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Energy Investing for Yield

Energy in its many forms is traditionally fertile ground for investors that want or need regular income from their investments. Utilities have, even in the last few years of ultra low interest rates and puny returns on bonds, often offered yields around 5% and many oil exploration and production Master Limited Partnerships (MLPs) have paid even more in pass through profits to investors. To those of us who remember the 80s, this is hardly stellar, but compared to a 2.5-3% yield on the US 10 year is quite acceptable.

This has provided a much needed source of income for many people, but over the last 3 or four years, that has been only half of the story.


 
If you had invested in, say, the utility NextEra Energy (NEE) or the MLP Markwest Energy (MWE) three years ago, then you would have seen some pretty nice capital appreciation while you were drawing your dividend. This is all well and good, but it is history, and viewing markets with the benefit of 20/20 hindsight is a frustrating exercise.

My role here is not just to look back, but rather to look forward and give an opinion as to what will look that good three years from now. Unfortunately, given what we know and expect from here, it is unlikely that such performance will be repeated by any utility or MLP during that time. Last week, I gave a brief interpretation of the news from the Fed. New Chair Janet Yellen had said in a press conference that the Central Bank expected QE to end by the Fall of 2014 and interest rate rises to follow not long after. When pressed, she indicated that “not long” would be something around 6 months. If this is the case, then both oil and gas MLPs and utilities will both be hit in two ways by the prospect of a rising rate environment before the year is out.

Both would naturally drop on the prospect of higher rates as instruments that derive some of their value from yield. MWE, despite all of that price appreciation, still has a 5.3% yield and while NEE’s 3.07% dividend at current prices is not as great, it is still decent for a growing company when the US 10 year is yielding 2.69%. After the end of QE, however, and with Central Bank interest rate rises imminent, many are forecasting a yield of around 4-4.5% on the 10 year note. If that is the case then both MWE and NEE will have to drop significantly in price to maintain their spread over Treasuries. (For the record, while I think Treasury yields will definitely go…




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