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How Investors Can Capitalize on the Domestic Energy Boom

Meg Handley

Thanks to the discovery of large stores of crude oil trapped in shale rock formations, the United States is poised to overtake Saudi Arabia as the world's largest oil producer by 2020, the International Energy Agency said this week. With vast amounts of both oil and natural gas still untapped across the continent, the opportunity for further growth in the industry is immense, experts say, especially if global crude oil prices remain relatively high.

But the fortuitous combination of technological advances and high oil prices that helped propel the recent resurgence of domestic oil production isn't just a home run for the companies directly involved. Investors, too, can take advantage of the recent success and potential for growth, and the opportunities are numerous throughout the energy industry.

"There's really a broad array of opportunities there, from the reserves in the ground all the way to the end user," says Quinn Kiley, a senior portfolio manager at FAMCO MLP, a division of Advisory Research, Inc.

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But according some experts, the most lucrative plays might not be where you think. While oil industry giants such as ExxonMobil and Chevron enjoy instant brand-name recognition and have their hands in pots across the globe, it's actually the mid-sized companies that give investors the most precise access to the flourishing domestic energy industry.

To hone in on the U.S. market, "you want to maintain exposure to domestic producers, specifically the ones that are less globalized," says Paul Justice, analyst at Morningstar. "They're certainly going to benefit from that [domestic oil] production and they're going to have a hand in that, but their earnings exposure is going to be somewhat diluted compared to the [companies] that are just focusing domestically with some of the innovative techniques such as horizontal drilling and fracking."

Justice recommends iShares Dow Jones US Oil & Gas Index (symbol:IEO) because it zeroes in on medium- to large-sized companies on the ground floor of the domestic oil production industry. That gives investors more direct exposure to oil and gas price changes and less potential for the revenue dilution associated with oil- and gas-themed funds that largely hold big, integrated energy companies.

Another option Justice recommends is SPDR S&P Oil & Gas Exploration & Prod (XOP) because again, it focuses on a narrow slice of the energy universe, designed to offer investors targeted exposure to U.S.-based companies that specialize in exploring and producing oil and natural gas. The neat thing about this fund is that it dials down firm-specific volatility because it's equally-weighted, Justice says, meaning large or small, each stock in the ETF's 73-company portfolio has the same weight. So while oil industry giant ExxonMobil might be in the portfolio, it's right beside relative no-name Tesoro Corp. and they both have just as much sway when it comes to the fund's performance.

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Another potential area for investment is the infrastructure needed to refine, store, and transport the oil extracted from shale. Much of the nation's current refinery infrastructure (especially refineries on the coast) is optimized to process oil imported from Saudi Arabia or Venezuela. Processing crude oil from North Dakota's Bakken oil fields or Canada's tar sands requires different methods and as long as the price of oil stays high, investment dollars will likely be rolling into the space in coming years.

"We're seeing some efforts to build from scratch new petrochemical facilities in western Pennsylvania and Louisiana," says Tom Kloza, chief oil analyst at the Oil Price Information Service. "There's no question petroleum logistics is going to be one of the hottest investments in the next couple of years."

The same is true with pipelines and other means of shuttling oil around. North America already faces challenges when it comes to bottlenecks in transmission lines and with demand for oil and refined petroleum products not likely to collapse anytime soon, experts anticipate more projects to launch in the future. Kiley manages open-end fund FAMCO MLP & Energy Income (INFRX), which invests in both the debt and equity of energy infrastructure companies.

"The fund has [a mix of] companies who have reserves in the ground all the way to those who deliver product to the end user," Kiley says. "But when you move away from the producers and talk about the infrastructure guys, you get exposure to this big boom in energy production across North America but you do it with a lot less commodity price exposure."

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Less volatility is the key benefit of the fund when it comes to investing in the notoriously volatile energy industry. Putting a little separation between the supply-and-demand-fueled ups and downs of the oil and gas markets can give jittery investors a little more peace of mind when it comes to navigating the choppy waters of global energy markets.

"You can make money by investing in companies that run assets that care about the volumes they handle as opposed to the prices they handle, and you can profit in a volatile environment like this," he adds.

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