Barchart.com’s Picks in the Energy Equity Sector

ETF Research written by the Barchart.com ETF Research Team

Last Updated: February 1, 2011

Table of Contents

Introduction

This report covers ETFs that hold the stocks of companies in the energy business.  The energy business primarily involves oil & gas companies, but in this report we also cover ETFs involving just natural gas and coal.  We have separate reports that cover the nuclear energy sector and also the clean energy sector (or alternative energy), which includes companies involved in solar and wind power and energy conservation.  We also have reports that cover investing in energy commodity prices including petroleum ETFs and natural gas ETFs .

When analyzing the Energy sector, it is important to understand the Global Industry Classification Standard (GICS) because the energy ETFs use GICS classifications to select their holdings (link to GICS information ).  The GICS system splits the Energy sector into two industries:  (1) Energy Equipment and Services, and (2) Oil, Gas & Consumable Fuels.  These two Industries are then split into sub-industries, which GICS describes as follows:

Energy Equipment and Services

• Oil & Gas Drilling — Drilling contractors or owners of drilling rigs that contract their services for drilling wells.
• Oil & Gas Equipment & Services — Manufacturers of equipment, including drilling rigs and equipment, and providers of supplies and services to companies involved in the drilling, evaluation and completion of oil and gas wells.

Oil, Gas & Consumable Fuels

• Integrated Oil & Gas — Integrated oil companies engaged in the exploration & production of oil and gas, as well as at least one other significant activity in either refining, marketing and transportation, or chemicals.
• Oil & Gas Exploration & Production — Companies engaged in the exploration and production of oil and gas not classified elsewhere.
• Oil & Gas Refining & Marketing — Companies engaged in the refining and marketing of oil, gas and/or refined products not classified in the Integrated Oil & Gas or Independent Power Producers & Energy Traders Sub-Industries.
• Oil & Gas Storage & Transportation — Companies engaged in the storage and/or transportation of oil, gas and/or refined products. Includes diversified midstream natural gas companies facing competitive markets, oil and refined product pipelines, coal slurry pipelines and oil & gas shipping companies.
• Coal & Consumable Fuels — Companies primarily involved in the production and mining of coal, related products and other consumable fuels related to the generation of energy.  Excludes companies primarily producing gases classified in the Industrial Gases Sub-Industry.

We have separated the large number of energy ETFs into a variety of groups, each of which we will discuss in more depth.  We will first discuss the broad energy ETFs that cover the entire energy sector, and then we will discuss the narrower industry-level ETFs that focus on Energy Equipment and Services and Oil & Gas Exploration and Production.

U.S. Broad Energy

Energy Select Sector SPDR Fund (XLE) (issuer web site link ) – This fund, launched in December 1998, has $8.7 billion in assets under management, which makes it the largest ETF in the energy sector by far.  The fund has an expense fee of 0.21%.  The fund is part of the SPDR family of ETFs offered by State Street Global Advisors and tracks the Energy Select Sector Index.  The index has a 78.4% weight on Oil, Gas & Consumable Fuels, and a 21.6% weight on Energy Equipment and Services.  The fund holds 42 U.S.-listed stocks with the largest holdings being Exxon Mobil (17.4%), Chevron (13.1%), Schlumberger (8.3%), ConocoPhillips (5.2%), and Occidental Petroleum (4.9%).

Vanguard Energy Index Fund (VDE) (issuer web site link ) – This fund, launched in September 2004, has $1.645 billion in assets under management.  The fund has an expense fee of 0.24%.  The fund tracks the MSCI U.S. Investable Market Energy 25/50 Index.  The fund holds 160 U.S.-listed stocks but 140 of those stocks have weights of less than 1.0%.  The fund holds 71.8% large-cap stocks, 22.4% mid-cap stocks, and 5.8% small-cap stocks.  The fund has the largest weights on the following subsectors:  Integrated Oil & Gas (46.3%), Oil & Gas Exploration & Production (22.1%), Oil & Gas Equipment & Services (19.3%).  The top five holdings are Exxon Mobil (21.4%), Chevron (12.3%), ConocoPhillips (6.1%), Schlumberger (4.6%) and Occidental Petroleum (4.4%).

