Are Energy ETFs Now A Buy?

by on July 12, 2010 | ETFs Mentioned:

The first half of 2010 has not been particularly kind to U.S. equity markets, but some corners of the economy have had a tougher road than others. The domestic energy sector has been battered and bruised by the first six months of the year; nearly all of the funds in the Energy Equities ETFdb Category are in negative territory year-to-date and some are down as much as 30%. A major oil spill in the gulf, ongoing debt crises in western Europe, and an adverse regulatory environment have cast a shadow over energy stocks, causing most investors to flee for greener pastures [also see Uncertain Future For Energy ETFs]. 

But some contrarian investors see an attractive buying opportunity in the energy sector, reasoning that all of the turmoil in the space has created a chance to act out an old Buffett mantra. “Investors should remember that excitement and expenses are their enemies,” the legendary investor once said. “And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.”

Below, we profile three reasons to be greedy in the energy sector in the current environment:

  1. Oil Price Outlook: On April 19th, crude oil closed at almost $86 per barrel; prices were recently hovering in the $70 range. Crude prices may not be headed back towards the $140 levels touched before the recession, but most analysts agree that there is ample room for an up-side rally.
  2. Regulatory Fears: The Deepwater spill has had an adverse impact on the stocks of oil companies linked to the disaster, including BP, Halliburton, Transocean, and Schlumberger; most notably, BP has lost over 55% of its share price since April 20th. But the impact of the spill has been felt far beyond BP, as expectations for increased regulation have weighed on the oil industry. As evidenced by the unprecedented erosion of BP’s market value, most investors have already priced in a worst case scenario. But crippling legislation is far from a done deal, and it’s entirely possible that Big Oil will continue to generate impressive earnings and pay big dividends.
  3. Clean Energy Setback: Many are using the Deepwater spill to jumpstart the clean energy push once again. But the reality of the situation is that clean energy has been dealt a major setback by Europe’s mounting debt crisis. As austerity plans are rolled out, generous subsidies to alternative energy firms have been drastically scaled back or cut altogether, putting the still nascent industry on life support [see more at Why Clean Energy ETFs Are No Slam Dunk]. While the clean energy switch may be a realistic plan long-term plan, the fossil fuels addiction isn’t going to weaken any time soon.

Energy ETFs are no slam dunk, especially in the current environment. But for those who prefer to seek out buying opportunities in sectors that have bean beaten down, the current prices for many energy ETFs may be attractive. Below, we highlight three ways to establish exposure to this corner of the market:

HOLDRS Merrill Lynch Market Oil Service (OIH)

This HOLDRS ETF does not track a specific benchmark, but rather is made up of 15 securities that are in the oil service industry. The fund’s top holdings include Transocean (13.8%), Schlumberger (13.4%), and Halliburton (11.3%). The ETF invests nearly all of its assets in the energy sector and stays mostly in the realm of large and giant market capitalization firms. Though this fund has seen major losses in the last few months, it could be one of the biggest winners if energy stocks rally.

WisdomTree International Energy Sector Fund (DKA)

This ETF tracks the WisdomTree International Energy Sector Index, a benchmark that measures the performance of dividend-paying energy companies in developed markets outside of the U.S. and Canada. The companies are weighted by the cash dividends payed out. BP once accounted for a big portion of DKA’s assets, but the suspension of the company’s dividend led to its expulsion from the fund [see 7 ETFs For Investors Mourning The Death Of BP's Dividend]. The fund’s is entirely international, investing primarily giant and large market capitalization funds.

PowerShares Dynamic Oil Services (PXJ)

PXJ measures the Dynamic Oil & Gas Services Intellidex Index, a benchmark comprised of stocks of oil and gas services companies that is designed to provide capital appreciation by thoroughly evaluating companies based on a variety of investment merit criteria, including fundamental growth, stock valuation, investment timeliness and risk factors. Both Halliburton and Schlumberger account for two of this ETF’s top holdings, but PXJ offers material exposure to small and mid cap companies as well [see PXJ's technicals here].

Disclosure: No positions at time of writing.