It’s only natural that investors might wonder what the impacts of all these stimuli will be on the market in general and energy stocks in particular. Unfortunately, there’s a tendency to read too much into these measures; for example, I’m convinced that the USD787 billion American Recovery and Reinvestment Act won’t result in the big boost for alternative energy stocks some pundits predict.

But that doesn’t mean there aren’t implications. I see potential upside for infrastructure names as well as the master limited partnership space.

In This Issue

The 1,400-page American Recovery and Reinvestment Act is the subject of much discussion in the political as well as the financial media. Cut to the chase and find out when and where the money will be spent–and how to profit. See Washington’s Stimulus.

The US government isn’t alone in its efforts to stimulate the economy; China, too, is spending a lot of money. The key question is, of course, will it work? See Wider Impacts.

Congress and the administration have obviously been active, but what’s going on with Treasury and the Fed? We know a lot about last year’s TARP, but let’s take a look at this year’s FSP and TALF. See Beyond the Stimulus.

I’ve focused on income-producing securities, integrated oils, high-quality, gas-focused exploration and production firms and beaten-down value names in the oil services in the current environment, but I’ve also introduced another strategy for playing the energy space. See Covered Call Update.

Washington’s Stimulus

Washington, DC has supplanted New York City as the nation’s key financial center. The latest news on the economic stimulus package and the Treasury Dept’s financial stabilization plan (FSP) has been the single most important driver for the stock market so far this year.

At the Orlando Money Show earlier this month, I was asked repeatedly what effect the stimulus plan would have on the economy and, more particularly, on energy-related sectors. At the time, it was difficult to know for sure as the House and Senate bills still contained wide differences.

But after weeks of debate in the House of Representatives, the Senate and various committees, a compromise bill has been signed into law by President Obama. The measure drew little support from the GOP; no Republican members of the House voted for the bill, and only three Republican Senators crossed the aisle. The stimulus plan has also seen what can be generously characterized as a mixed reaction from the public.

I avoid political commentary in The Energy Strategist because it’s not my job to save the world, nor do I weigh in on the potential efficacy of various pieces of legislation on a regular basis. But this USD787 billion stimulus package clearly has an impact on the stock market, the economy–and on energy stocks in particular. Like it or hate it, as investors we simply can’t afford to ignore the impacts of the American Recovery and Reinvestment Act of 2009.

The final bill is broadly divided into two parts: Division A involves direct government spending and indirect spending through the states, while Division B primarily directs payments and tax rebates to individuals. Roughly 28 percent of the package constitutes tax breaks and rebates; the remainder is spending.

Here’s a chart summarizing the report on the American Recovery and Reinvestment Act (the Act) published by the Congressional Budget Office (CBO):

Source: Congressional Budget Office

The media has reported the value of the bill to be about USD787 billion, but that figure is really just the CBO’s estimate as to its long-term impact on the US budget. Far too many people assume that all of that cash will hit the US economy immediately upon passage of the bill; this is a total fallacy.

The chart above breaks the Act down into two components, tax breaks and spending. The chart further shows exactly when the stimulus is projected to impact the economy; when reading the chart, keep in mind that the government’s fiscal year (FY) ends on Sept. 30, FY2009 would end Sept. 30, 2009.

Roughly USD185 billion of the package is projected to hit the economy this fiscal year, while the peak year for the stimulus will be FY2010, with about USD400 billion. Broadly speaking, tax provisions will be among the first to have an impact and are heavily weighted in the first two years of the CBO projection. The spending provisions have a bit longer tail and will continue to impact the budget significantly out through FY2014.

Let’s take a closer look at exactly how this USD787 billion will be spent, starting with Division A.

Source: Congressional Budget Office

Division A is the so-called appropriations segment and represents a total of around USD310 billion in spending. This primarily involves money flowing through various federal agencies and departments. The pie chart offers a vastly simplified look at where the money’s headed.

A few of the big spending items include:

State Fiscal Stabilization Fund (USD56.3 billion): It’s estimated that 46 US states face big holes in their budgets over the next few years, and many would need to cut back on services to remain fiscally sound; some, such as California and Kansas, are in particularly dire fiscal straights right now. This fund provides federal dollars to help plug those budget gaps. About 82 percent of this cash is required to go toward education at all levels.

