Energy Exploration ETFs: A Bright Spot in The Choppy Market

The year 2014 has started favorably for the Oil & Gas Exploration & Production (E&P) space of the broad energy sector. First, the record U.S. chills this year brought about nice price appreciation for the oil ETFs and then the intensified geo-political tension on Ukrainian issues gifted another round of returns to oil and gas stocks and the related exchange traded products (read: Oil ETFs Warm Up as U.S. Chills Again).

To add to this, shale oil boom in the U.S. driven by the country’s energy independent mission has also supported this slice of the investing world as evident from increasing domestic production and falling imports.

Some positive U.S. economic data and solid consumer confidence also hinted at improved economic activity and higher energy consumption. Notably, the U.S. is the world’s biggest oil consumer. As a result, improved U.S. growth can lead to firmer oil prices.

While some foreign markets may be slowing down, it appears as though investors haven’t yet started to take it seriously in less bubbly sectors. Natural gas prices also rallied in the recent trading thanks to the forecast of below-normal temperatures in some northeastern U.S. regions and lower stockpiles.

Moreover, energy company Anadarko Petroleum’s (APC) recent settlement worth $5.15 billion in an environmental case pushed up the stock by about 14.5% benefitting the entire energy space (read: 3 Energy ETFs to Buy on the Ukraine Crisis).

Thus, all three Oil & Gas Exploration & Production ETFs have held up quite well this year while the broader market has succumbed to a slowdown. While the SPDR S&P 500 ETF (SPY) has tumbled 0.55% in the YTD frame, top three Oil and Gas exploration ETFs – iShares U.S. Oil & Gas Exploration & Production ETF (IEO), SPDR S&P Oil & Gas Exploration & Production ETF (XOP) and PowerShares Dynamic Energy Exploration & Production ETF (PXE) – have gained about 5.9%, 6.43% and 3.86%, respectively.

How to Play

While playing this bullish trend is certainly possible through any number of individual stocks, this approach could produce high levels of volatility and miss out on some of the big winners. Instead, investors may be better served by taking an ETF route for a wide exposure to the space. Below, we have highlighted the three ETFs mentioned above in detail:

iShares U.S. Oil & Gas Exploration & Production ETF (IEO)

This ETF tracks the Dow Jones US Select Oil Exploration & Production Index. The product invests about $440 million in 77 companies. The fund charges investors 45 basis points a year in fees, while volume is modest at about 100,000 shares a day.

ConocoPhilips (COP) takes the top spot at about 12.5% of assets, while EOG Resources and Anadarko occupy the next two positions with respectively 7.93% and 7.40% of share. The fund is mainly governed by large caps.

The ETF currently has a Zacks ETF Rank #1 (Strong Buy) and added about 2.47% last week (see all the Top Ranked ETFs here).

SPDR S&P Oil & Gas Exploration & Production ETF (XOP)

This equal-weight ETF looks to track the S&P Oil and Gas Exploration and Production index. The fund holds about 84 stocks in its basket, charging a quite low expense ratio of 0.35%. Thanks to its strategy, no single security makes up for more than 1.51% of assets thus ruling out concentration risk.

The fund is diversified across capitalization levels as well with large caps accounting for 32% of the portfolio followed by small and mid caps with about 25% each. The ETF added over 1.50% in the past week.

PowerShares Dynamic Energy Exploration & Production ETF (PXE)

PXE adopts an enhanced index approach and tracks the Dynamic Energy Exploration and Production Intellidex index. The benchmark selects stocks based on criteria like price momentum, earnings momentum, quality, management action, and value. It charges 65 bps in yearly fees which makes it the priciest choice in the space.

Though the product follows an equal weighted approach like XOP, the weight attributed to each stock is higher than XOP. Valero Energy Corp (VLO) – the top most allocation of the ETF accounts for about 5.29% of the product. Apache Corp (APA) and Phillips 66 (PSX) round out the top three positions in the fund.

The basket, made of 30 stocks, is currently slightly skewed toward large caps with about 50% of exposure, and one-third share of the fund goes to the oil refining & marketing segment. PXE was up 2.17% last week.

Bottom Line

While the broader market momentum will likely slacken or be range bound in the near term thanks to investors’ movement into defensive assets, the best of the bunch will remain afloat. The energy E&P space is such a sector. However, the latest Libyan oil deal – which signifies increased supplies in the energy space – has weighed on this part of the ETF universe.

Thus, we suggest investors to ride out the broader market volatility and some occasional glitches in the otherwise booming energy sector through the top-ranked energy E&P ETF IEO while the rest of the market struggles (read: Play the U.S. Oil Boom with These Energy ETFs).

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Read the analyst report on APC


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