Five ETFs To Hedge Against Skyrocketing Gas Prices

by on April 13, 2010 | ETFs Mentioned:

Warm weather across much of the U.S. in recent weeks has marked the end of winter and the start of spring. It also signals that the summer driving season is quickly approaching, and kicks off a period of time when oil prices are closely scrutinized. Last year saw below average oil demand as consumers tightened their budgets in the midst of a still uncertain economic environment. With a recovery now well underway, estimates for the upcoming vacation season have been all over the board; some analysts expect a surge from consumers while others anticipate another year of conservative budgeting and relatively empty freeways. 

On Tuesday, the Paris-based International Energy Agency warned that rising oil prices could hinder recovery efforts in developed nations. The IEA also raised its 2010 global oil demand forecast by about 30,000 barrels a day, citing increased consumption primarily in China and Saudi Arabia. Global oil demand is expected to grow by 1.7 million barrels per day this year to 86.6 million barrels, which would be the highest level ever recorded.

The immediate future for crude oil markets is uncertain to say the least. Some analysts view projections of record demand as overly optimistic, claiming that they rely too heavily on government-funded programs that are already being scaled back. Oil inventories in the U.S. have now increased for ten consecutive weeks, while gasoline stocks are hovering near 17-year highs. “Still, the prevailing oil market perception is that healthy economic activity in emerging markets like China will eventually run down the more-than-ample spare production capacity currently held in Organization of Petroleum Exporting Countries,” writes Spencer Swartz.

In recent years the importance of Chinese demand for global equity markets has surged. Similarly, China is an increasingly important player in the oil markets, accounting for more than a third of the annual increase in world consumption. China is now expected to consume about 9.1 million barrels per day this year, up 90,000 barrels from previous forecasts. Beijing recently announced that it will increase gasoline and diesel prices by 4.0% and 4.5%, respectively, to reflect higher prices for crude oil. After climbing as high as $87 per barrel this month, crude prices have pulled back slightly in recent sessions.

Demand from both emerging and developed markets will be closely watched in coming weeks as investors try to figure out where prices will peak during the summer. For investors who think oil could be headed higher in coming months, there are a number of ETF options for playing a jump in prices. Below, we profile five ETFs that each offer a unique way to make a play on rising crude prices:

1. Energy Select Sector SPDR (XLE)

This ETF tracks the performance of the Energy Select Sector Index, a benchmark that includes large cap U.S. oil and gas companies. XLE’s major holdings include a number of companies that usually find themselves with skyrocketing profits (and increased political scrutiny) when oil prices rise, such as Exxon, Chevron, and ConocoPhillips.

2. Dow Jones Emerging Markets Energy Titans Index Fund (EEO)

For investors looking to make a play on the energy sector but hesitant to invest heavily in U.S. equities, EEO offers an interesting alternative. This ETF tracks the performance of the Dow Jones Emerging Markets Oil and Gas Titans Index, a benchmark that consists of 30 energy companies headquartered in about a dozen emerging markets, including Russia, China, and Brazil. For investors who think a windfall profits tax is a distinct possibility if oil prices climb skyward, EEO presents an ex-U.S. alternative that could avoid any adverse regulatory developments.

3. United States Oil Fund (USO)

The two ETFs profiled above offer ways to gain exposure to companies in the energy sector. USO takes a different approach to oil exposure, investing in futures contracts for light, sweet crude oil traded on the NYMEX. Because USO invests primarily in near month futures contracts, it will “roll” its holdings on a monthly basis. As such, returns to this fund will be closely correlated spot crude oil prices, but will also be impacted by the slope of the futures curve (see How Contango Impacts ETFs). USO is up about 4% on the year, although the fund has slid in recent sessions as crude oil prices endured a week-long losing streak.

4. United States Gasoline Fund (UGA)

This fund is similar to USO, but invests instead in futures contracts on unleaded gasoline traded on the NYMEX. Not surprisingly, there is a very strong correlation between UGA and USO, but the risk/return profile isn’t always identical. UGA is also up about 4% on the year, and has gained more than 50% over the past year. The futures curve for unleaded gasoline is in very mild contango, with September contracts recently trading less than 1% higher than May contracts. By comparison, September WTI crude oil futures were recently trading about 4% higher than May contracts.

5. Oil Services HOLDRS (OIH)

This ETF consists of 16 companies engaged in the business of providing drilling, well-site management, and related products and services for the oil industry. Although component companies aren’t directly involved in the sale of crude oil or unleaded gasoline, demand for the services of the Schlumbergers and Oilwell Varcos of the world tends to increase when prices are on the rise (see Five Facts About HOLDRS Every Investor Should Know).

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Disclosure: No positions at time of writing.