iShares Dow Jones U.S. Energy Sector Index Fund (IYE) (issuer web site link )  — This fund, launched in June 2000, has $868 million in assets under management.  The fund has an expense fee of 0.48%.  The fund tracks the Dow Jones U.S. Oil & Gas index and holds 92 U.S.-listed stocks.  The five largest holdings are Exxon Mobil (24.7%), Chevron (11.8%), Schlumberger (6.9%), ConocoPhillips (5.7%), and Occidental Petroleum (4.9%).  The sector breakdown is 74.66% in Oil & Gas Producers, 24.68% in Oil Equipment, Services & Distribution, and 0.59% in Alternative Energy.

Rydex S&P Equal Weight Energy ETF (RYE) (issuer web site link ) – This fund, launched in November 2006, has failed to gain much traction and has only $25 million in assets under management.  The fund has an expense fee of 0.50%.  The fund tracks the S&P Equal Weight Index Energy, holding 41 U.S.-listed energy companies with an equal weight of about 2.4% for each stock.

Figure 1:  Broad U.S. Energy ETF Comparison — Energy Select Sector SPDR Fund (XLE) (live chart link )

Broad U.S. Energy Investment Conclusions – Our Best in Class choice for the U.S. broad energy sector is the Energy Select Sector SPDR Fund (XLE) because it has the longest track record, the highest assets under management by far, the best liquidity, and the lowest expense fee.  The three largest ETFs in the U.S. broad Energy sector all track fairly closely in terms of performance, as seen in Figure 1, which is a 3-year weekly chart.  The performance of all three ETFs is similar on other time frames, with no one ETF gaining a big and sustainable performance advantage over the others in terms of performance or risk.

U.S. Energy – Small-Cap

PowerShares S&P SmallCap Energy Portfolio (XLES) (issuer web site link ) – This fund, recently launched in April 2010, has about $50 million in assets under management.  The fund tracks the S&P SmallCap 600 Capped Energy Index and holds 22 U.S.-listed small-cap energy stocks.  This fund has recently outperformed a comparable large-cap benchmark, as seen in Figure 2, thus potentially making it a good choice for investors who are looking for small-cap exposure in the energy sector.

Figure 2:  PowerShares S&P SmallCap Energy Portfolio (XLES) versus Energy Select Sector SPDR Fund (XLE) (live chart link )

U.S. Broad Energy – Quantitative or Enhanced ETFs

PowerShares Dynamic Energy Sector Portfolio (PXI) (issuer web site link ) – This fund, launched in October 2006, has $113 million in assets under management.  The fund has a net expense fee of 0.65%.  The fund is based on the Dynamic Energy Sector Intellidex Index, which uses a rule-based methodology to select holdings based on a variety of investment merit criteria, including fundamental growth, stock valuation, investments and risk factors.

First Trust Energy AlphaDEX Fund (FXN) (issuer web site link ) – This fund, launched in May 2007, has $95 million in assets under management.  The fund has a net expense ratio of 0.70%.  The fund is based on the StrataQuant Energy Index, which is an enhanced index that employs the AlphaDEX stock selection methodology.  The index ranks the Russell 1000 stocks in the energy sector based on value factors including book value to price, cash flow to price and return on assets and then selects the top 75% of the ranked stocks to include in the index.

Investment Conclusion — As seen in Figure 3, PXI on a 3-year weekly chart substantially outperformed FXN and the broad SPDR Energy ETF XLE, making it a possible choice for an investor who would like to allocate at least part of his or her investment portfolio to an energy ETF that attempts to beat a passive basic energy benchmark.

Figure 3:  Quantitative Energy ETF Comparison (live chart link)

U.S. Oil & Gas Exploration & Production

This group of ETFs is focused on companies in the sub-industry sector of Oil & Gas Exploration & Production (E&P), thus excluding energy companies that are involved in drilling, services, refining, marketing, storage, and transportation.  The E&P companies are more of a pure-play on the business of exploring for and extracting oil and gas and should theoretically have a higher correlation with oil prices than energy services companies, although in reality the correlation is fairly close, as seen in Figure 4.

