Every once in a while we see the kind of disruptive macro-economic event on which alternative thinking and investing thrives. The precipitous drop in oil prices is one such event—and it’s not over yet.

We started developing our oil thesis more than a year ago, when crude was more than double its current price of around $55. It was clear even then that technological developments in fracking and shale oil and gas extraction would completely change the energy landscape in North America. The question is how to play this paradigm shift.

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Most Canadian investors already have a lot of exposure to the energy sector through the TSX and the Canadian dollar. By some estimates, 20% of the Canadian economy and as much as 60% of the TSX is somehow related to natural resources. The loonie is strongly correlated to the price of oil and, to a lesser extent, gas. So, when the price of oil falls as drastically as it did this fall, Canadian investors can end up taking a double hit to their portfolios: a decline in the value of their energy-exposed assets plus a decline in the Canadian dollar.

Our research has uncovered a strategy that benefits from the new paradigm and potentially benefits from a drop in energy prices as well: investing in the infrastructure—including pumps and pipelines—that must be adapted to meet the new geography of oil transportation in the U.S. This also happens to be a sector where mis-valuations persist due to the yield and income orientation of a large part of the investor base, which tends to overlook fundamentals.

Changing directions

For the last hundred years or so, oil and gas has predominantly been transported from the coasts of the U.S., where it’s drilled or imported, inland to end users. An entire infrastructure network has been developed to connect suppliers with consumers. But many of the largest shale oil and gas deposits currently being developed are located deep inland. As a result, the direction of nearly all the infrastructure, pumps and pipelines to transport oil and gas to the coasts, either for refining, consumption or potentially, export, needs to be reversed.

The current oil and gas transportation network took decades to build, and will take years to reverse. There’s a need for an estimated US$3.4 trillion in energy infrastructure in North America over the next 20 years. U.S. oil and gas production is in the early stages of a renaissance that is expected to be decades long.

Even better, energy infrastructure will likely be immune and possibly counter-cyclical to energy prices. Once big infrastructure projects are well underway it’s difficult to change course, so they tend not to be sidetracked by energy price fluctuations. Even better, as energy prices fall, producers become even more sensitive to pricing pressures, giving them an incentive to spend heavily on anything that delivers a cost advantage. More efficient transportation falls into this category and is therefore likely to benefit.

OPEC’s assist

While we did foresee the investment potential of this disruptive technology, what we didn’t see coming was the huge assist the strategy got last fall from OPEC.

The new dynamic of shale oil, fracking, and energy independence for the U.S. threatens the price and supply dictating advantage OPEC’s enjoyed for more than four decades. For months, OPEC’s 12 fractious members debated how best to respond to this new challenge. Late last year, the members decided to reach into their collective pockets and maintain current supply levels in an effort to push marginal producers—and those using newer technologies like fracking—out of business. And they made a point of stating they are willing and able to keep up the pressure for years, if necessary.

That’s good news for oil consumers, but very bad news for oil producing nations like Canada, Russia, and Venuezula. Predictably, the price of oil plummeted and, as one would expect, it took the Canadian dollar with it.

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How did the alternative energy infrastructure strategy hold up? Unsettling new information tends to disrupt markets abruptly, with more nuanced and subtle outcomes manifesting themselves only later. We see this kind of reaction often and in almost all markets, so we weren’t surprised when suppliers of infrastructure were initially hit as hard as energy producers, and traded dramatically downward.

To contrarian thinkers, that downward movement provided the opportunity to buy and sell mispriced infrastructure-related assets they were waiting for. And buy and sell they did. In the intervening months, as more information on how the drop in energy prices will affect individual companies has been disseminated, prices have started to correct—producing healthy profits.

Looking ahead

The new paradigm can benefit clients in 2015 and beyond, without increasing their exposure to energy prices. Consider:

1. The disruption isn’t over. Markets tend to overreact to sudden events, taking whole sectors up or down without distinguishing between very different companies. That’s why it’s important to invest with veteran managers with sector specialties and deep knowledge of all of the players. It’s also critical to hedge risks whenever possible, and that means gravitating towards long-short strategies that can hedge out some of the market risk inherent in equity investing.

2. Most of the damage to the Canadian dollar may have already been done. November’s oil price collapse was bad for the loonie, and therefore good for U.S. denominated assets. While it may not be the best time to convert from Canadian to U.S. dollars, holding U.S. dollar denominated assets can provide beneficial diversification for Canadian clients. There’s some evidence that the exchange rate is inversely correlated to the price of oil, and can create a free and natural hedge for Canadian investors, as purchasing power parity tends to hold in the longer term and inflation rates between Canada and the U.S. are highly correlated.

3. U.S. rising. The U.S., which benefits from the decrease in the price of oil, is emerging from 2008 as the strongest developed economy. Clients with U.S. dollars to spend have a wealth of interesting and potentially uncorrelated mainstream and niche hedged strategies available to them. And while the loonie’s suffered relative to the U.S. dollar, it’s strengthened relative to the euro. So, now may be a good time to invest in assets in countries with weaker currencies, including those in Europe.

Even the most sanguine of Canadian cheerleaders are not forecasting a significant recovery for the price of oil or the Canadian dollar any time soon. Oil supply and inventories are still rising and the Bank of Canada is on hold with rates. The carnage in the energy sector has the potential to spread to the larger economy over time, so the real damage of an overly Canadian-focused portfolio may be yet to come.

An oil infrastructure play can, with proper coordination, work hand in hand with other alternative strategies and potentially improve the performance and lower the risk profile of a broadly diversified portfolio.

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Ari Shiff is president and head of research of Inflection Management Inc., a Vancouver-based manager of the ISOF stable of alternative managers.