Top Energy ETFs Of 2016

These ETFs performed the best in a comeback year for oil.

By all accounts, it's been a good year for energy. After 1 1/2 years of steep declines, oil and natural gas prices made a surprising comeback in 2016, ending one of the most devastating downturns ever for energy commodities.

On a year-to-date basis, front-month WTI crude oil futures contracts gained more than 21% to last trade at $45/barrel, while front-month Henry Hub natural gas contracts rose by nearly 14% to last trade at $2.61/mmbtu.

In the context of these bullish price movements, it's hard to imagine that any energy-related exchange-traded funds could be down this year, but there are actually 30 such ETFs in the red for 2016. Among those are the United States Oil Fund (USO), down 7.6%; the United States Natural Gas Fund (UNG), down 17.9%; and the VelocityShares 3x Long Crude Oil ETN (UWTI), down 52%.

The declines in these ETFs are a stark reminder to investors about the perils of contango (along with the perils of daily rebalancing in the case of UWTI) and why it's impossible to capture the spot returns for energy commodities.

Runaway Coal Prices Boost KOL

Aside from those losers, there were plenty of energy-related ETFs that performed well this year. Most of those ETFs hold energy stocks, which have been a much better bet than ETFs that hold commodity futures.

The VanEck Vectors Coal ETF (KOL) is one of those outperformers. As well as oil and natural gas prices have done this year, it's nothing compared to coal. Global prices for metallurgical coal (used to make steel) have tripled, while prices for thermal coal (used to generate electricity) have doubled.

The story of this year's coal surge is ironic. In an effort to reduce the glut of coal, increase prices and bail out indebted Chinese coal miners, the government of China ordered cutbacks in production.

However, those cutbacks have proven to be much more severe than expected, prompting a rally in coal prices beyond what anyone had imagined. Now China is reversing course and determining how to bring prices back down without harming the country's struggling coal industry.

With its basket of global coal mining stocks, KOL—which already surged 116.5% this year―is well-positioned to benefit from any further gains in coal prices. However, if China backtracks on its policy of propping up coal prices, the ETF could get hit.

Energy Infrastructure ETFs Buoyed By Stable Production

Aside from KOL, most of the top-performing energy ETFs of 2016 are infrastructure funds, including those that hold MLPs. At the top of this heap is the Tortoise North American Pipeline Fund (TPYP), up 31.9%.

Energy infrastructure ETFs such as TPYP have bounced back this year amid signs of stabilization in U.S. crude oil production following a steep decline in the year ending in June. Cash flows for many infrastructure companies, such as those that build and operate pipelines, are largely dictated by the volume of oil and natural gas that flow through their systems. If U.S. oil output rises, that's a boon for these companies and the ETFs that hold their stocks.

TPYP is one of a handful of energy infrastructure products structured as a 40 Act fund, which limits its MLP exposure to 25%. The others include the Alerian Energy Infrastructure ETF (ENFR), the Global X MLP & Energy Infrastructure ETF (MLPX) and the First Trust North American Energy Infrastructure Fund (EMLP)―all up more than 23% on the year.

FRAK To Benefit From Resumption Of Oil Boom

Rounding out the top 10 energy ETFs list are the Guggenheim Canadian Energy Income ETF (ENY), up 28.1%; the VanEck Vectors Unconventional Oil & Gas ETF (FRAK), up 24.9%; and the Guggenheim S&P 500 Equal Weight Energy ETF (RYE), up 22.4%.

ENY targets the Canadian energy industry, and in turn, has benefited from a modest rebound in the Canadian dollar against the U.S. dollar this year.

FRAK holds a basket of stocks focused on unconventional oil and gas, primarily U.S. shale drillers that stand to benefit if the country's oil boom resumes in the future.

Contact Sumit Roy at [email protected]