Oil ETFs In Focus As “Top Kill” Begins

by on May 26, 2010 | ETFs Mentioned:

When an oil rig exploded and collapsed in the Gulf of Mexico last month, few imagined that the fallout from the disaster would still be making headlines nearly five weeks later. But the explosion spawned one of the worst environmental disasters in U.S. history, and resolving the situation has been a daunting challenge for all parties involved. BP, the British oil giant that has accepted responsibility for the leak, has attempted a variety of maneuvers to stop the flow of oil; all have had limited success.

On Wednesday, BP announced that is was beginning a risky “top kill” operation that it hoped would plug the leaking well. Success in the initiative could mark a turning point in the company’s efforts to contain the disaster. But failure could mean that oil will continue to spill for another two months, as BP is nearly out of ideas for stopping the leak (see What Oil ETFs Are Telling Us About Crude Prices).

As the “top kill” maneuver commenced on Wednesday, a variety of groups around the world were watching intently. Countless business owners and fisherman along the Gulf coast waited for updates, as did politicians in Washington and environmental groups around the world. Also monitoring the latest developments closely were investors on Wall Street, where traders have watched oil stocks plummet in recent weeks as outrage over the spill has built.

Backlash Ahead

An “onslaught of regulation” in the wake of the spill now seems inevitable, but the success of the current initiative may go a long ways in determining the severity of the backlash against Big Oil. The current situation has made for some strange bedfellows; at a shareholder meeting on Wednesday Exxon CEO Rex Tillerson said his company continues to provide assistance to BP in hopes of resolving the situation.

President Obama bashed the current state of the oil industry earlier this week, vowing to end the “cozy relationship” between executives and regulators. Some startling discoveries have been made about these arrangements; it has been reported that some inspectors let oil companies fill out their own inspection reports in pencil, tracing over the form later in ink.

Predictions for the regulatory backlash against the oil industry have been all over the board. Some legislators have proposed raising the cap on damages from $75 million to $10 billion, a step that would significantly increase exposure from future spills. But the biggest area of concern relates to potential restrictions offshore drilling. The Deepwater incident has already triggered a pause on new well construction permits, but is threatening to change the way both deepwater drillers and those that drill in shallow waters do business.

Already, investors have fled from small offshore drilling companies, highlighting the uncertainty not associated with these stocks. “The heavy toll the Gulf disaster has taken on the smaller drilling companies underscores how damaging the incident is for the offshore oil industry’s economic and political fortunes, no matter the size of the players,” writes Jason Womack.

ETFs In Focus

As the Deepwater Horizon drama continues to unfold, ETFs focusing on companies in the oil exploration and production industry figure to see a spike in trading activity, and perhaps some big price swings:

  • Oil Services HOLDRS (OIH): With more than 80% of assets in its top ten holdings, OIH is sensitive to changes in its heaviest weightings. The largest holdings include Transocean, Schlumberger, and Halliburton–three companies whose fortunes could be altered dramatically by regulatory changes.
  • SPDR S&P Oil & Gas Equipment & Services ETF (XES): This ETF tracks the S&P Oil & Gas Equipment & Services Select Industry Index, a benchmark that includes companies providing various services to oil companies.
  • PowerShares Dynamic Energy Exploration & Production (PXE): This ETF’s holdings include energy exploration and production companies such as Hess Corporation, Occidental Petroleum, and Anadarko Petroleum.

Disclosure: No positions at time of writing.