Most of my energy after the Fed rate cut

Last week, the Fed did something that somewhat surprised the markets. The fact that they cut interest rates at the September meeting was certainly no surprise. Many people, myself included, expected exactly that, but to do so by 50 basis points, or half a percent, was somewhat out of character for a Fed that, until now, has been seen as quite cautious. As you might expect, the stock market reacted positively to the move, but what does it mean for energy investors?

Oil, the most significant and widely traded energy market, reacted positively initially, with WTI climbing above the $70 level, but has since given up those gains and more and is now trading below its pre-announcement level. Oil traders may see the size of the cut more as a warning from the Central Bank of economic weakness than as a stimulative change in policy, but even if not, the hope of boosting what is seen as a weakening economy Chinese and continued strong supply was enough to keep crude moving lower.

This makes me wary of oil companies as a way to play this, although the recent move down puts crude just a few dollars away from the lows since late 2021. So, barring a full blown economic meltdown , consolidation and a bounce is more likely from here than any major decline. However, this risk, combined with the uncertainty of oil’s future in an election season, leads me to look beyond oil stocks.

The obvious place to go would be utilities, but there are very few opportunities there. Indeed, when I started checking for dividend payers, the first half dozen or so utilities I looked at were all unsuitable for the same reason…negative free cash flow over the last twelve months. That means it’s stretched to pay current dividend rates, and any economic weakness, even a mild downturn, could lead to dividend cuts, which would be bad news for shareholders and negate the basic thesis here.

So we stuck with natural gas producers and, more attractively in many cases, MLPs. The first one I will buy is Energy Transfers LP (ET). They are primarily a transporter and supplier of natural gas through their extensive pipeline network, which gives them a degree of protection against oil prices. It also insulates them from the political risk that must be taken into account right now in the US. Natty is seen as a fossil fuel by traditionalists and a “clean” or at least “cleaner” energy source by oil and coal divestment advocates, so whoever wins in November benefits.

However, the main appeal of power transfer as a yield play comes from the numbers. The stock offers a forward dividend yield of 7.9%, significantly higher than most diversified utilities or oil companies, but still generated more than $5 billion in free cash flow. Value metrics such as a forward P/E below 9 and a PEG ratio of 0.52 suggest there is also significant room for price appreciation.

By cutting interest rates as aggressively as it did, the Fed sent a clear signal to investors that yield is becoming a much more valuable trait in stocks, and the Energy Transfer seems like a good way to heed that message and lock in some yield while still offering the possibility of capital appreciation over the next few months. That’s why it’s my top choice after the rate cut.