Energy fuels the world, but it doesn’t always fuel the stock market.

And many are the long-only investors who have felt the pain as oil prices swooned more than 50% between last June and last month, resulting in numerous oil-related stocks across the value chain getting smacked.

The markets have been spooked by tales of global oversupply caused in large part by fracking technologies that literally cracked open U.S. oil (and gas) production, coupled with reports of U.S. crude-oil stockpiles at eight-decade highs and accompanying fears we’re running out of storage space for all of the black gold being siphoned from the ground.  

Falling oil prices have thrilled consumers at the gas pump but have roiled the financial markets. For investors, the question is whether this is just a hiccup in a naturally cyclical industry or, given this country’s growing proficiency as a hydrocarbon producer and its newfound role as a major force among global suppliers, the dynamics have changed to the point where the oil industry will gag on oversupply for the foreseeable future.

The energy sector is too important to ignore, and the recent tumult can be seen either as a buying opportunity in the oil patch, a chance to look at other types of energy-related companies as viable long-term investments, or both.

Kenneth Waltzer, managing director at KCS Wealth Advisory in West Los Angeles, Calif., sees the drop in oil prices as temporary and a chance to invest in good energy-related companies at bargain prices. “We favor well-capitalized companies and those with significant reserves that can be taken over by the majors,” he says.

Among the possible takeover candidates, Waltzer cited Apache. This oil and gas exploration and production outfit is an example of a company whose stock was hammered. But it has proven reserves, and that could make it an attractive target, especially among those major oil companies that would rather cost-effectively seek new sources of crude than try to extract new reserves in expensive, hard-to-drill areas.

Among the oil majors, Waltzer likes Royal Dutch Shell for its favorable balance sheet, which the Anglo-Dutch giant is using to bid $70 billion for BG in a move to dominate the market for liquefied natural gas. He also notes that refining and marketing companies such as Valero Energy have done well because their refining margins increased as the price of raw crude plummeted.

Waltzer also sees opportunities in the renewable energy space, and two of his top picks are solar company First Solar and Gamesa, a Spanish wind energy company whose operations include making the inner workings of windmills for energy generation. “That company went through very hard times when many of the government subsidies for wind energy disappeared, but over the long term it’s a place to go in wind because regardless of which windmill you use you have to have the insides,” he says.

Investment manager Nick Kaiser at Saturna Capital says his firm has reduced its holdings in oil and coal companies. “We don’t see rising dividends in Big Oil; we see cutting dividends,” he offers. “We see natural gas taking market share [from coal] because it’s more friendly to the environment, relatively speaking, and that’s probably where the biggest short-term opportunities are in the big three of coal, oil and gas.”

Kaiser is director and chief investment officer at Saturna, which last month launched both a sustainable equity and a sustainable bond mutual fund under the Saturna banner. It also manages the Sextant, Idaho and Amana mutual funds. “We’re long-term investors looking for long-term plays that will make sense,” he says, adding that his firm looks at sustainable energy sources as a way to consistently make money over the long haul.

To Kaiser, sustainable energy can include nuclear, which, despite setbacks in recent years in Germany and Japan, could be bolstered going forward as China builds more nuclear power plants to combat its air pollution problem. As part of the sustainable energy theme, Kaiser says his firm isn’t keen on renewable energy sectors that are reliant on government subsidies.

“Energy sources that require subsidies might not be sustainable, so you have to look at the government picture,” he says. “Hydro, nuclear, solar and wind do work. Parts of the U.S. have wind power that works without subsidies.”

Subsidies
Colm O’Connor, co-portfolio manager of the cleantech-focused Calvert Global Energy Solutions Fund, says renewable energy sources in the U.S. grew by 140 million megawatts per hour, or a 40% growth rate, from 2008 through 2013. “But that comprises a small part of overall energy consumption, so it’s growing from a small base.”

O’Connor says he expects demand for renewable energy in the U.S. to remain strong both this year and next, though the picture beyond that could be murky because solar investment tax credit (ITC) subsidies are due to expire at the end of 2016.

The ITC is a 30% federal tax credit for solar installations for both residential and commercial properties. If the current program isn’t extended, starting in 2017 the commercial credit will drop to 10% and the residential credit will be totally eliminated.

Even so, O’Connor believes the solar industry’s maturation makes it more viable than ever. “Because of price declines due to technology improvements, the industry is less reliant on subsidies and there’s a much more healthy demand picture,” he says. “Solar panel makers are profitable because their costs have declined faster than falling panel prices. I wouldn’t say solar is mainstream, but it’s certainly part of the existing energy mix. People will say it relies on subsidies, and while they’re important for solar, subsidies are important for every form of energy generation.”

Equity Versus Fixed Income
Mark Travis, CEO and chief investment officer of Intrepid Capital Management in Jacksonville Beach, Fla., says his firm’s absolute-value investment approach has made it hard to find investments for its managed accounts and mutual funds as the bull market has raged on.

“The only things we’ve found are in the commodities-related space, whether that’s oil and gas, gold and silver, or whatever,” he says. “We try to be conservative when we think about the long-term price for oil, and we’re not assuming oil is going back to $90 a barrel anytime soon.”

