The Complete Guide to Oil and Gas ETF Investing - ETF News And Commentary
Outlook for Crude Oil
Crude prices posted 46% annual loss in 2014; the biggest yearly fall since 2008. Such was the ferocity of the crash that last year’s three worst-performing stocks in the S&P 500 index were all energy companies - Transocean Ltd. (RIG), Denbury Resources Inc. (DNR) and Noble Corp. plc (NE), which were down approximately 63%, 52% and 49%, respectively. The broad-based S&P 500 index gained 11.5% over the same period.
Still in stormy waters, many analysts believe that the commodity will fall further before mounting a real recovery. From about $105 per barrel last July to around $60 now – sinking in between to a 6-year low of under $44 recently – the plummeting value of oil represents a decline of roughly 45% over ten months. (Read: Big Oil Beats Q1 Earnings; Energy ETFs in Focus)
What’s more, in the absence of major production cuts from OPEC, the effects of booming shale supplies in North America and a stagnant European economy, not much upside is expected in the commodity’s prices in the near term. Moreover, a stronger dollar has made the greenback-priced crude more expensive for investors holding foreign currency. The Iranian nuclear framework agreement, which has the potential to release more oil in the already oversupplied market, has put the final nail in the coffin.
With crude inventories at the highest level during this time of the year in 80 years at least, the commodity is very well stocked. On top of that, OPEC members (like Saudi Arabia) have made it clear time and again that they are more intent on preserving market share rather than attempting to arrest the price decline through production cuts. Therefore, the commodity is likely to maintain its low trajectory throughout 2015.
In the medium-to-long term, while global oil demand is expected to get a boost from sustained strength in China – which continue to expand at a healthy rate despite some moderation – this will be more than offset by sluggish growth prospects exhibited by Japan and the Western economies.
In our view, crude prices in the next few months are likely to exhibit a sideways-to-bearish trend, mostly trading in the $50-$60 per barrel range. As North American supply remains strong and demand looks underwhelming, we are likely to experience a pressure in the price of a barrel of oil.
Outlook for Natural Gas
Over the last few years, a quiet revolution has been reshaping the energy business in the U.S. The success of ‘shale gas’ – natural gas trapped within dense sedimentary rock formations or shale formations – has transformed domestic energy supply, with a potentially inexpensive and abundant new source of fuel for the world’s largest energy consumer. (Read: Mixed Q1 Earnings Put Oil Services ETFs in Focus)
With the advent of hydraulic fracturing (or "fracking") – a method used to extract natural gas by blasting underground rock formations with a mixture of water, sand and chemicals – shale gas production is now booming in the U.S. Coupled with sophisticated horizontal drilling equipment that can drill and extract gas from shale formations, the new technology is being hailed as a breakthrough in U.S. energy supplies, playing a key role in boosting domestic natural gas reserves. As a result, once faced with a looming deficit, natural gas is now available in abundance.
While natural gas output has been setting records almost every month, the commodity’s demand has failed to keep pace with this rapid supply surge. In the past, winter weather has played a factor in boosting prices with demand for domestic natural gas exceeding available supply. But with no dearth of new supply, even this association is becoming more and more obsolete. As a result, prices continue to suffer.
Natural gas peaked at about $13.50 per million British thermal units (MMBtu) in 2008 but fell to sub-$2 level in 2012 – the lowest in a decade. Though it has recovered somewhat, at around $3 now, the commodity is still way off the heights reached seven years back. Consequently, the stock prices of major U.S. natural gas producers like Chesapeake Energy Corp. (CHK), Cabot Oil & Gas Corp. (COG) and Range Resources Corp. (RRC) remain beaten down. (See: 3 Energy ETFs Leading the Oil Rally)
What’s more, with improved drilling productivity offsetting the historic decline in rig count, and expectations of tepid heating demand with the arrival of soft spring temperature, we do not expect much upside in gas prices in the near-to-medium term.
PLAYING THE SECTOR THROUGH ETFs
Considering the turbulent market dynamics of the energy industry, the safer way to play the volatile yet rewarding sector is through ETFs. In particular, we would advocate tapping the energy scene by targeting the exploration and production (E&P) group.
This sub-sector serves as a pretty good proxy for oil/gas price fluctuations and can act as an excellent investment medium for those who wish to take a long-term exposure within the energy sector. While all oil/gas-related stocks stand to move with fluctuating commodity prices, companies in the E&P sector tend to be the most important, as their product’s values are directly dependent on oil/gas prices. (See all Energy ETFs here)
SPDR S&P Oil & Gas Exploration & Production ETF (XOP):
Launched in June 19, 2006, XOP is an ETF that seeks investment results corresponding to the S&P Oil & Gas Exploration & Production Select Industry Index. This is an equal-weighted fund consisting of 75 stocks of companies that finds and produces oil and gas, with the top holdings being Clean Energy Fuels Corp. (CLNE), EP Energy Corp. (EPE) and Rosetta Resources Inc. (ROSE). The fund’s expense ratio is 0.35% and pays out a dividend yield of 1.32%. XOP has about $1,358.4 million in assets under management as of May 14, 2015.
iShares Dow Jones US Oil & Gas Exploration & Production ETF (IEO):
This fund began in May 1, 2006 and is based on a free-float adjusted market capitalization-weighted index of 75 stocks focused on exploration and production. The top three holdings are ConocoPhillips (COP), EOG Resources Inc. (EOG) and Phillips 66 (PSX). It charges 0.43% in expense ratio, while the yield is 1.26% as of now. IEO has managed to attract $509.0 million in assets under management till May 14, 2015.
PowerShares Dynamic Energy Exploration and Production (PXE):
PXE, launched in October 26, 2005, follows the Energy Exploration & Production Intellidex Index. Comprising of stocks of energy exploration and production companies, PXE is made up of 30 securities. Top holdings include Devon Energy Corp. (DVN), EOG Resources Inc. (EOG) and ConocoPhillips (COP). The fund’s expense ratio is 0.64% and the dividend yield is 1.70%, while it has got $118.5 million in assets under management as of May 14, 2015.
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SPDR-SP O&G EXP (XOP): ETF Research Reports
ISHARS-US O&G (IEO): ETF Research Reports
PWRSH-DYN ENRG (PXE): ETF Research Reports
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