Transportation, Housing and Urban Development (USD61 billion): The biggest chunk of this spending (USD27.5 billion) is going to the Federal Highway Administration for highway infrastructure investments. Only around USD2.7 billion of this amount would be spent in fiscal year 2009–not all highway projects are “shovel-ready.” The bulk would be spent in FY2010 and FY2011. This section of the bill also includes USD8 billion for high-speed rail infrastructure, and a further USD1.3 billion for the National Railroad Passenger Corporation, also known as AMTRAK.

As for Housing and Urban Development, the Act provides USD4 billion for new public housing and USD3 billion in funding for community rehabilitation.

Energy and Water Development (USD50.8 billion): Energy-related spending programs account for about USD45.2 billion, about 90 percent, of this total. The list of spending includes USD16.8 billion for the Dept of Energy’s (DoE) Energy Efficiency and Renewable Energy Program, USD4.5 billion for energy reliability, USD3.4 billion in fossil energy research and some USD6 billion in loan guarantees for renewable generation and transmission technologies.

This section of the bill also includes USD4.6 billion in funding for the Army Corps of Engineers, primarily aimed at flood and water control projects of various descriptions.

The interesting point to note about energy- and water-related spending is that much of it won’t actually flow into the economy until after FY2010; many of these longer-term research and infrastructure related projects aren’t “shovel-ready.”

Obviously, this segment of the bill most directly relates to The Energy Strategist; I elaborate on these provisions below.

Labor, Health and Human Services and Education (USD71.3 billion): This is the biggest single spending priority in Division A of the Act. About USD15.7 billion of this will go towards Pell Grants; the Pell Grant program provides for need-based funding primarily for undergraduate education.

Another USD25 billion is slated for education for the disadvantaged and special education initiatives; both of these programs are designed to provide funding for the 2009-10 and 2010-11 school years to offset declines in funding from cash-strapped local and state education authorities.

This section also includes about USD10 billion in additional funds for the National Institutes of Health, a federal agency that focuses on medical research. Finally, the National Coordinator for Health Information Technology, a rather obscure post created in 2004, gets nearly USD2 billion; this is part of President Obama’s announced plan to introduce health care-related IT modernization as a means of cutting medical costs.

Division B of the Act is more targeted at tax provisions.

Source: Congressional Budget Office

The biggest component of Division B is the so-called revenue impact–the amount of forgone tax revenues due to the enactment of the bill.

Tax provisions include a “Making Work Pay” credit. This credit covers taxable years 2009 and 2010 and is the lesser of USD400 (USD800 for married couples) or 6.2 percent of individuals’ earned income. The credit would be phased out for individuals earning over USD75,000 annually or couples earning over USD150,000.

In addition, the Act provides for additional tax credits for children, an increase in the Hope credit against tuition expenses, and a first-time homebuyer credit equal to the lesser of USD7,500 or 10 percent of the home’s value.

Many of the Act’s tax provisions are refundable, meaning that if the credit exceeds a taxpayer’s federal tax liability, the difference is payable as a refund to the taxpayer. In other words, these tax credits can result in a person receiving a refund even if they don’t actually have to pay federal taxes. This is one reason you’ll hear discrepancies in terms of what portion of this bill is considered spending compared to tax cuts; many consider refundable credits to be spending because they result in cash flowing to Americans that don’t pay taxes.

Another important point to note is that in most cases, credits are phased out or eliminated for taxpayers earning over a specific amount. If an individual earns over USD75,000 or a couple earns over USD150,000, they’re unlikely to see much, if any, tax benefit from this bill.

In addition to refundable tax credits the Act also contains about USD40 billion in additional funding for unemployment compensation, about USD18 billion in child support and Temporary Assistance for Needy Families and USD90 billion in additional state fiscal relief. In Division B, most of that state fiscal relief is aimed at health care and Medicaid programs as opposed to the education-focused fiscal relief that is included in Division A.

With regard to energy-focused investments, there are two areas of potential impact: the economy as a whole and companies that will benefit from the direct flow of money into energy-related research and development.

I’ll begin with the second half of that equation; the chart below offers a rundown of exactly how the USD45 billion in energy related funds are to be spent.

Source: Congressional Budget Office, Dept of Energy, House Committee on Rules

The most direct expenditure on energy is part of Division A, Title IV of the bill. The total spend is about USD45.2 billion; as the chart shows, only about 4 percent of that total will be spent in FY2009, followed by about 16 percent in FY2010. The projected peak year for energy-related spending is FY2011, when close to a quarter of the total package will be spent. Don’t expect any real short-term impact on energy stocks as a result of this spending.

