Energy ETFs Look Prospective, S&P Says

January 21, 2011

Rising oil prices and growth make energy ETFs worth looking at—for now.


Energy ETFs are likely to be good tools for investors looking to capitalize on rising oil prices and steady U.S. economic growth in 2011, that many economists see coming in between 3 and 3.5 percent, Standard & Poor’s analysts said.

Energy stocks have generally outperformed the broader stock market in recent months, buoyed by oil prices that have risen above the $90-a-barrel mark, S&P said in its latest MarketScope Advisor report. Oil costs should continue to rise and are likely to average $95.15 a barrel throughout 2012, amid dropping inventories and solid demand, Stewart Glickman, S&P energy and materials equities analyst, said.

“Historically, energy prices are correlated to GDP,” Glickman said in a telephone interview. “Obviously things can go too far, like when oil hit $140 a barrel, and people changed their behavior a bit. But in general, when energy prices go up, GDP goes up.”

He said equity ETFs with direct exposure to integrated oil and natural gas companies are particularly prospective, because they represent just over half the market capitalization of the S&P 500 energy sector.

He singled out a number of ETFs, including the $8.28 billion Energy Select SPDR (NYSEArca: XLE), the iShares Dow Jones U.S. Energy (NYSEArca: IYE), the iShares S&P Global Energy Sector Index Fund (NYSEArca: IXC) and the Vanguard Energy Index Fund (NYSEArca: VDE).

“The energy sector's recent valuation of 13.1 times estimated 2011 earnings per share (EPS) is below the 500's P/E of 13.6, as the unpredictability of oil prices leads investors to generally assign this sector a lower valuation than the broader market. The sector's P/E-to-projected-five-year EPS growth rate (PEG) ratio of 0.9 is below the broader market's 1,” the S&P report said.

While energy prices should continue to see a “gradual upward trend” in the next three to four years, no one is projecting a return to the $140-a-barrel level, Glickman said, while acknowledging the difficulty of energy price forecasting.

Weighing Options

Among his picks, XLE is the largest in terms of assets under management, and it’s also the cheapest of the four with an annual expense ratio of 0.21 percent.

But the fund is relatively small in terms of holdings—41 names —and therefore carries more company-specific risk than, say, IXC, which not only has a slightly bigger portfolio, it’s the only one of the four to carry sizable international exposure as well as the one with the largest dividend yield.

Although all four ETFs include huge companies such as ExxonMobil, Chevron, Schlumberger and ConocoPhillips among their biggest holdings, IXC also includes foreign names such as BP, Royal Dutch Shell and Total. About 48 percent of the portfolio is allocated outside the U.S. It also underperformed its three counterparts in the past year.



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