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Oil: The Calm before the Storm?

Posted by on in Economics
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A story in The Economist last week outlined the current state of the oil industry:
- Running out of storage capacity. If this is maxed out, fire sale prices on the spot market.
- 4.5mm bpd of spare capacity (vs <1mm in '06)
- Countries like Venezuela running out of cash.
- Days reserves >60 vs an average of 50.

So why think oil is going to run again? As they said in Econ 101 - Inelastic demand.

If incremental demand picks up in BRIC countries, and there is a reasonable increase in demand from developed ones, then we are right back to where we started, and there is no end in sight.

So how to play this? Master Limited Partnerships (MLPs). MLPs are companies formed for tax purposes whereby 90% of income is requried to be paid back to shareholders. Obviously the operating costs of these assets are fixed, so in lean years, there is not a lot of yield. As a result of the beneficial tax consequences of MLPs (dividends are considered a return of principal, and reduce your cost basis, and so are suitable for indivdiuals), they were sold off aggressively in 2008, and have yet to recover.

According to McDep Research, cashflow at a number of MLPS, Royalty Trusts (Canadian equivalents to MLPs) is above dividend levels, which implies 1) dividends are safe 2) they will go higher.  For the individual looking for a little cashflow (5-8% in a deflationary environment) and some upside in oil, these vehicles offer a reasonable risk/reward tradeoff for investors.

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Guest Monday, 25 May 2020