions. I would, for example, start using a rolling stop as soon as on a break of $20 and consider reversing if we get around the $23 high, particularly if we do so in a rush.

Hopefully, though, what we will see is a steady climb in KMI over the coming months, as they and their customers make the most of the rare fossil-fuel friendly political environment. That would enable investors to collect a couple of dividend checks as a bonus along the way and would make further gains in the second half of the year far more likely.

Long-term investing is about identifying and playing themes, and this year, oilfield infrastructure and mid-stream operations look like the best way to play the theme of industry growth that is, for once, not entirely price-dependent. There are plenty of opportunities in those areas, but until the theory is proven, bigger is better. Larger companies will make it through any short-term volatility without having to cut long-term plans, so KMI looks like a decent pick to benefit.




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