Stress Remains on Energy ETFs
Following dismal showings in 2014, equity-based energy exchange traded funds are trying to show some signs of life as highlighted by a gain of nearly 5% over the past week for the Energy Select Sector SPDR (XLE) .
The more volatile SPDR S&P Oil & Gas Exploration & Production ETF (XOP) has been even better with a five-day gain of 6.4%. Then again, ETFs focused on exploration and production stocks fared for worse in 2014 than rivals with heavy tilts to large-cap and integrated oil names. For example, XOP lost 29.4% last year, more than triple the 8.7% loss suffered by XLE.
While XLE, XOP and other energy ETFs have recently rebounded, some market participants expect the energy sector to endure more stress this year as at least two scenarios adversely impact exploration and production companies. [Glum Views on E&P ETFs]
“The first is the reemergence of volatility in the wholesale oil and gas markets, and the second is high correlation between oil and gas prices and the valuation of the E&P sector,” writes HCB Investment Management on Covestor. “Additionally, the decline in energy prices in 2014 has severely challenged many of the financial assumptions and projections made by producers. At the start of 2015, oil and gas production is much closer to the margin, if it is even profitable, than it was at the start of 2014.”
Making matters worse are forecasts for further oil price declines. For example, Bank of America sees oil falling to $32 per barrel by the end of the current quarter. Such a decline would likely deal another blow to exploration and production and oil services ETFs, which have historically shown tighter correlations to oil prices than ETFs like XLE.
Risks with exploration and production have not stopped investors from allocating new capital to XOP, though year-to-date inflows of $569 million are arguably deceiving. XOP is often a haven for short sellers as there have been instances over the ETF’s almost nine years of trading where short interest has eclipsed 100% of the fund’s shares outstanding. When traders short an ETF, new shares are created, giving the impression the ETF is increasing in size, but when traders cover those positions, the shares are redeemed and the ETF loses mass if long traders do not initiate new positions. [An ETF Loaded With Short Seller Faves]
Some investors continue looking for shelter from the oil storm with more traditional energy ETFs, such as XLE. Lure by sector valuations that are among the lowest in the S&P 500 and the steady dividends of XLE’s two largest holdings, Dow components Exxon Mobil (XOM) and Chevron (CVX), investors have poured $267.4 million into XLE since the start of this year. That is after XLE added $5 billion in new assets last year, a total surpassed by just nine other ETFs. [Waiting on Energy Sector ETF Bounce]
Energy Select Sector SPDR
ETF Trends editorial team contributed to this post.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
