ETFs for a World Running on Fossil Fuels

Several decades into global efforts to address threats of climate change, crude oil, natural gas and coal continue to power the world.  

Fossil fuels continue to rule as China and India—home to more than one-third of the world’s population—largely fail to join U.S. and European climate change efforts.  

Other efforts support the carbon economy’s primacy. For one, the shift in U.S. energy policy under the Biden administration decreased the U.S.’ pricing power in the global petroleum market, handing it back to OPEC, the international oil cartel.  

Meanwhile, OPEC’s close ties and cooperation with Russia have caused the cartel’s moniker to change to OPEC+, which refers to Russia’s significant role in worldwide oil production policy. Today, output quotas and other production decisions are a function of negotiations between Saudi Arabia and Moscow.  

OPEC leader Saudi Arabia requires over $80 per barrel to balance its domestic budget. Russia depends on petroleum revenues to finance its war effort in Ukraine and limit the sanction’s impact on its economy. At the most recent OPEC+ meeting, the cartel cut production to support prices.  

Meanwhile, the U.S. is planning to replenish the nation’s Strategic Petroleum Reserve after selling nearly a billion barrels over the past few years.  

The Energy Select Sector SPDR Fund (XLE) and the Vanguard Energy ETF (VDE) own shares of the leading U.S. traditional energy companies. While the U.S. energy policy inhibits hydrocarbon production and consumption, the high prices have caused a profit boom for U.S. oil and gas producers. XLE and VDE have experienced significant rallies, and higher highs could be on the horizon.  

XLE vs. VDE 

XLE, issued by State Street Global Advisors, is the leading exchange-traded fund owning a portfolio of traditional U.S. energy companies. Trading around $80, XLE has $34 billion in assets under management and, about 20 million shares are bought and sold every day on average. It’s been around nearly 25 years.  

The smaller VDE owns a portfolio of traditional U.S. energy companies. Currently the fund trades at around $111, and manages $7.3 billion. The 19-year-old fund trades an average of nearly 435,000 shares daily, offering significant liquidity.  

Performance Comparison 

Crude oil and natural gas futures markets have experienced wild volatility over the past years, and after trading to lows in the first half of 2020, with nearby NYMEX crude oil futures trading below zero for the first time and nearby NYMEX natural gas futures reaching a 25-year low, oil and gas prices exploded to 14-year highs in 2022 before correcting.  

XLE and VDE tracked the explosive price action, with both rising fourfold over the two-year stretch.  

Both funds have around 40% of their assets in Exxon Mobil Corp. and Chevron Corp. Since the 2022 high, both have dropped around 15%.  

They each pay a dividend just over 4.1%, and the 0.10% expense ratio they charge is easily covered by the dividend in less than a month. 

Fewer assets under management could make VDE more flexible in its investment approach, leading to better percentage performance from the 2020 low to the 2022 high. 

Fund Flows Suggest Profit-Taking 

Volatility in oil and gas markets and profit-taking have caused funds to flow out of XLE and VDE in 2023. 

Source: etf.com 

The chart shows over $3.3 billion has flowed out of XLE since the end of 2022. Based on the assets at the end of 2022, the outflow is around 8.8% 

Source: etf.com 

The chart shows nearly $408 million has flowed out of VDE since the end of 2022. Based on the assets at the end of 2022, the outflow is around 5.3% 

Fewer outflows from VDE on a percentage basis suggest holders of the less liquid and more flexible product are stickier than XLE’s investors.  

Fossil Fuels Still Dominate 

The prospects for elevated prices levels over the coming months support profits for the leading fossil fuel companies. Remember a few things: 

• Demand from China and India is likely to rise. 
• Most U.S. vehicles burn gas.  
• Saudi Arabia and Russia will strive to keep prices high.  
• The U.S. will begin buying to replace barrels sold from the Strategic Petroleum Reserve.  
• The leading U.S. oil companies have significant free cash flow, and higher prices will boost revenues.  

XLE and VDE are excellent ETF products providing exposure to traditional U.S. oil and gas companies. Global consumption and the current prices will likely keep profits flowing into the sector. While VDE is smaller and could offer its managers more flexibility, XLE and VDE will rise and fall with sector profits. The trend over the past years suggests that revenue growth will continue.