Riding the Rails a Good Energy Play

 | May 02, 2013 | 12:00 PM EDT
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We all like straight recommendations to buy stock, but sometimes just staying away from a sector is a very good call.

 This year, it's been tough in the energy patch, and I've worked hard to make sure my calls were focused and not sector wide, missing much of the latent disasters that have befallen various parts of the energy patch, particularly in mid-cap exploration and production players and in refining.

It is in refining where I want to look to find a focused play that is riding one of these negative trends. The intensifying focus on crude by rail will benefit some well-positioned master limited partnerships.

In the last several weeks, I've gone against the recommendations of the big energy traders at Goldman Sachs and Morgan Stanley and predicted that the spread between West Texas Intermediate and Brent crude would continue to contract, moving finally under $10. That spread has been largely responsible for the tremendous outperformance of the refiners, particularly the mid-con refiners who have taken advantage of the low-priced domestic crudes and the relatively high prices they could charge for refined products.

That's been changing as the spread has slowly collapsed and we can see the relative weakness of the mid cons and other refiners in the last days -- refining is not the place you've recently wanted to be. Even talking about the majors recently with Jim Cramer, I emphasized that Chevron's (CVX) good quarter was masking a vulnerability to downstream assets that will be a drag going forward, should the WTI-Brent spread continue to show weakness.

I definitely believe it will continue to show weakness. But instead of trying to short refiners or sell other weakening majors, is there something we can instead buy to take advantage of this trend?

Perhaps there is. WTI has begun to catch up to international crude prices largely because of some pipeline rescheduling (like Seaway), but also significantly because of the use of rails to transport crude from new production nexus points. And there are specific rail companies that are poised to benefit from that trend. Canadian Pacific (CP) and Canadian National (CNI) are two rail stocks that are moving Western Canadian grades of cheap crudes out towards the West and East coasts. The rails will continue to be a great recovery sector to invest in and crude by rail is just another reason why these stocks haven't reached the end of their run.

But master limited partnerships are also beginning to establish rail car fleets of their own to transport faraway crudes. I've been a big believer that everyone needs these companies as part of a correctly diversified energy portfolio and CBR is a growing trend that points you in the direction of some better ones.

Both Plains All-American (PAA) and Global Partners (GLP) have significant rail car fleets that have been driving both stocks higher in 2013. Plains is far more diversified and might be overbought with its 4% yield. But Global partners, even after its run is delivering over 6% -- more appropriate for this tinier and less well capitalized master limited partnership, but equally safe, in my view.

An investor looking to start a necessary master limited partnership portfolio could do worse than to start with these two, both taking advantage of a growing trend of crude by rail.

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