Despite the fact that crude oil inventories are high and Americans are driving less, crude oil has been on a tear in recent months. Just four months ago, NYMEX-traded crude oil went for around $30 barrel. Now $70 appears likely, perhaps as soon as this week. Start bracing for a little more pain every time you head to the gas station.
There are five distinct categories of energy-related ETFs and ETNs, namely those that track indexes of:
- Energy commodities
- Energy sector equities (diversified)
- Exploration and production industry
- Energy services industry
- Alternative energy industry
Each group has its own advantages and limitations. The ability of ETFs and ETNs to properly track the crude oil price has proven elusive thanks to contango effects in the futures market. Broad-based energy ETFs are heavily weighted in the multinational integrated oil companies. The alternative energy industry consists primarily of companies that don’t rely on crude oil. The exploration and production industry, as its name implies, has historically had a high correlation to crude oil prices.
However, today, we are going to look at another way to play a potential rise in crude oil prices: ETFs focused on the energy services industry. These are the companies that supply drilling rigs, seismic information, logistics, and other related equipment and services to the entire energy sector. Some of the big players include Schlumberger (SLB), Diamond Offshore (DO), National Oilwell Varco (NOV), and Transocean (RIG). The four ETFs that cover this space are:
- SPDR S&P Oil & Gas Equipment & Services ETF (XES) (XES fact sheet) is well-diversified with 26 companies and no holding representing more than 5%. It has an expense ratio of 0.35% and is my favorite member of this group.
- PowerShares Dynamic Oil & Gas Services Portfolio (PXJ) (PXJ overview) is well-diversified with 30 companies but uses a multi-tier weighting system with the top eight holdings receiving higher weighting. It has a net expense ratio of 0.63%.
- HOLDRS Oil Services Trust (OIH) (OIH holdings) continues to enjoy first mover status: it is the heaviest traded and most liquid of the group, although it has below-average diversification with 16 holdings and weightings of RIG at 16.8% and SLB at 11.7%. The HOLDRS structure is dated and has many drawbacks including the requirement that all trades are in round lots (multiple of 100 shares), but there are no management fees.
- iShares Dow Jones U.S. Oil Equipment & Services (IEZ) (IEZ overview) has 42 holdings yet it is the least diversified of the four with SLB at 21.1% and HAL at 9.2%. It has an expense ratio of 0.48%.
Currently there are no leveraged or inverse products that focus on this industry.
These ETFs have a high positive correlation to oil prices. A positive move in oil usually translates into positive moves for energy service stocks, and that obviously trickles down to the ETFs.
To be sure, these ETFs have been just as hot as oil in recent months. In other words, they could be due for a pullback. The volatility of energy investing can be a lot for investors to handle. But rest assured – oil prices aren’t likely to see the levels they fell to in the latter part of 2008, at least not in the near-term. OPEC is diligently trying to keep prices heading toward $70 a barrel because most of OPEC can’t turn a profit when crude is anywhere below $50 a barrel.
Yes, green is all the rage now. But Wall Street still appears to be a long way off from falling in love with green stocks. Translation: crude oil and related investments won’t escape the market’s eye anytime soon. Using the trend as a guide, it is obvious that the long term trend in oil prices is up.
The charts of the energy service ETFs indicate some possible consolidation in the short-term. A strong move above $70 for crude oil, without a retracement below that level, could certainly tack on some points. XES, PXJ, OIH and IEZ are all comfortably above their 50-day moving averages and recently cleared their 200-day moving averages, despite the negative factors like rising inventories and a drop in consumption. Current prices are back at 2005 levels, before the 2006-2008 run-up in energy. This suggests there is more potential upside in these funds.