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Opportunity With A Battered Energy ETF

ETF Professor

As is often the case, shares of oil services providers and the related exchange traded were highly sensitive to crude's gyrations in the second quarter, prompting a nearly 16% for the VanEck Vectors Oil Services ETF (NYSE: OIH).

What Happened

OIH, one of the largest oil services ETFs, and rival funds face some near-term headwinds because although the Organization of Petroleum Exporting Countries recently indicated it will cut supplies to support prices, oil hasn't responded in earnest to that news.

That's potentially troublesome for an ETF like OIH, which allocates over 29% of its combined weight to Schlumberger Ltd. (NYSE: SLB) and Halliburton Co. (NYSE: HAL).

The $814 million OIH holds 23 stocks.

Why It's Important

Sagging oil prices are an obvious headwind for the energy sector, but group also looks inexpensive.

“As of June 25, the median price/fair value in our U.S. energy coverage was 0.83,” said Morningstar in a recent note. “The underperformance in energy has made it the cheapest sector in Morningstar's coverage, with a median price/fair value significantly below the 0.96 median for our entire coverage. We see particular opportunity in oilfield-services stocks, which haven’t looked this cheap in more than a decade.”

All of the oil services providers in Morningstar's coverage universe earn four-star ratings from the research firm.

“The decline in crude prices from the 2019 peak in mid-April has erased most of the energy stock gains from earlier in the year, when fundamentals were supported by strong compliance with steep OPEC cuts,” said Morningstar.

What's Next

Risk-tolerant traders willing to make a bet on OIH obviously need some support from oil prices. Further deterioration that could take crude into the $40s would be a major issue for oil services providers.

“We see $55 as the fully loaded cost for the marginal barrel of oil that will balance global supply and demand in the long run, and we expect this barrel to come from a U.S. shale well,” said Morningstar. “Shale wells today are much cheaper per barrel than the large, complex megaprojects that would have set prices in a world without U.S. shale.”

Assuming global trade tensions ease, that could be enough to spark a second-half rally in oil, perhaps carrying it back to the $70 to $75 per barrel range.

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