The largest single component of the package is the DoE’s Energy Efficiency and Renewable Energy (EERE) program. The EERE essentially provides funding for energy-related projects that are undertaken as public-private partnerships.

One example of a project that EERE has funded is the Hawaii clean energy initiative. Hawaii gets about 84 percent of its total primary energy (transportation and electricity generation) from crude oil; this is expensive, not environmentally friendly and makes the state heavily reliant on imported energy. In fact, Hawaii’s electricity prices are the highest in the United States, averaging 22 cents per kilowatt-hour compared to a national average of less than 9 cents.

The goal of this initiative is for Hawaii to garner about 70 percent of its energy needs with clean energy by 2030. This will generally involve measures to improve energy efficiency and increase the state’s exposure to energy from sources such as wind, solar and biofuels. This goal sounds a bit pie-in-the-sky, but it’s spending just the same and will benefit alternative energy companies with exposure to Hawaii.

Another program is the Solar America Initiative. The goal is to make photovoltaic (PV) power cost-competitive with conventional electricity generation by 2015. EERE is providing cash to industry, universities and other government industries to advance solar research and development. In fact, the DoE is pouring about USD30 million into university research and millions more into grants to cities to encourage solar power use.

There are other examples, but this is a general picture of how this money would be spent: renewable energy, biofuels and energy efficiency research and demonstration projects.

One important point to note: USD16.8 billion is a lot of cash when you consider most projects EERE is involved with are more on the order of tens of millions of dollars. It will take time to grant all that cash to specific projects, which is why most of the spending won’t flow through until after FY2010.

Here are some of the other programs being funded in the Act:

·          USD4.5 billion in funding for electricity transmission improvements;

·          USD3.4 billion in fossil energy research and development, including USD800 million for a clean coal initiative and USD1.52 billion for work on carbon capture and sequestration;

·          USD6.0 billion in loan guarantees for renewable energy and transmission technologies;

·          USD5.527 billion for defense-related environmental clean-up.

Many investors believed this stimulus package would constitute a huge giveaway for alternative energy companies. There does appear to be significant funding that will flow into the sector over the next few years. I also expect we’ll see more energy-focused bills out of the Obama administration in coming years that will, quite likely, involve more money flowing into the alternatives industry.

But don’t buy into the hype. If you’re using the American Recovery and Reinvestment Act of 2009 as a reason to buy alternative energy stocks, you’re reading too much into the stimulus package.

Alternative energy stocks are currently facing significant headwinds. For one thing, still-weak credit markets make it harder for companies to finance major wind and solar farms. And the slowdown in residential construction spells a decline in household solar installations.

Another USD42 billion will help at the margin, but it can’t offset these headwinds. Moreover, as I’ve noted, a large portion of the cash to be spent on energy won’t hit the economy this fiscal year or next; it’s hardly a short-term catalyst.

The action in alternative energy stocks over the past few months further supports my contention.

Source: Bloomberg

This chart shows the relative strength of two of my favorite alternative energy stocks, Vestas Wind Systems (OTC: VWSYF) and First Solar (NSDQ: FSLR), versus the S&P 500 Energy Index. A rising line indicates the stock is outperforming the index, and vice versa.

As you can see, since late September there’s no sustained evidence that either stock is outperforming the energy sector as a whole. And there’s no real sign of an improvement over the past month and a half while the Senate and House discussed stimulus proposals. Bottom line: The Obama stimulus plan isn’t a reason to rush to buy alternative energy stocks.

One potentially meaningful provision is the funding for clean coal and carbon capture technologies. While less than USD2 billion out of a USD787 billion package is hardly a game-changer for the coal industry, it does suggest that Obama isn’t as negative for coal as some assumed him to be, nor as he as anti-coal as the more environmentally focused members of his own party would prefer.

I see this as an incremental positive for coal mining firms such as Peabody Energy (NYSE: BTU), Consol Energy (NYSE: CNX) and Arch Coal (NYSE: ACI).

Three areas of the economy are likely to see meaningful impacts from the stimulus package: infrastructure, health care and education. The heavy spending on all three of these groups is clear in my outline of the package.

Health care and education are way beyond the scope of The Energy Strategist coverage universe. There are, however, a few relevant plays on the infrastructure front that are likely to benefit from the stimulus bill.

