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All Contents © 2020The Kiplinger Washington Editors
By Kyle Woodley, Senior Investing Editor
| January 3, 2020
Energy stocks and exchange-traded funds (ETFs) were a miserable bet in 2019. Indeed, the energy sector was the worst-performing sector by a mile, gaining less than 5% – far below the S&P 500's 29% return, and significantly lagging even the second worst sector, health care (18%).
However, despite tepid analyst outlooks for oil and gas prices in 2020, energy ETFs and individual stocks are suddenly being thrust in the spotlight once more.
On Jan. 2, the Pentagon confirmed that the U.S. military killed Qasem Soleimani – a top Iranian general who headed the Islamic Revolutionary Guard Corps' elite Quds Force – with a drone airstrike in Iraq. While the Pentagon said the attack was meant to deter "future Iranian attack plans," Iran nonetheless has vowed "severe revenge." The clear, abrupt escalation in Middle East tensions immediately sent oil prices higher in response.
Whether oil continues to climb is unclear. Tensions could de-escalate. Also, American fracking has changed the playing field. "The major potential risk – to oil markets – is mitigated by the fact that the U.S. is now the largest producer of oil and essentially approaching Energy independence," says Brad McMillan, Chief Investment Officer for Commonwealth Financial Network. "Our oil supplies are much less vulnerable than they were, and the availability of oil exports from the U.S. means that other countries have an alternative source."
However, if the conflict worsens – especially if oil tankers and infrastructure are targeted in any violence – oil might continue to spike, regardless.
Here, we explore five energy ETFs to buy to take advantage of higher oil prices. But approach them with caution. Just like increases in crude-oil prices should benefit each of these funds in one way or another, declines in oil have weighed on them in the past, and likely would again.
Data is as of Jan. 2. Yields represent the trailing 12-month yield, which is a standard measure for equity funds.
Market value: $25.6 million
Dividend yield: 1.7%
Expenses: 0.63%, or $63 annually on a $10,000 investment*
Exploration and production (E&P) companies are among the energy stocks most heavily dependent on commodity prices. These firms seek out sources of oil and natural gas, then physically extract the hydrocarbons. They typically make their money by selling oil and gas to refiners, who turn them into products such as gasoline, diesel fuel and kerosene.
While costs to extract those hydrocarbons vary from company to company, in general, the more they can sell those hydrocarbons for, the fatter their profits.
The Invesco Dynamic Energy Exploration & Production ETF (PXE, $16.69) is a smaller energy ETF that allows you to buy the industry broadly, providing access to 30 U.S. stocks that are primarily engaged in E&P. These companies include the likes of Marathon Oil (MRO), Devon Energy (DVN) and ConocoPhillips (COP).
While many sector funds will simply assign weights to each stock based on their relative size (e.g., the largest stocks account for the largest percentages of the fund's assets), PXE does things a little differently. For one, its underlying index evaluates companies based on various criteria, including value, quality, earnings momentum and price momentum. It also "tiers" market capitalization groups, ultimately giving mid- and small-cap stocks a chance to shine. Roughly half of PXE's assets are allocated to small companies, and another 36% are in midsize firms, leaving just 14% to larger corporations.
These smaller companies sometimes react more aggressively to oil- and gas-price changes than their larger brethren – good news for PXE when commodity prices spike, but more painful when they slump.
* Includes a one-basis-point fee waiver good through at least Aug. 31, 2021.
Learn more about PXE at the Invesco provider site.
Market value: $11.1 billion
Dividend yield: 3.7%
The Energy Select Sector SPDR Fund (XLE, $60.58) is the de facto king of energy ETFs, with more than $11 billion in assets under management – No. 2, Vanguard Energy ETF (VDE), has just $3.2 billion. But it's also a much different creature than the aforementioned PXE – and that affects how much it can benefit from oil-price spikes.
For one, the Energy SPDR is a collection of the 28 energy stocks within the S&P 500, so most of the fund (83%) is large-cap stocks, with the rest invested in mid-caps. There are no small companies in the XLE.
More importantly: While the XLE owns pure E&P plays, including some of PXE's holdings, it also invests in other businesses that have different relationships with oil prices. For instance, refiners – who take hydrocarbons and turn them into useful products – often improve when oil prices decline, as that lowers their input costs. Middle East flare-ups can negatively affect some refiners that rely on crude oil supplies from the region, too, while lifting those that don't. This fund also carries energy-infrastructure companies such as Kinder Morgan (KMI), whose "toll booth"-like business is more reliant on how much oil and gas is going through its pipelines and terminals than on the prices for those products.