Figure 4:  Broad Energy ETF and Energy Exploration ETF versus Crude Oil Prices (live chart link )

SPDR S&P Oil & Gas Exploration & Production ETF (XOP) (issuer web site link ) – This fund, launched in June 2006, has $928 million in assets under management.  The fund has an expense fee of 0.35%.  The fund tracks the S&P Oil & Gas Exploration & Production Select Industry Index, which represents the oil and gas exploration and production sub-industry portion of the S&P Total Markets Index.  The index is actually a little broader than just E&P and has the following sub-industry weights:  Oil & Gas Exploration & Production (72.69%), Oil & Gas Refining & Marketing (16.44%), and Integrated Oil & Gas (10.86%).  The fund holds 39 U.S.-listed companies.  The index is an equally-weighted index, meaning the weight of each stock is the same at about 2.6%.  The weight of each component will fluctuate as stock prices move, but the index is rebalanced back to equal weights once a quarter.

iShares Dow Jones U.S. Oil & Gas Exploration & Production Index Fund (IEO) (issuer web site link ) – This fund, launched in May 2006, has $439 million in assets under management.  The fund has a fee of 0.48%.  The fund is based on the Dow Jones U.S. Select Oil Exploration & Production Index, which is a market-cap weighted index of 60 U.S.-listed companies that specialize in oil exploration and production.  The five largest holdings are Occidental Petroleum (15.29%), Apache (9.33%), Anadarko Petroleum (8.04%), Devon Energy (7.49%), and EOG Resources (5.58%).

PowerShares Dynamic Energy Exploration & Production Portfolio (PXE) (issuer web site link ) – This fund, launched in October 2005, has $82 million in assets under management, which is relatively low for an ETF that has been in existence for more than five years.  The fund has a net expense fee of 0.63%.  This fund uses the Intellidex system discussed earlier in order to select energy stocks in the E&P sub-industry.

Thomson Reuters / Jefferies CRB Wildcatters Exploration & Production Equity Fund (WCAT) (issuer web site link ) – This fund, recently launched in January 2010, has only $18 million in assets under management.  The fund has an expense fee of 0.65%.  The fund focuses on small-cap U.S. and Canadian companies involved in the exploration and production of oil and natural gas.

Investment Conclusion – Our Best in Class choice in the Energy E&P group is the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) for the following reasons:  (1) we like the equal-weighting of the index, which gives smaller-cap E&P companies a bigger influence in the index instead of the index simply being dominated by the larger-cap stocks (like IEO), (2) the fee of 0.35% is lower than 0.48% for IEO, and (3) XOP’s recent performance has been better than IEO, as seen in Figure 5.

Figure 5:  SPDR S&P Oil & Gas Exploration & Production ETF (XOP) versus iShares Dow Jones US Oil & Gas Exploration & Production Index Fund (IEO) (live chart link )

U.S. Oil & Gas Equipment & Services

iShares Dow Jones U.S. Oil Equipment & Services Index Fund (IEZ) (issuer web site link ) – This fund, launched in May 2006, has $500 million in assets under management.  This fund has an expense fee of 0.47%.  The fund tracks the Dow Jones U.S. Select Oil Equipment & Services Index, which is a market-cap weighted index that currently holds 44 U.S.-listed stocks.  The top five holdings are Schlumberger (16.93%), Halliburton (8.54%), National Oilwell Varco (7.62%), Baker Hughes (6.94%), and Weatherford (5.24%).

SPDR S&P Oil & Gas Equipment & Services ETF (XES) (issuer web site link ) – This fund, launched in June 2006, has $460 million in assets under management.  The fund has a fee of 0.35%.  The fund tracks the S&P Oil & Gas Equipment & Services Select Industry Index.  The fund has a 63.80% weight on the Oil & Gas Equipment & Services sub-industry and a 36.20% weight on the Oil & Gas Drilling sub-industry.  The index is an equal-weighted index that holds 26 U.S.-listed stocks, which means each stock has a weight of about 3.8% after the quarterly rebalancing.

