Recently, we discussed the inherent risks associated with trying to time the bottom in crude oil prices via the well-known United States Oil Fund (USO ). Today, we’re examining the same issue through from the perspective of making an oil rebound-related bet in the equity market rather than the commodity futures market.
Trying to time the bottom in any asset is a risky endeavour, especially when dealing with commodity prices that are known for being inherently unpredictable over the near-term. Luckily, the ETF universe spans far and wide, giving investors a variety of choices when it comes to accessing a particular corner of the market; more specifically, we’re talking about using MLP ETFs to take advantage of the sell-off in oil prices in anticipation of a rebound over the coming weeks and months.
Why MLPs?
Since peaking in early July of last year, falling crude oil prices have dragged down energy-related assets across the board. Simply put, anything and everything associated with crude oil has taken a beating in recent months in light of bearish pressures looming over the entire energy sector.
Consider the performance chart below, which compares how various energy-related assets fared during the prolonged selloff and most recent rebound; please note that crude oil, the energy sector, and MLPs, are represented by (USO ), (XLE ), and (AMLP ), respectively.
There are two key takeaways here; first and foremost, the selloff in crude oil triggered a period of profit-taking across all energy-related assets, as evidenced by the negative returns across the board during the “Oil Selloff” period (blue bars). Second, and more importantly, notice how MLPs have been the least volatile asset class during both the selloff and subsequent rebound (gray bars) periods.
This leads us to conclude that MLPs were simply guilty by association during the oil selloff period. That is to say, AMLP sank because it falls under the energy sector umbrella, and not necessarily because falling oil prices had a material impact on the profitability of the underlying component holdings of the ETF.
Factors to Consider
The fundamental reason for why MLPs didn’t get hit as hard as some other energy-related assets during the oil selloff has everything to do with the nature of their business model. Energy MLPs operate under a “toll road” business model, meaning that they generate fee-based revenues that are inherently dependent on the sheer volume of oil and gas traveling through their pipelines more so than the underlying spot prices for these energy commodities. In other words, MLPs are more “defensive” than energy producers, like those included in XLE, since their profitability is not directly tied to the prevailing price of crude oil.
With that in mind, we think MLP ETFs offer a lucrative opportunity for investors who are looking to favorably position themselves in anticipation of oil prices rebounding, but wish to avoid companies whose underlying profitability is directly linked to the price of oil.
If oil prices head south again, MLP ETFs, like AMLP, should remain more insulated from further downside than other energy-related assets as we saw during the oil selloff period highlighted in the chart above. Likewise, if oil prices continue to rebound, MLP ETFs will likely continue to lag their energy-related counterparts because they are fundamentally not as well positioned to take advantage of rising oil prices.
Read more about Understanding the Nuances of MLP ETF Expenses.
The Bottom Line
In light of the recent selloff seen across energy-related assets, MLP ETFs currently present a “safer” way to bet on oil’s rebound going forward; these securities offer less upside potential in the event of a continued rebound, but they are also better insulated from further profit taking pressures in case oil prices turn lower once again.
See our complete list of Energy MLP ETFs here.
As always, be sure to look closely under the hood of any one product and carefully consider its nuances and limitations before pulling the trigger and making an allocation.
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Disclosure: No positions at time of writing.
