Energy Plays: How to Profit From the Oil-Price Boom

The seemingly endless surge in energy prices is lightening wallets at gas stations everywhere. But it's also a potential bonanza for investors who have a multitude of ways to play the astonishing bull market run.


As analysts continue to debate whether there's an energy bubble, market pros aren't wasting their time. Instead, they're focusing on how to profit from the trend.

"There are so many excellent ways to play the energy market," says Jordan Kimmel, a hedge fund and mutual fund manager at Magnet Investment Group in Randolph, N.J. "Everyone keeps looking over their shoulder to figure out where the top of the market is going to be and not recognizing how deep this global explosion is. This is not a supply interruption increase, this is really demand-driven."

To be sure, there are plenty of risks in the strategy. Should the oil boom suddenly go bust that would spell trouble for a variety of investments. At the same time, if prices continue to rise that also would put pressure on major producers, as would the potential of windfall profits taxes that Congress continues to discuss.

As such, Kimmel is playing the energy market with diversification though a number of angles: Pipeline builders, natural gas suppliers and even alternative energy. Exploration companies have been popular among money managers, and President Bush's announcement Wednesday that he will encourage Congress to reverse a ban on offshore drillinglikely will boost the industry.

Kimmel's plays include pipeline companies BP Prudhoe Bay Royalty Trust and Persian Basin Royalty Trust. Both pay solid dividends and, because they are focused on transporting fuel, are not subject to price fluctuations.

In natural gas, Kimmel recommends Contango Oil & Gas and Warren Resources. His top alternative energy play is Canadian Solar.

"Every guy's out there looking for the guy who's going to call the top," Kimmel says. "That's definitely not going to be me, and it's not going to be here."

Big Oil or No Big Oil?

Some investment advisors are staying away from the oil majors on the thinking that prices are too volatile and a big surge can have a negative impact on the major producers.

But Peter Miralles, president of Atlanta Wealth Consultants, is playing the entire sector and isn't afraid of stalwarts like BP and ConocoPhillips.

"It's the same theme we've been on before--pretty much anything in energy. With prices where they are, they're going to continue to make a lot of money," Miralles says. "A 10 percent correction is nothing in the commodity area."

Elsewhere in the sector, Miralles likes companies that make the machinery and equipment used in petroleum, including National Oilwell , FMC Technologies and Weatherford International.

He also is in coal, with recommendations for CONSOL Energy and Massey Energy .

Natural gas also has the attention of John Massey, portfolio manager at AIG SunAmerica Asset Management, who believes a high trading ratio compared to gas, a warm summer trend and the possibility of a severe hurricane season as bullish factors.

In that industry he likes Ultra Petroleum , a company based in the Rocky Mountains that will benefit from the construction of a new pipeline that will greatly help with distribution.

Generally in energy, he recommends Schlumberger for its big international base and ability to get into countries like Russia and Venezuela, which are more difficult places for US-owned companies.

And he says Cameron International is a strong company for playing offshore and deep water drilling.

ETFS Play the Trend But Limit Exposure

Mindful of energy volatility, some investors are diversifying by playing exchange-traded funds, which mimic the movement of indexes and commodities.

Rydex, a leader in ETF offerings, last week rolled out two new energy ETFs, the S&P Select Sector Energy for a long play and the Inverse S&P Selector Sector Energy for a short play for those who believe the sector will fall.

The funds follow Standard & Poor's 500 energy indexes and provide double exposure on each side. They were released at the same time as ProShares also rolled out a fund that shorts the energy indexes, the Short Oil & Gas ProShares.

Another popular energy ETF is the Energy Select Sector SPDR, which owns exploration and drilling companies and also has oil and gas components.

Nadav Baum, managing director of investments at BPU Investment Management in Pittsburgh, recommends XLE to his clients who don't want to trade oil but want the benefits of energy investment.

"For an investor who keeps a much longer time horizon I think oil, energy, alternative energy is going to be here for a while," Baum says. "If you're trying to trade based on oil prices, that could be a little sketchy here on the near term, but in the longer term ... I think portfolios should have an allocation toward energy companies and alternative energy sources."

Baum also advocates the Powershares Dynamic Energy Exploration & Production fund, which is tied to an equity index.

"As opposed to having a single company, you own the basket via the ETF. You're going to do yourself a big favor because you're going to reduce the volatility and still get the upside if these things continue. I think the consensus on Wall Street is this is a good sector to be in."