PowerShares Dynamic Oil & Gas Services Portfolio (PXJ) (issuer web site link ) – This fund, launched in October 2005, has $208 million in assets under management.  The fund has an expense fee of 0.63%.  The fund tracks the Oil & Gas Services Intellidex Index, which is a stock selection and weighting method that takes into account 25 factors that measure company fundamentals, stock valuation, timeliness, and risk.

Investment Conclusion - Our Best in Class choice for this ETF group is the SPDR S&P Oil & Gas Equipment & Services ETF (XES) for the following reasons:  (1) XES is an equally-weighted index, which means it puts a higher weight on smaller-cap stocks that may have a better potential to perform and avoids the situation in a market-cap weighted index where a few large-cap stocks dominate the index, (2) XES has a fee of 0.35% versus  0.47% for IEZ, and (3) XES has outperformed both IEZ and PXJ in the past two years, as seen in Figure 6.

Figure 6:  Oil & Gas Equipment & Services ETF Comparison (live chart link )

U.S. Energy – Leveraged Long and Short ETFs

Leveraged Long Energy ETFs

There are two ETFs that provide leveraged exposure to the energy sector, as listed below.  These products can be appropriate as trading or investment vehicles, although investors should recognize that they can also get a 2X leveraged effect by buying a regular 1X energy ETF on 50% margin in one’s brokerage account

Short Energy ETFs

There are three short energy ETFs but only the ProShares UltraShort Oil & Gas (DUG) has sufficient assets under management for consideration in our view.  Investors should remember to compare the costs of these vehicles with what it would cost to simply go short the ETFs in one’s brokerage firm account.

Global Energy

iShares S&P Global Energy Sector Index Fund (IXC) (issuer web site link ) – This fund, launched in November 2001, has $1.4 billion in assets under management.  The expense fee is 0.48%.  The fund tracks the S&P Global Energy Sector Index, which is a market-cap weighted index that holds 88 globally-listed stocks.  The top holdings are Exxon Mobil (14.20%), Chevron (6.80%), BP (5.38%), Total (4.96%), and Royal Dutch Shell (4.40%).  The country breakdown is heavily weighted to North America and Europe, which together account for 88% of the index.  Outside the North America and Europe, the only holdings are China (3.13%), Brazil (2.52%), Australia (2.39%), and Japan (1.15%).

WisdomTree International Energy Sector Fund (DKA) (issuer web site link ) – This fund, launched in October 2006, has $53 million in assets under management.  The fund has an expense fee of 0.58%.  There are two twists on this fund (1) the component weighting is based on the relative size of a company’s dividend payments, and (2) the fund holds virtually no U.S. energy companies, meaning that it can act as a good complement for investors who might already hold U.S.-listed energy stocks or ETFs and are looking for a non-U.S. energy ETF.  The fund is heavily weighted towards Europe with a 71% weight, although it provides exposure to other countries including Australia (17.27%), Hong Kong (6.48%), Japan (4.44%), and Singapore (0.66%).  The dividend weighting means that this fund can be attractive to investors who are seeking to maximize their dividends from the non-U.S. energy sector.  The fund has a dividend yield of 4.05%.  Top holdings include Total (7.46%), Shell-B (6.82%), Shell-A (6.80%), CNOOC (6.35%), and ENI (6.35%).

There are two other ETFs in the global energy group, but the assets under management are too low and we will not discuss these funds in detail.

Figure 7:  Global vs Domestic Energy ETFs – SPDR iShares S&P Global Energy Sector Index Fund (IXC) versus Energy Select Sector SPDR Fund (XLE) (live chart link )

Investment conclusions – Our Best in Class choice in the global energy ETF group is the iShares S&P Global Energy Sector Index Fund (IXC), which is by far the largest ETF in the group with $1.4 billion in assets.  We like the global exposure that this fund provides, although it is highly concentrated on North America and Europe.  The fund’s fee of 0.48% is very reasonable for a global fund.

As more of a specialty fund, we want to give the WisdomTree International Energy Sector Fund (DKA) a special mention as a fund that may be attractive to investors who are specifically looking for non-U.S. energy exposure and are looking to maximize dividends.  However, the size of the fund at just over $50 million is relatively low and that raises questions about the long-term viability of the fund if assets do not continue to grow.