One such firm is Shaw Group (NYSE: SGR), a recent addition to my uranium field bet. Shaw operates in three main markets: power plants; energy; and environment and infrastructure (E&I).

The E&I division accounts for about 20 percent of Shaw’s total revenues. The biggest customer for this division is the federal government; Uncle Sam is behind more than 90 percent of Shaw’s existing E&I backlog. Projects include transport infrastructure, levee construction and environmental remediation.

These are exactly the sort of projects the stimulus bill seeks to fund in coming years. And even with no new orders, Shaw already has USD5 billion in E&I backlog, about a third of its USD14 billion-plus backlog of incomplete projects.

Shaw’s biggest business is power plants, including both conventional fossil fuel plants as well as nuclear reactors. Shaw owns a 20 percent stake in Westinghouse, one of the two main builders of nuclear plants globally. The company has already won myriad nuclear contracts including a USD4 billion deal with Progress Energy (NYSE: PGN).

On the fossil fuel side, Shaw builds natural gas, coal and even geothermal plants. In addition, Shaw makes scrubbers used to clean pollutants from power plant emissions; advanced scrubbers will clearly be part of any clean coal initiative. Shaw Group is a buy at current prices.

Another firm to watch is Switzerland-based ABB (NYSE: ABB). ABB’s largest divisions are power products, power systems, automation products and process automation.

The company’s power products and power systems divisions make the products and components necessary to transmit and distribute electricity; in fact, ABB is the world leader in transmission and distribution networks (T&D). These two divisions account for about half of ABB’s sales.

The stimulus package contains several provisions to invest in enhancing the efficiency and reliability of the US electric grid, and ABB will benefit from this spending. And the US government isn’t alone: China’s USD586 billion stimulus package, announced in late 2008, includes investment in grid construction. I’m not yet adding ABB to the Portfolio but I will track it in How They Rate. ABB is a buy.

A bit further off the beaten path is Proven Reserves Portfolio holding NuStar Energy (NYSE: NS). NuStar is a master limited partnership (MLP), a group I described at some depth in the November 5, 2008 TES, Time for Income.

NuStar’s traditional business is the ownership of refined products pipelines and related infrastructure such as crude oil terminals. These businesses account for nearly 75 percent of operating income and are primarily stable and fee-based. NuStar is paid based on the volume of oil and refined products traveling through its pipelines, not the value of those commodities.

The nasty recession has resulted in an outright drop in volumes of refined products traveling through US refined products pipelines. The obvious supposition is lower revenue for NuStar; however, there’s a key offset in the form of higher rates. Effective July 1, 2009, NuStar’s tariffs increase by about 7.5 percent, more than offsetting the decline in volumes. These tariffs reset automatically based on inflation-indexed increases.

The final quarter of NuStar’s operating earnings comes from its two asphalt refineries. Like all refining operations, NuStar’s margins in asphalt vary from quarter to quarter. NuStar earns a profit based on the spread between the cost of the crude oil it must buy as feedstock for its refineries and the value of the asphalt and other products NuStar makes. (I explained the basics of the refining business in last week’s issue of Pay Me Weekly, Over the Barrel.)

There are several potential positives for the asphalt markets. On the supply front, several companies that used to produce asphalt have stopped doing so. The reason is that most refiners have set up their operations to maximize production of light products such as gasoline and diesel fuels.

These companies have installed special equipment that allows them to turn heavy residual products like asphalt into these lighter, higher-value products. As a result, in 2008 US asphalt production was off 10 percent and imports were down nearly 50 percent against 2007 levels. This leaves less competition for NuStar’s dedicated asphalt refineries.

At the same time, the stimulus bill will pump billions into the Federal Highway Administration as well as recapitalize states struggling with fiscal shortfalls. Building new highways means using more asphalt; some estimate that the stimulus package could mean as much as a 10 percent jump in asphalt demand for FY2010 and beyond. Higher demand and sluggish supplies spells higher margins in the asphalt business, and that’s good news for NuStar.

One point to note is that NuStar has traditionally relied on shipments of heavy crude from Venezuela as feedstock for its refineries. This is less of an issue than it might seem. The US remains the only real market for Venezuela’s heavy crude as that oil wouldn’t have much value in Asia at present. And while Venezuela has announced cuts to heavy oil shipments in compliance with OPEC quota reductions, NuStar has stated that it has several alternative heavy oil suppliers offering similar profit margins.

