How to Invest in the Energy Sector with ETFs2015-04-24
Energy has long been a popular destination for all types of investors, ranging from smaller individuals to sophisticated billion dollar hedge funds. It wasn’t that long ago that the strategies for investing in energy were relatively simple and straightforward: for example, buy ExxonMobil (XOM).
But thanks in part to the ETF boom, there are now options aplenty for tapping into global energy markets. Below are 13 different strategies for investing in energy, each offering unique risk / return profiles.
1. “Plain Vanilla” Energy ETFs
The traditional form of exposure to energy is still the most popular, as there are billions of dollars invested in products that offer exposure to “Big Oil” stocks such as Exxon, Chevron, and others. Even within this category, however, the options are far from homogeneous; there are various broad-based funds in the Energy Equities ETFdb Category that deliver unique exposure through weighting methodologies, geographic focuses, and other nuances.
A few of the “plain vanilla” options out there include:
2. Small Cap Energy ETF
For investors looking to target smaller companies in the domestic energy sector, the PowerShares S&P SmallCap Energy Portfolio (PSCE ) offers a way to tap into “little oil.” You won’t find the Exxons or BPs of the world in this ETF; PSCE offers a portfolio of the energy stocks that make up the S&P SmallCap 600 Index, meaning that it will generally consist of younger companies that may exhibit more volatility in certain environments [see PSCE Holdings].
3. Emerging Market Energy ETFs
Many of the largest energy companies in the world aren’t headquartered in the U.S.; they operate in places such as Brazil, China, and India. As the need for energy in emerging markets has skyrocketed, so too have the sizes of energy companies headquartered in these markets.
And there are ETFs that deliver targeted exposure to emerging markets energy stocks, including broad-based and country-specific funds:
Master Limited Partnerships are a unique corner of the energy sector that has attracted significant interest in the low interest rate environment. That’s because MLPs must distribute significant portions of current earnings in order to realize certain tax benefits, leading to hefty distribution yields that now often exceed 5%.
Be sure to read MLP ETFs: Fact And Fiction.
There are a number of products in the MLPs ETFdb Category that offer exposure to this segment of the market, including both ETFs and ETNs. Due to the tax consequences of these structures, the decision between these two routes can be a very important one that has a major impact on bottom line returns.
5. Exploration & Production
In addition to broad-based energy ETFs highlighted above, there are some more precise tools out there that deliver rather granular exposure to energy stocks. Companies engaged in exploration and production activities tend to perform rather well when gas prices rise, since higher prices generally results in increased investment in tapping into new reserves and discovering new deposits.
See our Energy Bull ETFdb Portfolio ETFdb.
There are a handful of exploration and production ETF out there, including:
6. Equipment & Services
Another segmented corner of the energy market is the equipment and services industry, which involves providing critical support to the big players in the space. Again, there are a handful of oil equipment and services ETFs out there, including the popular Market Vectors Oil Services ETF (OIH ) and iShares Dow Jones U.S. Oil Equipment & Services Index Fund (IEZ).
Other ETFs in this category include:
7. Unconventional Oil & Gas
The Unconventional Oil & Gas ETF (FRAK ) represents an interesting alternative to the traditional energy industry. This ETF focuses on companies that are engaged in utilizing new technologies and processes to unlock reserves of petroleum products and natural gas, including fracking, shale-related extraction methods, and tight oil and tight sands.
See also Oil ETFs With A Twist.
8. Broad Energy ETFs
While achieving “indirect” exposure to energy through stocks is perhaps the most popular strategy, many investors prefer to invest directly in futures products linked to these natural resources. For those who wish to cast a wide net and tap into a portfolio of various energy-related futures contracts, the following broad energy ETPs might be worth investigating:
While the exact mix varies, these ETPs generally deliver exposure to crude oil, natural gas, and a handful of other energy commodities.
9. Crude Oil ETFs
For those seeking more targeted exposure to oil futures, crude oil is often a popular destination [see also 25 Ways To Invest In Crude Oil]. And there are a number of ETPs that deliver access to this commodity, each offering slightly different exposure through various contract lengths and roll strategies. Crude oil ETFs include:
10. Natural Gas
Natural gas futures have always been popular among active traders. For investors looking to play natural gas futures, there are a number of ETPs available:
11. Natural Gas Stocks
For those with a bullish outlook on natural gas but hesitant to use futures contracts to establish a position, the First Trust ISE Revere Natural Gas Fund (FCG ) could be an interesting opportunity. This fund invests in a portfolio of stocks whose operations revolve around the discovery, extraction, and sale of natural gas. So this ETF should reflect the market for this fuel without exposing investors to the nuances of futures-related strategies.
12. Brent Oil
While the WTI contract remains the primary oil benchmark in the U.S., the rest of the world considers Brent to be the relevant oil contract [see Crude Oil: Brent Vs. WTI].
For investors who believe Brent is a more meaningful gauge of oil prices, the United States Brent Oil Fund (BNO ) may be appealing.
In addition to crude oil, investors have the option to gain exposure to RBOB gasoline–a variant of the fuel that more closely corresponds to what consumers put into their cars. While crude oil and RBOB tend to exhibit relatively strong correlations, they aren’t perfect substitutes.
14. Heating Oil
Heating oil isn’t thought of regularly as an option for achieving exposure to energy, but those seeking exposure to this commodity can find it in the United States Heating Oil Fund (UHN ). Again, there’s a relatively strong correlation to more traditional energy commodities, but the correlation is far from perfect.
15. Leveraged and Inverse Options
There are several leveraged and inverse options to play the energy market, including equities and futures based exposure. You can find leveraged and inverse futures exposure in our Leveraged Commodities and Inverse Commodities.
Our ETF Screener is another great resource to narrow down leveraged and inverse options for both commodities and energy equites.
The Bottom Line
There are many ways for investors to gain exposure to the energy industry. ETFs are a great way to invest in an industry while remain diversified.
Disclosure: No positions at time of writing.