McCall’s Call: Gulf Spill Creates Opportunity

The growing oil disaster in the Gulf of Mexico has spilled into energy ETFs, but investors should see opportunity, as the
U.S. and global appetite for energy means the whole sector is quickly becoming a value play.

The BP (NYSE: BP) oil disaster in the
Gulf of Mexico is into its seventh week and oil continues to gush with no clear end in sight. The ramifications of the spill are in plain view on the shores of the
Gulf of Mexico, and unfortunately the cleanup may take many years.

From an investment view, the oil spill has taken its toll on energy ETFs as offshore drilling and equipment stocks take a beating. The six-month drilling moratorium imposed by the
U.S. government affects 33 deep-water rigs directly. Indirectly, the moratorium and other future government restrictions could dramatically alter the state of the energy sector and the related ETFs.

Given our strong appetite for oil to fuel our cars, run our airplanes and even heat our homes, those investments will bounce back some day, probably sooner rather than later.

But investors needn’t wait that long, as other pockets of the energy world remain quite prospective for energy investors. While the whole sector has taken a hit since the BP disaster, many alternatives are poised for a solid rebound, notably natural gas.

Effect Of The Oil Spill On Energy ETFs

The BP Deepwater Horizon rig sank into the Gulf of Mexico on April 22, a day before the
U.S. stock market hit its most recent high. Since that time, the S&P 500 has fallen 12 percent and the energy ETFs have taken even bigger hits.

The largest energy ETF as measured by assets is the Energy Select Sector SPDR (NYSEArca: XLE), and since the day the rig sank, the ETF has lost 15 percent of its value. The second-largest energy ETF has been decimated by the oil disaster: The Oil Services HOLDRS ETF (NYSEArca: OIH) has fallen by 28.8 percent in six weeks.

The reason for the great disparity between the two ETFs is allocation. XLE is composed of 40 stocks, all based in the
U.S., with Exxon Mobile (NYSE: XOM) and Chevron (NYSE: CVX) totaling 30 percent. OIH only has 15 stocks in its portfolio and has a major emphasis on big drilling companies. The No. 1 holding, Transocean (NYSE: RIG) is directly related to the oil spill because they owned the rig.

Natural Gas ETFs Win

As deep-water drilling becomes more heavily scrutinized, the near-term and long-term outlook for the sector is questionable at best. It’ll have its day in the sun again as a value play because, realistically, we still need oil and we therefore still need to drill for it. But until the market fully accepts that, investors ought to turn their attention to alternative energy ETFs.

The biggest beneficiary of the entire disaster may be the on-shore drilling and natural gas companies. The
U.S. has an abundance of natural gas on shore and it’s a cleaner-burning fuel. Even environmentalists prefer it to crude oil. The two ETFs that target this sector include the First Trust ISE Revere Natural Gas ETF (NYSEArca: FCG) and the Jefferies | TR/J CRB Wildcatters Exploration & Production ETF (NYSEArca: WCAT).

FCG is composed of a basket of mainly U.S.-based natural gas companies involved in exploring and producing natural gas. WCAT was introduced in January 2010 and has yet to really take off, but it’s an interesting idea. The ETF is composed of 60 small- and mid-cap stocks in the U.S. and
Canada that are in the natural gas business in some manner. Both FCG and WCAT lost approximately 12 percent since the rig sank, which is in line with the overall market and slightly better than the energy ETFs.