I cut my recommendation on NuStar from buy to hold last year due to concerns that this refining business would add to cash flow volatility. But, in light of the potential boost in asphalt demand and ongoing cuts to supply coupled with NuStar’s flawless execution over the past year, I’m now a believer. Yielding nearly 9 percent, NuStar Energy is a buy under 55.

Back to In This Issue

Wider Impacts

Above I outlined some of the direct impacts I see coming from the stimulus package. The other issue is the potential for the stimulus package to actually promote economic growth.

This is a far more contentious issue. If you ask the promoters of the package, they’ll tell you it’s the key to generating growth and that it will create millions of jobs. If you ask the detractors, they’ll tell you massive spending will do little to stimulate growth but will have significant negative impact on the US deficit.

It’s fair to say the truth probably lies somewhere between these two extremes. According to the CBO, a total of USD185 billion should be pumped into the economy this fiscal year, with about USD65 billion of that coming from tax cuts.

Roughly a year ago, President Bush signed the Economic Stimulus Act of 2008 into law; it cost about USD152 billion. That act provided a USD600 tax rebate for individuals and USD1,200 for married taxpayers; the rebate didn’t apply to individuals making over USD75,000 or couples making over USD150,000. All told, this sounds broadly similar to some of the tax provisions in the Obama stimulus package.

There was an impact from the 2008 stimulus, though it was short-lived.

Source: Bloomberg

Source: Bloomberg

Last year’s stimulus checks began to impact the economy in roughly the April-to-June period. The first chart above shows monthly same-store sales for a selection of about 75 major retailers last year and into early 2009. Same-store sales is a key metric for retailers that measures how fast sales are growing at stores open at least one year.

There was a clear downtrend in sales figures in early 2008 that suddenly seemed to reverse in the April-to-June period before resuming a downtrend again later in the summer. It’s impossible to know for sure, but this certainly looks like that USD152 billion influenced consumer spending habits.

Another way to look at the data is to examine quarterly GDP. Just as with same-store sales, the trend was negative for GDP in early 2008. However, in the second quarter, there was a spike in annualized GDP growth to 2.8 percent. This seemingly anomalous reading was likely caused by the temporary impact of the stimulus checks that impacted the US economy through the second quarter and then quickly faded.

It seems a fair assumption that the stimulus planned for FY2009 and FY2010 will have at least some impact, just as the smaller 2008 rebate checks did. It may simply be a short-lived and temporary stabilization of the data, but there should be an impact. And remember that China and other countries are also in stimulus mode; external stimulus could also help generate growth in the US economy.

There may already be signs that the Chinese economy is stabilizing.

Source: Bloomberg

This chart shows the Baltic Dry Index over the past year. This index measures the rates charged by dry bulk shippers to transport commodities such as iron ore, grain and coal.

As you can see, rates have totally collapsed since summer 2008, for two main reasons. Chinese importers began de-stocking their inventories of key commodities and therefore had less need to import commodities. As the Chinese economy slowed in the final months of 2008, this situation became worse.

Adding to the downward pressure was the inability of companies to get letters of credit from banks to cover shipments. This was part of the severe credit crunch that hit the market in the latter months of 2008.

We can now see the beginning of a turn higher in the Baltic Dry Index. This is consistent with comments made by Chinese Premier Wen Jiabao over the weekend. Wen stated that in the final days of 2008 the picture for the economy began to improve as Chinese producers ran through some of their excess inventories. In addition, Wen noted a pick-up in lending activity in January and the beginnings of impacts from China’s stimulus package. The Premier further stated that more stimulus would be forthcoming as needed.

I’ll leave it up to readers to determine if they feel the potential benefits of the USD787 billion US stimulus package justify its cost. However, one thing remains clear in my mind: All of this stimulus will eventually increase inflationary pressures and quite likely lead to a weaker dollar. I discussed this effect in the Feb.4 TES; suffice to say this is broadly positive for physical commodities such as oil and natural gas.

Back to In This Issue

Beyond the Stimulus

Although the media has focused primarily on the stimulus package, the financial relief measures being pushed by the US Treasury Dept and Federal Reserve are arguably more important and will have bigger impacts on stocks.

Most investors are familiar with the so-called troubled assets relief plan (TARP) passed late last year. The original idea was to buy up bad assets directly from banks. This would have essentially recapitalized the banks and created a market for otherwise illiquid, hard-to-value loans.

The original TARP plan morphed into a fund for investing government cash in banks. The Bush administration abandoned the original intent of the TARP due in large part to difficulties determining what price to pay for assets purchased from banks.

