Shale Recovery Doesn't Guarantee Upside For E&P ETFs

The energy sector was one of the best-performing groups in the S&P 500 last year, but that trend has reversed this year with energy noticeably lagging as the broader U.S. equity market continues flirting with new highs.

The Energy Select Sector SPDR ETF XLE, the largest energy sector exchange traded fund, is lower by 4.2 percent year-to-date and things have been even tougher for more volatile exploration and production ETFs. For example, the SPDR S&P Exploration and Production ETF XOP is sporting a year-to-date loss that's nearly twice as bad as XLE's.

As an exploration and production ETF, XOP is often more levered to fluctuations in oil prices than a more diversified fund like XLE. That strategy has its risks and rewards, but in what could be a good sign for XOP, U.S. shale drillers appear comfortable betting that higher prices are on the way. The other side of that equation is if U.S. shale drillers producers boost output, that could serve as a de facto lid on oil prices.

That situation could be exacerbated if some members of the Organization of Petroleum Exporting Countries don't abide by the cartel's production cuts, which were announced in the fourth quarter.

“OPEC's November announcement that its members would cut production by about 1.2 million barrels per day (mmbbl/d) and the commitment of non-members to curtail production by roughly 600,000bbl/d have helped support oil prices in a $50-55 range,” said Fitch Ratings in a recent note. “OPEC compliance has reportedly been strong, but it remains to be seen whether it will be enough to meaningfully reduce abnormally high inventories. The exclusion of Libya and Nigeria and a poor record of adherence by some members makes us skeptical that the arrangement will be sustainable in the longer term.”

Higher interest rates can benefit cyclical sectors and energy, the seventh-largest sector weight in the S&P 500, is a cyclical group. XOP is an equal-weight ETF so none of its 63 holdings dominate the lineup, in turn reducing single stock risk. Still, the weighted average market value of $23.4 billion for XOP's holdings is smaller compared to a traditional energy ETF like XLE.

“Our 2017 base case Brent price assumption has been raised to $52.50/bbl from $45/bbl and we continue to assume prices of $55/bbl in 2018, $60/bbl in 2019 and $65/bbl in the long term,” said Fitch. “Our 2017 WTI price assumption was raised to $50/bbl from $45/bbl and our assumed 2018, 2019, and long-term prices were all adjusted lower by $2.50/bbl to reflect the re-established Brent-WTI spread. The base case does not factor in the effects of a potential US border adjustment tax.”

Investors have pulled $267 million from XOP this year.

Posted In: Long IdeasNewsSector ETFsCommoditiesMarketsTrading IdeasETFsOiloil drillersOil ShaleOPEC
Benzinga simplifies the market for smarter investing

Trade confidently with insights and alerts from analyst ratings, free reports and breaking news that affects the stocks you care about.

Join Now: Free!

Loading...