We’ve been dealing with a little bit of “drama” here at the Scheidt house lately.
My 5-year-old, Caleb, has started testing his limits by throwing the occasional temper tantrum. The other day I heard him yelling at his mom because he didn’t want to brush his teeth.
THAT was a big mistake.
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After sitting down and explaining to Caleb that this was not acceptable behavior, Caleb then had to sit on the front step for 10 minutes while his big sisters rode bikes just outside the window. That definitely caught his attention.
There were a couple other minor instances last week. Each time, we talked about the situation and then there was a consequence. I’m happy to report that today, Caleb appears to have learned the lesson. He’s now talking respectfully to his mom and listening to instructions.
Ironically, at the same time that Caleb was pitching a fit last week, traders on Wall Street were also dramatically expressing their frustration.
It’s a situation that happens often. Traders react to a particular piece of news in an “overly dramatic” fashion. And ultimately, these traders are taught a lesson.
Best of all, investors like us who keep cool heads can be the ones who teach this lesson. And as a teacher, you can lock in a very lucrative income yield in the process.
Let’s take a look!
Shares of pipeline companies have traded lower recently because of an obscure piece of news.
The Federal Energy Regulatory Commission (FERC) — which sets the regulations for energy companies like oil and natural gas pipelines — changed one of its rules. According to the statement, pipeline companies will no longer be able to take advantage of a specific tax benefit.
To understand how this affects pipeline stocks, let’s take a quick look at how most of these companies are organized.
Most pipelines are set up as master limited partnerships, or MLPs.
To encourage investment in our nation’s energy infrastructure, the government has agreed not to charge MLPs with corporate income tax. In exchange for avoiding corporate taxes, these MLPs must pass the vast majority of their profits directly to investors. And these investors then pay personal taxes on the gains.
One part of this agreement previously allowed the MLP companies to recover what is known as an “income tax allowance.” In other words, there was an additional small tax advantage for these pipeline companies.
But now, that small “recovery of income tax allowance” is being taken away.
As a result, investors metaphorically put their hands on their hips, stomped their feet and sold their pipeline stocks. That’s why many of these stocks have given up a lot of ground.
As an income investor, my immediate question was whether things are really as bad as the market seems to think they are. And if not, where are the best opportunities for us to lock in high yields?
Shortly after the FERC statement was released, pipeline executives started hitting the airwaves with more detailed information about how this ruling will affect their operations.
It’s important to note that the only pipeline companies that will be affected by this ruling will be those that use regulated “cost of service” contracts. Many pipeline companies don’t even engage in these contracts, so they won’t be at all affected by the new decision.
The other important factor is that this “income tax allowance” is just a small part of the advantage MLPs enjoy.
The more important structure to their business is that the companies are not required to pay any federal tax. And also that these companies are required to pay regular dividends to us as investors.
Because of this setup, I’m very fond of MLPs for income investors.
Especially when we have a chance to buy these pipeline companies at a discount!
You see, when you pay less to own shares of a company that pays a lucrative dividend, you’re essentially locking in a higher yield for your investment. And that’s exactly the type of opportunity that is being set up by this temper tantrum the market is throwing.
This week, I’m combing through my list of pipeline stocks, looking for the companies with the best yields, the least amount of exposure to this new FERC ruling and pipelines that will benefit from higher oil and gas production in the U.S.
Remember, with oil prices higher and strong energy demand in the U.S., oil production is hitting all-time highs.
As oil and natural gas are pulled out of the ground, they must be transported through pipelines to refineries. And then the refined gasoline, diesel and jet fuel must be transported again to service stations, airports and so forth.
So U.S. pipelines are great companies to operate right now.
Pipeline stocks are great income investments to make right now.
And lower stock prices following the FERC announcement just make the situation all the better.
This article originally appeared on The Daily Reckoning.