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Energy ETFs: Solid Fundamentals, But Oil Prices Could Decline

This article was originally published on ETFTrends.com.

The Energy Select Sector SPDR (XLE) , the largest equity-based energy exchange traded fund, gained a modest 0.40% in the third quarter, extending its year-to-date gain to 7%. While market observers acknowledge the energy sector's fundamentals are solid, some believe current oil prices are too high.

A combination of diminished global output and rising global demand have helped reduce the global supply glut that dragged on oil prices for years. Production cuts from the Organization of Petroleum Exporting Countries and their allies have largely contributed to the cut in supply. Meanwhile, expanding economies around the world has bolstered demand for raw materials such as crude oil.

“We believe the market continues to underestimate the capacity of the shale industry to eventually throw oil markets back into oversupply,” said Morningstar in a recent note. “U.S. production reached a new high-water mark in June and should keep hitting new records, though that may come in fits and starts due to temporary Permian pipeline shortages.”

Related: October: A Bad Month for Commodity ETFs?

More Oil Fundamentals

Recent domestic inventory data has also been a help to crude prices and the related ETFs. Analysts argued that the continued drawdowns in oil stockpiles, even though we are past the summer driving season, are a result of increased U.S. crude oil exports, which have been supported by the widening differential between U.S. benchmark WTI prices and the global benchmark, Brent crude.

“Eventually, we expect pain for oil prices as growing U.S. production serves as the primary weight to tip oil markets back into oversupply,” said Morningstar. “Our midcycle forecast for WTI is still $55/bbl. We think oil bulls are failing to recognize the potential for further productivity gains from U.S. producers and are unduly worried about prime shale acreage running out more quickly than it really will.”

XLE and other traditional cap-weighted energy ETFs are typically heavily allocated to Exxon Mobil (XOM) and Chevron (CVX). Those stocks combine for over 37% of XLE’s roster.

Rivals to XLE include the Vanguard Energy ETF (VDE), iShares U.S. Energy ETF (IYE) and the Fidelity MSCI Energy Index ETF (FENY).

For more information on the oil market, visit our energy category.