Then there's XLE's top two holdings: Exxon Mobil (XOM) and Chevron (CVX), which collectively command 45% of assets. Exxon and Chevron integrated oil majors, meaning they're involved in almost every aspect of the business, from E&P to refining to transportation to distribution (think: gas stations). As a result, they can benefit from higher oil prices … but it's a complicated relationship.
Still, XLE typically does improve when oil and gas prices do, and it holds large, well-funded companies that are better able to withstand price slumps than smaller energy firms. It also offers up a generous 3.7% dividend yield that will help you withstand small disruptions in energy prices.
Learn more about XLE at the SPDR provider site.
Market value: $496.0 million
Dividend yield: 5.6%*
The iShares North American Natural Resources ETF (IGE, $30.17) provides broad-based energy-sector exposure similar to the XLE, but with a number of twists.
The first has to do with the name. Whereas the XLE is a collection of U.S. companies within the S&P 500, the IGE's holdings are within all of North America. U.S. companies still dominate the fund, at 77%, but the remaining assets are spread across numerous Canadian companies, including multinational Enbridge (ENB).
IGE also invests more broadly, across 100 energy-sector companies. The fund is cap-weighted, so Chevron and Exxon are still tops, but they make up far smaller percentages at the fund – roughly 10% each, versus about 22% each in XLE.
Another difference is found in the name: "natural resources." In addition to heavy investment in energy industries such as integrated oil and gas companies (26%), E&P (19%) and storage and transportation (17%), IGE also owns gold mining (7%) and even construction materials (3%) companies, among other non-energy firms. Thus, while IGE will move on changes in oil and gas prices, its movement can be affected by other commodities, too.
* IGE's most recent distribution included a special one-time distribution from Occidental Petroleum (OXY) as part of its acquisition of Anadarko Petroleum. This has skewed the dividend yield data at providers such as Morningstar. While Morningstar lists a trailing 12-month yield of 5.6%, iShares' listed trailing 12-month yield of 2.8%, as of Nov. 29, 2019, is much closer to what investors can expect. XLE's stated yield of 3.7% excludes a separate special payout it made closer to the end of the year related to its exposure to Occidental.
Learn more about IGE at the iShares provider site.
Market value: $852.2 million
Dividend yield: 7.0%*
The iShares Global Energy ETF (IXC, $31.08) takes geographical diversification another step farther, and unlike IGE, it focuses completely on energy.
A reminder here that "global" and "international" mean different things. If a fund says it's international, chances are it holds no U.S. stocks. A global fund, however, can and will invest in American stocks as well as international ones … and often, the U.S. is the largest slice of the pie.
The IXC is no exception, holding a 52% slug of American companies. It also has another 12% of its assets invested in Canadian companies. However, the U.K. (16%) and France (6%) are significant weights in the fund, and it also allows investors to reach energy companies in Brazil, China and Australia, among a few other countries. International top holdings include France's Total (TOT) and Dutch-British oil giant Royal Dutch Shell (RDS.A).
Like other energy ETFs, IXC's holdings are primarily driven by oil and gas prices. But other factors are at play, such as the fact that some of these companies have distribution businesses that are reliant on strong gasoline demand, which can be affected by a country's economic strength. Investing across several countries can help reduce such risks.
* Like IGE, IXC's most recent distribution was affected by a special one-time distribution from Occidental Petroleum. While Morningstar lists a trailing 12-month yield of 7.0%, iShares' listed trailing 12-month yield of 4.0%, as of Nov. 29, 2019, is much closer to what investors can expect.
Learn more about IXC at the iShares provider site.
Market value: $1.2 billion
Dividend yield: N/A
But what if you want to invest closer to the source? That is, what if rather than buying oil companies, you wanted to invest in crude oil itself?
The United States Oil Fund (USO, $12.81) is one of a few energy ETFs that let you do that … but be warned that it's not as straightforward as it seems.
The USO is an "exchange-traded security designed to track the daily price movements of West Texas Intermediate ("WTI") light, sweet crude oil" – what most refer to as "U.S. crude." However, unlike some commodity funds, such as the iShares Gold Trust (IAU), that actually hold the physical commodity, USO invests in crude oil futures, as well as other financial instruments to generate its returns.
The problem? USO holds "front-month" futures, so every month it must sell any contracts that are about to expire and replace them with futures expiring in the next month. This can result in cases where USO is selling contracts for less than what it's buying up new ones from – or sometimes the opposite, buying for less than what it's selling for.
In short, this means that sometimes USO will reliably track WTI, but sometimes it won't – it might go lower when West Texas crude goes higher, and vice versa. The fund's expenses further throw off performance.
USO clearly is far from perfect. But it remains a more direct play on oil than publicly traded companies, and it generally will follow WTI's direction over time.
Learn more about USO at the USCF provider site.