Energy Etfs: A Smart Investment Move Now?

Energy ETFs are a great way to invest in the energy industry without becoming an oil tycoon or installing solar panels. They are a form of exchange-traded fund (ETF) that invests in stocks in the energy sector, including oil and natural gas companies, as well as alternative energy companies such as wind farms or solar panel producers. Energy ETFs offer instant diversification and can be bought and sold throughout the trading day, making them a flexible investment option.

The energy sector is large and diverse, and energy ETFs can be broken down into sub-sectors such as exploration and production, refining, MLPs (master limited partnerships), oil equipment and services, and crude oil. Some ETFs also focus on clean energy companies, including solar and wind energy.

When considering investing in energy ETFs, it is important to look at the sub-sector, investment track record, and expense ratio. It is also worth noting that larger ETFs tend to have lower expense ratios.

Some popular energy ETFs include the Energy Select Sector SPDR Fund (XLE), iShares Global Energy ETF (IXC), and iShares Global Clean Energy ETF (ICLN).

So, should you invest in energy ETFs now? Well, that depends on your investment goals and risk tolerance. Energy ETFs can provide exposure to a diverse and volatile sector, and there may be opportunities for growth, especially with the current focus on renewable energy. However, it is always important to do your research and consult with a financial advisor before making any investment decisions.

Exploration and production

Energy Select Sector SPDR Fund (XLE)

XLE is the largest energy exchange-traded fund on the market and is a popular choice for investors looking for exposure to the energy sector. It includes companies involved in exploration and production, such as ExxonMobil and Chevron, which together account for about 38% of its assets. XLE has delivered healthy returns and has a dividend yield of 3.4%. However, its large allocations to these two companies mean that concentration risk is a serious concern.

Invesco Energy Exploration & Production ETF (PXE)

This ETF focuses on upstream assets and selects its holdings based on price momentum, earnings momentum, quality, management action, and value. Its top holdings include Phillips 66, EOG Resources, Marathon Petroleum, and Valero Energy. PXE has a higher expense ratio of 0.6%, but it offers a more diverse range of holdings.

IShares Oil & Gas Exploration & Production UCITS ETF (IE00B6R51Z18)

This ETF provides exposure to companies in the energy sector that are involved in exploration and production, refining, and marketing, storage, and transport of oil, gas, coal, and fuels. It is worth noting that this ETF does not include companies that produce or offer renewable energy.

Vanguard Energy ETF (VDE)

VDE offers market-cap-weighted exposure to the US energy sector and tracks the MSCI US Investable Market Energy 25/50 Index. This ETF captures a diversified portfolio of 110 holdings, with a slightly greater emphasis on mid-cap and small-cap energy stocks. It has a higher expense ratio of 0.1%, but it provides a low-cost, high-yield, and diversified option for investors.

Fidelity MSCI Energy ETF (FENY)

FENY is another option for investors seeking a diversified energy ETF. It tracks the MSCI USA IMI Energy Index, resulting in 111 holdings, including Exxon and Chevron, which make up 23% and 13% of the portfolio, respectively. FENY has a slightly lower expense ratio of 0.084% compared to XLE, making it a more cost-effective option.

In summary, investing in energy ETFs, particularly those focused on exploration and production, can offer attractive returns and diversification benefits. However, it is important to carefully consider the risks associated with the volatile nature of the energy industry and the concentration of certain holdings.

Clean energy

• Neuberger Berman Energy Transition & Infrastructure ETF
• TCW Transform Systems ETF
• IShares Climate Conscious & Transition MSCI USA ETF
• JPMorgan Carbon Transition U.S. Equity ETF
• SPDR MSCI USA Climate Paris Aligned ETF
• SSGA SPDR S&P 500 Fossil Fuel Free ETF
• Invesco Solar ETF (TAN)
• IShares Global Clean Energy ETF (ICLN)
• Invesco WilderHill Clean Energy ETF (PBW)

However, it's important to keep in mind that clean energy is a relatively new market, and there is inherent risk in investing in a new industry. When investigating clean energy ETFs, consider the expense ratios and weigh them against the fund's overall return net of fees.

Oil equipment and services

Energy ETFs are a great way to invest in the energy sector without having to pick and choose stocks yourself. They offer instant diversification and access to companies involved in the exploration, production, refining, marketing, storage, and transport of oil, gas, coal, and fuels.

Oilfield Services

Oilfield services companies provide the equipment used in the complex process of drilling and extracting oil. This includes drilling gear, testing and safety tools, and other heavy-duty components. Their profitability is closely tied to oil prices, as higher prices encourage producers to spend more on oilfield services to reach more challenging reserves.

Advantages of Investing in Oilfield Services

• Diversification: The energy sector does not usually correlate with the broader market, so investing in oilfield services can help balance your portfolio.
• Dividends: Oil stocks tend to have high yields, and companies often distribute a good proportion of their profits to shareholders during flush times.
• Tax advantages: Investing in oil and gas stocks offers unique tax benefits, such as treating earnings from royalties as passive income and deducting certain drilling and lease costs.

