Oil Sell-Off A Buying Opportunity In Energy ETFs

July 28, 2016

US Lower 48 States Crude Oil Production (thousand barrels per day)

At the same time, global demand is up big―by 1.4 million barrels per day year-over-year―according to the International Energy Agency.

Put the two together and you have a market that's made an "extraordinary transformation from a major surplus in [Q1] to near-balance in [Q2]," said the IEA in a recent report.

If these trends keep up, it's not hard to imagine that the oil market will move into a deficit sometime in 2017.

Buying Opportunity

Based on this outlook, it's unlikely that oil prices will fall anywhere close to where they were earlier this year. That's what the stock market and the junk bond market may be assuming, and helps explain the lack of panic in the air.

If anything, the recent pullback in oil may be a buying opportunity in energy ETFs, which have corrected modestly along with the commodity.

The Energy Select Sector SPDR Fund (XLE | A-92) is up 12.1% in the year-to-date period through July 27, but it is down 4% from its recent highs. The ETF, which has heavy weightings in integrated oil giants such as Exxon and Chevron, is one of the safest ways to get exposure to the energy sector, but it doesn't provide the biggest bang for an investor's buck.

ETFs that target smaller, independent oil producers, such as the SPDR S&P Oil & Gas Exploration & Production ETF (XOP | A-70), the iShares U.S. Oil & Gas Exploration & Production ETF (IEO | A-78) and the VanEck Vectors Unconventional Oil & Gas ETF (FRAK | B-25), offer more leverage to any potential rebound in crude prices.

Each of those ETFs is down almost 10% from recent highs, though they're all still in the green for the year as a whole.

XOP holds an equal-weighted basket of exploration and production (E&P) stocks, giving each holding about a 1.7% weighting in the fund on average.

IEO also focuses on E&Ps, but uses a market-cap-weighted approach. In turn, stocks of large E&Ps like ConocoPhillips and EOG Resources have a much larger weighting in the ETF than smaller ones like Oasis Petroleum or Denbury Resources.

Meanwhile, FRAK takes a slightly different tack by tracking an index of companies involved in unconventional oil and natural gas production. These are the companies at the heart of the U.S. shale boom, such as EOG, Pioneer Natural Resources, and others. FRAK is heavy on E&Ps, and its holdings see significant overlap with IEO and XOP.

In terms of performance, FRAK is leading the way this year, followed by XLE, XOP and then IEO.


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