Energy is one of the most valuable and important resources in the world. From the discovery of fire to the more advanced possibilities of the future, energy has and will continue to play an enormous role in society. In this, the first of three articles on the subject, we’ll discuss the importance of energy and its forms. In subsequent articles we’ll explore several ways to invest in it. Gaining knowledge of the energy industry is a significant step in understanding how to invest in and profit from it. 

Why do advisors need to understand the energy sector? If you believe Warren Buffett is a good investor, remember, he only buys businesses he understands, which is a good rule to follow. Oil & gas extraction may be less than 2.0% of U.S. GDP, but its ripple effect is significant. Here is a condensed list of the relative consumption of petroleum products in 2013, according to the U.S. Energy Information Agency (EIA):

  • Gasoline (46%)
  • Heating Oil (20%)
  • Jet Fuel (8%)
  • Propane (7%)

Petroleum products are also used to make chemicals, plastics, and synthetic materials, fuel oil, asphalt and road oil, lubricants, waxes, etc. 

In the investment arena, the energy sector comprises 7.52% of the market cap of the S&P 500 Index and 6.83% of total U.S. market cap. Needless to say, since it is used by so many other industries, the energy sector is vital to the U.S. economy. There is also a great opportunity in energy today since oil prices are well below their peak.

And if you’re looking for yield, an MLP may be a consideration. But do your homework. The potential upside may be good and the tax benefits appealing, but the downside can be a total loss if you invest in a specific well. We’ll look at this in greater detail over the next few articles.

The Significance of Energy

Energy was crucial in transforming small societies into modern-day states. In developed countries, energy production and usage is vital to economic growth and stability. Because of this, investing in energy has become wildly popular. After food, water, air, and other basic necessities like adequate shelter, energy ranks next in terms of its importance to society. Therefore, an investment in energy may be considered a defensive position in one’s portfolio.

In academia, energy can be classified as kinetic (in motion) or potential (not in motion). In a practical sense, energy is required to create motion for transportation purposes and to fashion a comfortable living environment. Before a particular type of energy will be adopted by the masses it must be available at a reasonable cost. Some types of energy are in competition with each other where, theoretically, the consumer casts the deciding ballot to determine which forms are utilized. 

There are several types of energy available today including oil, gasoline, natural gas, electricity, coal, nuclear, solar, wind, hydro, and others. Some are more advanced, some are more efficient, and some are more economical. Finally, some forms of energy are finite while others have an unlimited supply. 

Today, petroleum-based products are the most widely utilized of all energy sources. There is an extensive pipeline system in place in the United States. According to the American Petroleum Institute, the amount of pipeline that transports liquid petroleum in the U.S. exceeds 190,000 miles. Petroleum products are also transported by rail and semi-truck. However, most believe the pipeline method is the safest.

When you view a map of the U.S. showing the entire pipeline system, it touches every state except Hawaii. The highest concentration of crude oil pipelines is located in West Texas, North Texas (north of Dallas), and along the Gulf Coast from the southern tip of Texas to the tip of Louisiana. Because of this, the economies of Texas and Louisiana are greatly affected by the state of the oil industry. There are also a large number of refineries in the same region of the Gulf Coast. 

The Energy Debate

Prospecting and extracting and transporting petroleum products is not risk free, which has sparked a debate. This debate between fossil fuels and renewable, ‘green’ energy has two key components. The first is the risk of exhausting the supply. The other issue centers on risks to the environment and elicits strong emotions. Even though the details of this debate are beyond the scope of this article, the issue is of considerable importance to investors. Why? Because it’s a PR battle to sway consumer opinion which impacts the profitability of companies in this sector.

Although the debate rages, the status quo remains and has resulted in a healthy discussion on alternative forms of energy. However, before a new type of energy receives mass adoption by the American public, it must be efficient and economical. At this point, efficient and economicial solar, wind and hydroelectric sources of energy, as a replacement for fossil fuels, seems to lie somewhere over the rainbow.

What will be the new energy frontier? Will it be one of the aforementioned sources? Is nuclear a possibility? I doubt that it will ever become widespread, especially since a natural disaster or terror strike could result in radioactive fallout for the communities surrounding nuclear power generating plants. Will the next big thing be solar, hydro or perhaps wind? 

Here’s an example of where innovations in technology might change the entire energy equation. A company called Kite Gen Research, based in northwest Italy, has been working on a kite which generates energy from high-altitude winds. The kite has a wingspan of 33 feet and can generate three times the energy of a single wind turbine. It also contains an avionic sensor to report wind speed. 

Summary

What will the energy landscape look like in 20 or 30 years? Will green energy replace fossil fuels or will it even make a dent in the highly entrenched traditional sources of energy, like petroleum products? I have no doubt the debate will linger and both sides will continue their attempt to influence consumers. However, before a new source of energy gains mass adoption, it must be as cheap, or cheaper, than the existing method.

In the next article in this series, we’ll look at ways to invest in energy, including individual stocks, ETFs, mutual funds, MLPs and more. Stay tuned.