Winning Energy ETF Nobody's Talking About

One fund is poised to continue outperforming.

Energy stocks have been tanking this year. That's not really a surprise to anyone who has been keeping up with developments in the financial markets. The energy sector is the worst group in the S&P 500 so far in 2015, no thanks to a 19 percent slump in crude oil prices.

In turn, most energy-related exchange-traded funds are deep in the red. Of the 82 U.S.-listed energy ETFs out there, only 10 are up year-to-date, and nine of those are inverse funds.

Gasoline Strong

The lone noninverse fund is the United States Gasoline Fund (UGA | C-98), with a 2.9 percent gain for the year. As the name implies, UGA invests in front-month gasoline futures contracts. So far this year, gasoline has significantly outperformed crude oil, rising by 18.3 percent. As is often the case, the futures-based ETF does not match the return of the actual futures index, due to contango.

A combination of strong demand and tight supplies has bolstered prices of gasoline, a refined product. Demand during the past month was 5.4 percent higher than a year ago, according to data from the Energy Information Administration.

At the same time, supplies have been tight due to "refinery downtime on the West Coast caused by accidents, maintenance, and the labor strike," according to Fadel Gheit, energy analyst at Oppenheimer & Co.

PXE Outperforming

While UGA has performed well, it's not the most interesting energy ETF of the year. Another fund that isn't up on the year, but has still performed remarkably well, is the PowerShares Dynamic Energy Exploration & Production ETF (PXE | B-75).

PXE is down 1.1 percent year-to-date, but that's much better than the 11.3 percent loss of the broad Energy Select SPDR (XLE | A-95) or the 16.6 percent decline of the popular SPDR S&P Oil & Gas Exploration & Production ETF (XOP | A-56).

YTD Performance For PXE, XLE, XOP

At first glance, PXE's outperformance is startling. How could an ETF focused on exploration and production companies be holding up so well amid this year's bloodbath in those stocks? Upon further examination, it becomes clear that the ETF's name is somewhat misleading.

In fact, less than half the fund's portfolio currently comprises E&P stocks. The majority is actually in companies in the refining and marketing business. The top three holdings are all refining stocks: Valero Energy, Phillips 66 and Marathon Petroleum.

Refiners have been on a tear this year, with many hitting the highest levels in years, just as other energy stocks plummet. There are a number of reasons for the strength in the refining subsector, according to Fadel Gheit.

In addition to the tight supply and demand fundamentals for gasoline (the main end-product for U.S. refiners), according to Gheit, the companies have also benefited from "cheap natural gas, which is used as fuel and feedstock," as well as "continued export sales growth."

Unlike exploration and production companies, which are hurt by lower oil prices, refiners typically benefit from them. The margin for refiners is the spread between crude oil prices and product prices. With crude weak and gasoline relatively strong, that spread has recently been wide.

Gheit expects continued strength in refiners on the back of "share buybacks, dividend growth, and investments in high return, short payback projects."

Shifting Holdings

PXE has taken advantage of that rosy outlook by loading up on refining stocks. But the ETF hasn't always been so refinery-heavy. A year ago, for example, the fund didn't have any refining stocks in its top three holdings.

Indeed, PXE is a rather active ETF that shifts its holdings often, though these moves are based on rules rather than the fund manager's discretion. The fund weights its holdings based on a variety of criteria "including price momentum, earnings momentum, quality, management action, and value."

Currently, that methodology favors refiners, but if the situation changes, PXE has leeway to shift back toward the battered E&P subsector. There's no guarantee that PXE's methodology will outperform, but it has proven to be a winner as long as the fund has been around.

The fund has outperformed the broad-based XLE in every time frame: year-to-date; one-year; five-year; and since inception in October 2005.

5-Year Return For PXE, XLE, XOP

PXE is also the only energy fund to offer significant exposure to the refining subsector right now. A pure-play refining ETF is expected in the future from Market Vectors, which filed for the first such ETF back in May.

Yet even when CRAK―the ticker symbol for that planned ETF―begins trading, it won't have the flexibility of PXE.

Bottom Line

The PowerShares Dynamic Energy Exploration & Production ETF is a unique option for energy investors. The fund has a relatively long track record of success and is well-positioned to take advantage of continued gains in the refining subsector or an eventual turnaround in the exploration and production subsector.