Within energy, Travis says his firm focuses on companies with good balance sheets and which sell at a perceived discount to intrinsic value. As of year-end 2014, the Intrepid Small Cap Fund had a 20% weighting in energy. One of the fund’s top energy holdings, Contango Oil & Gas Co., has been taken to the woodshed during the past year and its shares traded at about $23 in early April, or nearly 54% off its 52-week high.

“We think the shares are worth in the high-$30 range, so it’s trading at what we believe is a significant discount,” Travis says. “The question is can we keep our shareholders comfortable long enough to reach that value.”

And with some energy-related holdings, Travis says he prefers fixed-income securities rather than stocks. “It depends on the name, but in some cases we’re comfortable being senior in the capital structure in just the debt,” he says.

Some financial advisors have remained undeterred by hard times in the energy sector. “With the decline that has occurred in energy, I’d think that people would be rebalancing toward energy, and not away from it,” says David Haraway, a financial planner and president of Substantial Financial in Colorado Springs, Colo.

His vehicle of choice is the Energy Select Sector SPDR Fund, a passive, cap-weighted exchange-traded fund that tracks the performance of the energy sector within the S&P 500 index. Portfolio holdings run the gamut from large integrated companies including Exxon and Chevron, services companies such as Schlumberger and pipeline companies such as Kinder Morgan. The fund’s expense ratio is 15 basis points.

“It’s where I suggest investors go for value,” Haraway says. As of early April, the fund was down nearly 25% from its 52-week high.

Cruising Midstream
Regarding oil and gas, an important trend in recent years has been the proliferation of mutual funds and ETFs focused on master limited partnerships, which are publicly traded entities that must get 90% of their revenue from qualified activities including energy and other commodities. Many energy-focused MLPs are centered on oil and gas pipelines and storage facilities––i.e., the midstream part of the production chain. These are stable businesses, and they tend to pay healthy dividends.

The MLP category hasn’t been immune to the travails of the overall energy sector. But the Alerian MLP Index has substantially outperformed the major stock, bond and real estate investment trust indexes since 2006. Not surprisingly, fund managers in this space believe midstream companies are in a sweet spot of the market because they can participate in good times while providing a degree of shelter in bad times thanks to their dividends and the steady need for their services.

Jim Cunnane, co-portfolio manager of the Advisory Research MLP & Energy Income Fund, says the energy infrastructure build-out in the U.S. will continue even in an environment of depressed commodity prices. “There’s been so much energy production that there’s now a glut, but that doesn’t change the fact there’s still a need to transport energy from where it’s produced to where it’s going to be utilized,” he says. “The infrastructure––the midstream guys––are the ones who do that.”

The mutual fund Cunnane co-manages recently had roughly one-quarter of its holdings in high-yield and investment-grade bonds. The high-yield bond sector took a header during the latter part of 2014 on fears that slumping oil prices could lead to debt defaults at energy-related companies, which make up a decent chunk of the junk bond market.

“I share those [debt-related] concerns, and it does to a limited degree apply to the MLPs, but it applies most directly to those MLPs focused on production,” Cunnane says. “The key is the type of assets owned. Those that own commodities highly exposed to price swings and have significant debt levels are challenged, and defaults are on the table if we see an extended period of depressed prices.”

One of the Advisory Research MLP & Energy Income Fund’s largest holdings is a high-yield bond from Spectra Energy, a pipeline company. “We’ve had a preference for its bonds rather than its stock because we felt the stock was on the richer side last summer versus other opportunities that we have,” Cunnane says. “But we think it’s a great company whose bonds will be a stable bedrock to help build a portfolio.”

The fund also owns NRG Yield Inc., one of a new breed of investment vehicles called “yieldcos” that have sprung up during the past couple of years. Yieldcos are created by power companies, such as NRG Energy Inc., as a way to package their renewable or conventional power-generating assets with long-term contracts inside publicly traded entities that pay sizable dividends to shareholders.

“They’re structured as yieldcos rather than MLPs because traditionally wind and solar assets haven’t qualified to be in MLPs,” Cunnane says.

The swoon in oil prices since mid-2014 has caused much angst in the marketplace, but some observers believe the collective angina caused by the supply-and-demand imbalance is overdone.

Kunal Nainani, senior MLP analyst at Eagle Global Advisors LLC in Houston, which runs the Eagle MLP Strategy mutual fund, says from a historical perspective the oversupply situation isn’t as bad as it was in times past. He states the current market is probably oversupplied about one-and-a-half to two million barrels a day, on global demand of about 93 million barrels a day. “So we’re about 1.5% to 2% oversupplied,” he says. “In 1986, we were oversupplied about 20% to 25% of global demand.”

Nainani posits that even as developed nations push for tighter energy standards and technology is creating more energy-efficient cars, factories and homes, the energy needs of the developing world should still provide a runway for energy consumption growth.

“This [global oversupply] has been painful for energy investors, producers, oil service companies and the midstream companies,” he says. “But I think this will prove to be transitory, and I think the recalibration can occur more quickly than the headlines are indicating.”

In other words, the recent throes in the energy sector are most likely just part of the industry’s normal boom-and-bust cycle. If so, the downturn among energy-related names could be a good investment opportunity.