Not surprisingly, the Obama administration is encountering the very same issues. The market clearly didn’t find Treasury Secretary Tim Geithner’s explanation of the so-called Financial Stabilization Plan (FSP)–or TARP II plan–sufficient; Mr. Geithner’s speech was notably short on details. As always, the market abhors uncertainty and sold off sharply.

In fact, the Treasury Secretary’s performance generated more questions than answers. He spoke of a comprehensive financial stress test that all banks would be required to undergo; those that don’t pass the test could access capital directly from the Treasury to recapitalize their balance sheets.

It’s unclear what form these capital injections would take, or whether they’d be voluntary or required. The government might inject capital via convertible preferred shares; if so, this could spell major dilution for existing private shareholders in some banks. And, from the tone of the speech, it would seem that the government plans to impose rather onerous restrictions on everything from capital adequacy to executive pay. After all, Mr. Geithner stated that the idea was to incentivize the banks to replace public capital with private capital as quickly as possible.

Whether you’re predisposed to believe in this idea or abhor it completely, what’s absolutely certain is that the financial industry didn’t like it: The S&P 500 Financials Index plummeted more than 10 percent the day Mr. Geithner outlined the FSP.

Whatever form the FSP ultimately takes far too many investors are ignoring what is perhaps a more significant plan, the so-called Term Asset-Backed Liquidity Facility (TALF). The TALF was originally announced in November as a USD200 billion fund for the government to buy up AAA-rated securities backed by credit card, auto loan, education and other receivables. The idea here was that by purchasing these illiquid assets, the feds could create a more liquid market and free up bank capital for lending.

TALF is now being quintupled in size. The new facility will allow the government to buy USD1 trillion in such asset-backed bonds. There’s also talk of adding more types of bonds to the list of eligible purchases.

All these trillions worth of financial stabilization plans have had an impact on the US credit markets.

Source: Bloomberg

This chart shows the TED Spread, a measure of the yield spread between three-month US Treasuries and the three-month London Interbank Offered Rate (LIBOR). LIBOR is the interest rate banks charge one another to lend money. A wide TED Spread means the interbank market isn’t healthy–that banks are unwilling to lend money to one another.

The TED Spread spiked to unprecedented levels during the height of the credit crunch last fall. Since then, however, it has normalized and now stands at less than 1 percent, near its early summer 2008 levels.

Another metric to keep an eye on is US corporate bond issuance.

Source: Bloomberg

As this chart indicates, the US corporate bond market totally dried up last fall, but issuance surged in December and January. This suggests a gradual unfreezing of credit. At the moment, most of these bonds are being issued by companies with high credit quality; however, it represents a marked improvement from the total freeze-out that prevailed just a few weeks ago.

The biggest beneficiaries of this improvement in my coverage universe are the MLPs. (See TES, November 5, 2008, Time for Income.)

 I sorted the returns for all of the stocks in The Energy Strategist coverage universe over the past three months; credit conditions have slowly but surely begun to normalize over this time period. Of the 15 top-performing stocks, 11 are MLPs or limited liability companies (LLC). These 11 MLPs are up an average of more than 25 percent over this time period.

More broadly, the industry benchmark Alerian MLP Index has rallied more than 15 percent so far in 2009, compared to a 12 percent decline for the S&P 500 and a near 10 percent decline for the S&P 500 Energy Index. That’s dramatic outperformance.

The Alerian MLP Index had by far its roughest year ever in 2008 amid fears that a widening credit crunch would impact MLP access to capital. This is of particular concern for the sector because most MLPs rely heavily on debt capital to fund expansion projects. An easing of debt and credit markets has resulted in improved sentiment surrounding the group.

Another factor that’s loomed over the MLP group for much of the past year and a half is the overhang of institutional shareholders needing to sell down their stakes to raise cash. This forced, cash-motivated selling caused a good deal of the volatility in the group–even within ultra-stable names like Enterprise Products Partners (NYSE: EPD) and Kinder Morgan Energy Partners (NYSE: KMP)–late in 2008.

But these holders are beginning to file their year-end 13-F forms detailing current positions. These filing suggest the overhang of shares is rapidly disappearing. For example, closed-end fund management companies Kayne Anderson Capital and Tortoise Capital owned 9.4 million and 6.3 million shares of Enterprise Products, respectively, a year ago.

