In the past few weeks I’ve received emails from subscribers to my premium newsletter, The Daily Paycheck, who are worried about their energy and energy-related holdings. I’ve also heard from others who are wondering if beleaguered energy securities represent a buying opportunity.

Just a year ago, West Texas Intermediate (WTI) crude oil was running at about $87 a barrel. But a strong U.S. dollar and concerns about a slowing Chinese economy have pushed the price of a barrel of WTI down to about $46 dollars.

#-ad_banner-#All oil exploration and production company stocks have been hit hard. Their revenues are directly impacted by the price of oil. This period of lower oil prices is probably less of a problem for large multinational companies such as ConocoPhillips and Exxon Mobil, which have strong balance sheets and good credit ratings. They are likely able to ride it out. But prolonged low oil prices could be a significant problem for small oil producers — and for investors who hold their stock or bonds.

With revenues dropping, oil companies are paying out a higher percentage of their operating cash flow to service their existing debt. Just take a look at this chart from the U.S. Energy Information Administration and you’ll see what I mean…

U.S. Onshore Oil Producers’ Debt Service As A Share Of Operating Cash Flow

Source: U.S. Energy Information Administration

Some energy companies are having a harder time servicing their debt. And the longer oil prices stay low, the more of a problem a default on that debt could be. This concern is starting to weigh on junk bond funds, which tend to hold a lot of energy bonds. For instance, the SPDR Barclays High Yield Bond ETF (NYSE: JNK) holds roughly 16% of its assets in energy-related bonds, and is down roughly 4.01% year to date (not including dividends).

We’ve also seen price erosion in energy-related master limited partnerships (MLPs). Upstream MLPs — those that produce oil and gas — are more sensitive to commodity prices and have been hit the hardest. They include firms such as Linn Energy (Nasdaq: LINE), down 74.6% year to date, and Breitburn Energy Partners (Nasdaq: BBEP), down 67.6%.

But even midstream MLPs — those that primarily transport and store oil and gas — have dropped in price, albeit not to the same extent as their upstream peers. Most of the revenue they generate is fee-based and isn’t sensitive to energy prices. Better yet, most of their customers have long-term contracts that require them to pay whether or not they use their services. For instance, gas companies reserve capacity on an MLP’s pipeline, and they have to pay the MLP even if they don’t use all of the capacity they reserved.

So why have prices of midstream MLPs come under pressure? For the same reason junk bond funds have come under pressure. Midstream MLPs’ fees are guaranteed by contract much the same way bond holders’ coupon payments are guaranteed. And that all works well — right up until your counterparty goes bankrupt.

What To Avoid, What To Own In The Energy Sector
Someone once observed that commodity prices don’t take the stairs, they take the elevator. In other words, when they move, they move quickly. And it’s possible that energy prices could rise back to a more “normal” range in the blink of an eye.

Unfortunately for small exploration and production companies — and for small upstream MLPs — low prices have already taken a toll. This is a group I’d avoid no matter how tempting they look right now. If you’re an aggressive investor with a longer time horizon and you want to bottom fish in the exploration and production sector, look for a big fish with a good balance sheet. At least you’ll know that it will still be around when prices rebound.

As for me, I’m comfortable holding both high-yield bond funds and midstream MLPs. And I’m happy to reinvest dividends at these prices. If prices take a moderate hit, then it means I’m simply able to buy more of an asset I already like. But they are securities I want to keep an eye on, especially if energy prices continue to remain low.

Consider one of my midstream MLP holdings in The Daily Paycheck: Enterprise Products Partners (NYSE: EPD). Just recently, it announced its 45th consecutive quarterly distribution increase. EPD raised its distribution to $0.385 from $0.38 per unit. I’ve held EPD for a while now, and it’s exactly the kind of stock I want to use with my Daily Paycheck Retirement Strategy.

By holding on to this fast dividend grower, I’m able to ride out any sort of market worry and compound my gains year after year. And it’s working… To date, I’m up over 56.9% on my original investment, and since I’m reinvesting my dividends, that figure will continue to improve and lead to even more impressive gains over time.

That’s the power of my strategy. If you’d like to learn more, simply visit this link.