Risks of Investing in Oilfield Services

• Volatility: Oil stocks are highly volatile and can swing dramatically with the market for oil.
• Geopolitics: Energy companies operate worldwide, relying on the fragile relations between countries where oil is produced, distribution routes are controlled, and consumers are located.
• Regulation and Environmental Concerns: The transition to renewable energy sources and efforts to reduce carbon emissions could negatively impact the demand for oil and gas stocks.

Key Considerations

When considering investing in oilfield services, look for companies with:

• Strong credit profiles and access to affordable credit.
• Low costs of operations or stable cash flow streams.
• Operational diversification, either geographically or across various activities.
• Strong dividend yields and free cash flow.
• A favourable price-to-cash flow ratio and forward price-to-earnings ratio.
• A large market capitalization to weather short-term volatility.

Examples of Oilfield Services Companies

• Weatherford International PLC (WFRD): A leading energy equipment and services supplier with a presence in drilling and well construction.
• Vista Energy S.A.B. de C.V (VIST): Engaged in oil and gas exploration in Argentina and Mexico.
• Vertex Energy Inc (VTNR): A company focused on oil refining and distribution.

Final Thoughts

Investing in oilfield services companies can be lucrative, especially when oil prices are high. However, it is essential to carefully consider the risks and choose companies with strong financial profiles and operational diversification.

Oil and gas stocks

Dividends and Volatility

Oil stocks tend to have high yields for their investors. In profitable times, companies across the industry will distribute a good proportion of their profits to shareholders, rewarding those who remain invested during tougher periods. However, it's important to remember that oil stocks can be volatile, and their performance is closely tied to the market price of oil.

Exploration and Production

Companies that explore and drill for oil tend to be the most volatile stocks in the oil industry. Their prices are very responsive to short-term trends, and their profitability is directly impacted by downturns in the oil market. Examples of these include:

• Diamondback Energy (FANG)
• Coterra Energy (CTRA)
• Saturn Oil and Gas
• Obsidian Energy

Oilfield Services

Oilfield services companies provide the equipment used in the complex process of drilling and extracting oil, including drilling gear, testing tools, and safety components. Their profitability is also influenced by oil prices. When prices are high, producers are more likely to invest in oilfield services to access more challenging reserves. Examples include:

• Black Stone Minerals (BSM)
• Chesapeake Energy (CHK)

Refining

Refining companies operate facilities that turn crude oil into products such as gasoline. They can perform well in favourable market conditions, as they buy oil in advance and sell refined products at higher prices. However, when oil prices decline, they may end up charging less for their products than their production costs.

Integrated Oil Companies

Integrated oil companies combine aspects of production, services, and refining. Their risks are spread out more broadly, but their prospects can still vary significantly with oil prices. Examples include:

• Exxon Mobil (XOM)
• Chevron (CVX)
• Shell
• BP

Master Limited Partnerships (MLPs)

MLPs are publicly traded companies that own energy infrastructure, such as pipelines. They tend to pay high dividends and are popular with retail investors, but their prices can be volatile. An example is the Alerian MLP ETF (AMLP).

Geopolitical factors

Israel-Hamas Conflict and Broader Regional Tensions: Geopolitical tensions in the Middle East, particularly the Israel-Hamas conflict and the potential for the war to broaden into oil-producing regions, have contributed to higher energy prices. The conflict between Israel, Hezbollah, and Iran has heightened concerns about disruptions to oil supplies, as Israel could potentially target Iran's oil export facilities. These geopolitical risks can impact the performance of energy ETFs.

Attacks on Oil Tankers: The attacks on oil tankers in the Red Sea by the Yemen-based Houthis, who are considered a proxy for Iran, have led to an increase in crude oil prices. Such incidents highlight the vulnerability of oil supplies and can influence investment strategies in the energy sector.

Seasonal Factors and Energy Demand: Geopolitical factors interact with seasonal fluctuations in energy demand. For example, during the winter heating season in North America, the demand for natural gas and other heating fuels rises. This increase in demand, coupled with geopolitical tensions, can impact the performance of energy ETFs.

Energy Transition and ESG Investing: The rise of environmental, social, and governance (ESG) investing has led to a shift in the demand curve for fossil fuels. Large institutional investors, such as sovereign wealth funds, have pledged to reduce or eliminate exposure to fossil fuel investments. This has resulted in a decrease in demand for traditional energy companies and a shift towards renewable energy investments.

Energy Sector Consolidation: Geopolitical tensions and fluctuations in energy prices can drive consolidation within the energy sector. For example, Chevron's acquisition of Noble Energy demonstrates how larger energy companies are consolidating their positions. This consolidation can impact the performance and risk profile of energy ETFs, as a significant portion of their holdings may be concentrated in a handful of major companies.

Overall, geopolitical factors significantly influence the energy sector and should be carefully considered when deciding whether to invest in energy ETFs. These factors can impact energy prices, supply disruptions, and the transition towards renewable energy sources. Investors should monitor geopolitical developments and assess their potential impact on the performance and risk profile of energy ETFs.

Frequently asked questions