Closed-end fund firms must maintain certain leverage limits as prescribed under the 1940 Investment Act or risk severe repercussions. The rapid selloff in the MLP space late last year effectively pushed up leverage levels beyond the maximum permitted; the closed-end fund firms were forced to sell down their holdings and raise cash. Kayne Anderson and Tortoise sold more than 2.1 million shares of Enterprise combined in the fourth quarter of 2008 alone. Over the past year, total sales from these two firms amount to more than 4 million units.

But the closed-end fund firms have cut their leverage and, with the sector now stabilizing, the pressure to sell off their portfolio to raise cash has been reduced. The selling from this important group of shareholders has abated.

In another positive sign, Dan Duncan, the widely respected billionaire chairman of Enterprise, has gradually increased his stake in the stock over the same period. With over 136.7 million shares, Duncan is Enterprise’s single largest shareholder and has added nearly 3 million units to his position over the past year. It’s encouraging to me to see a chairman support his stock so consistently amid all the volatility.

It’s also a big positive to see firms like Lehman Brothers no longer among the top holders of pass-through securities. One of the reasons that oil and gas producer Linn Energy (NSDQ: LINE) got hit so hard in September and October was that Lehman Brothers was the LLC’s top holder, with about 10 percent of the total units outstanding as of the end of the second quarter.

When Lehman went bankrupt it sold out of this stake; as you can imagine, the unloading of 10 percent of the outstanding units in a company like Linn created massive downside pressure. But Lehman no longer owns Linn; that overhang of shares is dissipating. Meanwhile, CEO Michael Linn and CFO Kolja Rockov have also been adding to their positions amid the turmoil.

Normalizing credit markets coupled with a big decline in institutional share overhang make me extremely bullish on the MLPs. And the MLP sector also benefits from low exposure to commodity prices and enormous income potential; investors are looking for high current income right now as a bastion of stability in a volatile market.

In view of this improving outlook, I now have 11 buy-rated MLPs and LLCs in the TES Portfolios:

·          Duncan Energy Partners (NYSE: DEP)

·          Enterprise Products Partners (NYSE: EPD)

·          Kinder Morgan Energy Partners (NYSE: KMP)

·          Natural Resource Partners (NYSE: NRP)

·          NuStar Energy (NYSE: NS)

·          Teekay LNG Partners (NYSE: TGP)

·          Tortoise Energy Infrastructure Group (NYSE: TYG)

·          Linn Energy (NSDQ: LINE)

·          Eagle Rock Energy Partners (NSDQ: EROC)

·          Sunoco Logistics (NYSE: SXL)

·          Williams Partners LP (NYSE: WPZ)

For those interested in safety first, stick with the MLP recommendations inside the Proven Reserves Portfolio. For those willing to take on more risk for a higher return potential, consider buying into the MLP picks in the Wildcatters Portfolio. The only MLP I’ve rated a hold is Hiland Holdings GP (NSDQ: HPGP), a name I explained in the last issue.

I’ll have more updates on these stocks as the group finishes reporting earnings over the next two weeks. For those of you who joined The Energy Strategist from The Partnership, see the December 24, 2008 issue of TES, Buy Income, Super Oils and Gas, for a rundown of my outlook for a long list of partnerships.

Back to In This Issue 

Covered Call Update

In the December 24 issue I outlined another investment strategy, writing covered calls. I recommended two covered call trades, both held within the aggressive Gushers Portfolio, one on Hess (NYSE: HES) and one on ExxonMobil (NYSE: XOM).

With reference to the latter position, I recommended buying Exxon and selling the February 2009 USD80 Call Option (Symbol: XOM BP). At the time, Exxon was trading around USD75 per share while the February USD80 calls fetched close to USD3.25. If you bought the stock and sold the calls, your effective cost basis would be USD72.14. If that explanation doesn’t make sense to you, check out the December 24 issue for a detailed look at how this trade works.

The calls you sold expire this Friday, Feb. 20, and Exxon currently trades around USD72. That means that these calls are highly unlikely to expire in the money or get exercised. This is good news for us because it means we get to keep both our position in Exxon and the entire proceeds received by selling the calls.

I’ll look to sell another call option on Exxon early next week once our existing calls expire. This will further lower our cost basis in the stock. It’s too early to pick an exact covered call recommendation, so be on the lookout for a Flash Alert early next week.

My recommended covered calls on Hess don’t expire until May, so we still have a few months left to run on that trade.

Back to In This Issue