The question arises whether it is better for a U.S. investor to invest in a global energy ETF or a U.S.-listed energy ETF.  We believe in the general principle of gaining exposure to globally-listed stocks wherever possible since most U.S. investors are substantially underweighted when it comes to global equities.  The energy business is a global industry and there are particularly good opportunities in overseas markets, highlighting to us the benefits of being in a globally-listed energy ETF versus a domestic ETF.  ETFs are a particular good vehicle for obtaining exposure to global stocks since all the custody and currency issues are taken care of automatically.  The only caveat is that an investor needs to recognize that there is some currency exposure in ETFs that hold globally-listed stocks since globally-listed stock prices need to be converted back into the ETF’s U.S. dollar-based index.  Figure 7 shows how the global IXC and domestic XLE have gone back and forth as the performance leaders, with neither fund consistently beating the other.

Canadian Energy

Guggenheim Canadian Energy Income ETF (ENY) (issuer web site link ) – This fund, launched in July 2007, has  $100 million in assets under management.  The fund has an expense fee of 0.65%.  The fund is based on the Sustainable Canadian Energy Income Index, which uses a fundamental selection methodology to choose a combination of Canadian royalty trusts and Canadian oil sands companies.  This fund may be appropriate for investors who are looking for dividend yields and exposure to Canadian oil sands.

Emerging Market Energy

We like the idea of investing in energy companies based in emerging countries since energy demand is growing much more quickly in emerging countries than in developed countries.  However, there are only two ETFs in this area and neither has enough assets under management to garner a recommendation.

U.S. Natural Gas

First Trust ISE-Revere Natural Gas Index Fund (FCG) (issuer web site link ) – This fund, launched in May 2007, has $403 million in assets under management.  The expense fee is 0.60%.  This is the only ETF that focuses on companies that produce natural gas, as opposed to ETF funds such as the United States Natural Gas Fund (UNG) that track natural gas prices by buying natural gas futures contracts.  As we discuss in our report on Natural Gas ETFs. the United States Natural Gas Fund (UNG) has a big problem with underperforming spot natural gas prices when the natural gas futures curve is upward sloping (contango).  Many investors have been unhappy with trying to invest in natural gas prices via UNG.  First Trust ISE-Revere Natural Gas ETF (FCG) provides an alternative to investing directly in natural gas by instead gaining exposure to the natural gas market via buying an ETF that holds the stocks of companies that extract and sell natural gas.  These companies can benefit from the expansion of the natural gas industry for electricity generation and for heating/cooking even if natural gas prices are not moving higher.  Figure 8 illustrates that FCG has far outperformed both spot natural gas prices and particularly UNG.  FCG is based on the ISE-Revere Natural Gas Index, which is an equal-weighted index that selects top-ranked U.S.-listed companies that derive a substantial portion of their revenues from the exploration and production of natural gas.

Figure 8:  First Trust ISE-Revere Natural Gas Index Fund (FCG) versus United States Natural Gas ETF (UNG) and Spot Natural Gas Prices (live chart link )

U.S. Coal

Coal has attracted negative attention recently due to mine disasters and the need to reduce pollution and greenhouse gas emissions.  Nevertheless, the fact remains that nearly 50% of U.S. electricity is generated with coal, meaning coal is not going away any time soon.  Van Eck with its Market Vectors Coal ETF (KOL) has the only real choice in the sector.  There is the PowerShares Global Coal Portfolio (PKOL) (issuer web site link ) that launched in September 2008 but that fund has not been able to gain any traction compared to KOL and has only $30 million in assets.  This leaves KOL as our Best in Class choice in the coal sector.

Market Vectors Coal ETF (KOL) (issuer web site link ) – This fund, launched in January 2008, has $600 million in assets under management.  The fund has an expense fee of 0.59%.  The fund is based on the Stowe Coal Index, which is a modified market-cap weighted index of globally-listed coal companies.  The largest holdings are Consol Energy (8.45%), Joy Global (8.45%), China Shenhua Energy (8.00%), Bucyrus International (7.88%), and Peabody Energy (7.69%).

From the Barchart.com ETF Research Team

Last Updated:  2/1/2011