To Drill or Refine? Good Ways to Collect Big Dividends

Robert is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The boom in US energy production creates an income opportunity for retirees and those smart enough to plan ahead for retirement.  With Social Security projecting benefit cuts and facing insolvency in 2033, Americans need to take care of their retirement income themselves.  Below are three energy companies that can help Americans achieve a measure of financial independence.

Did you catch them in the movie “Safe Haven?”

Even if you didn't catch one of their logos in the recent Hollywood tearjerker, you'll find Calumet (NASDAQ: CLMT) products in Armour All, Turtle Wax, WD-40 and Kingsford brands. You’ll even find Calumet in duct tape. But the big story for Calumet rests in its fuel products.

For fiscal 2012, Calumet reported significant increases in its earnings, led by a 59% increase in its fuel products division. Gasoline and diesel were the biggest contributors. This growth came from both acquisitions and organic growth.

Calumet pays a 7.1% distribution. Its payout growth was flat from 2008 to 2010, but since then, its distribution has increased from $1.84 to $2.30 per share.  Will this growth keep going?  I think so.

Calumet recently announced a joint venture to build a diesel refinery in southwest North Dakota using cheap Bakken shale oil. Calumet also plans on expanding its Karns City, Penn. refinery to incorporate a natural gas-to-liquid plant. This plant will use cheap Marcellus shale gas and Fischer Tropsch technology to make 1,000 barrels per day. Beyond oil refining, Calumet may ship oil by barge from its Lake Superior loading dock to take advantage of the takeaway problems Bakken oil suffers.  

On the downside, environmental concerns may scuttle the oil barge plans.  Currently, Calumet also owes much of its profits to a significant price differential between crude oil and Calumet’s products. If crude oil prices rise, profit margins will likely narrow.

Hedging its future and your income
Linn Energy (NASDAQ: LINE) recently received unfavorable press. In the Feb. 13 edition of Barron’s, Andrew Bary raised questions about how Linn accounted for its hedging activities. This is no small matter, since hedging oil and gas production is key to its financial performance. But Linn has since publicly explained its hedging activities and refuted Mr. Bary’s claims. Linn also reported excellent earnings for Q4 2012.

Three major developments over the year should excite Linn investors. First was the creation of LinnCo (NASDAQ: LNCO). This publicly traded corporation was created to invest in a Linn Energy master limited partnership, and disperse Linn distributions to shareholders.  This allows certain institutional investors to invest in Linn Energy who otherwise could not invest in a master limited partnership.

Second, LinnCo and Linn Energy teamed up and bought Berry Petroleum in an innovative deal. Describes as an accretive acquisition,  this merger should use Berry's assets to increase distributions, while allowing a more conservative payout rate.

Lastly, Linn has a winner with its Hogshooter Wash play; initial exploration yielded results so encouraging, the company plans to focus heavily on oil production there during 2013.  So by acquisition and organic growth, Linn’s current dividend yield of 7.7% looks safe.

Off the deep end
Understandably lost in the excitement over America’s onshore oil production was a banner 2012 in offshore and deepwater drilling.  Discoveries outside of the so-called “Golden Triangle” of the Gulf of Mexico, Brazil and West Africa have created opportunities for drilling companies like Seadrill (NYSE: SDRL).  

In fact, Seadrill currently has $21.5 billion in revenue backlog from such companies as British Petroleum, Total and ExxonMobil. With the youngest drilling fleet in the world, Seadrill claims a 5% increase in uptime, leading to $225 million in additional revenue compared to other companies.

Seadrill plans to continue modernizing its fleet. The big attraction for investors is the 9.4% dividend, which has steadily grown since 2009. With future oil consumption and non-OPEC production growing through 2014 as projected by the US EIA, demand for Seadrill’s rigs should stay high.

Against all this promise, what downside does Seadrill offer? First, debt, which Seadrill uses to finance new rig construction. It frequently doesn’t order new rigs until it's lined up sufficient leasing. Furthermore, Seadrill claims the cost of building new rigs is at historic lows, while the dayrate paid for rigs is at historic highs. So while the debt load may appear daunting, much of that debt may be already paid for in admittedly future business.

Second, the price of oil. If oil prices drop, secondary to the European economy slowing down or the dollar strengthening, this will make drilling for deepwater oil less profitable, and likely curtail activity. If oil prices fall in the short term, Seadrill may sink with them.  

Final Foolish Thoughts
Risk is proportionate to reward, and dividends from energy companies are no different. Overall, Linn Energy offers the best balance between a high and growing yield, and the future safety of that income.

Calumet offers a lower yield, but also the prospect of capital gains, as it expands its operations and benefits from inexpensive domestic oil and natural gas.

For those willing to take a calculated risk, Seadrill clearly pays the highest dividend at 9.4%. The risk is the debt. I think world oil consumption will continue rising which, in turn, will drive continued demand for Seadrill’s rigs. To me, Seadrill’s debt is actually an investment in modernizing its drilling fleet -- one that will pay off as offshore exploration expands.  


dylan588 owns shares of Calumet Specialty Products Partners, L.P, Linn Energy, LLC, and Seadrill. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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