2015 Outlook For Oil and Gas ETFs

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January 13, 2015 5:05pm NYSE:IEO NYSE:PXE

market outlookCrude Oil :  Currently, oil is deeply entrenched into bearish territory and has fallen below the $50-a-barrel level following OPEC’s decision to hold production unchanged, the effects of booming shale supplies in North America and a stagnant European economy.


Moreover, a stronger dollar has made the greenback-priced commodity more expensive for investors holding foreign currency. The cut in global crude demand growth by major energy consultative bodies has put the final nail in the coffin.

While the OPEC international oil cartel cut its 2015 forecasted consumption by 280,000 barrels per day from its previous expectation, the U.S. Energy Information Administration (EIA) trimmed its demand outlook for next year by 240,000 barrels per day. Paris-based International Energy Agency (IEA) reduced its 2015 global oil demand growth forecast by 230,000 barrels per day – all pointing toward a slowdown in world consumption.

Still in stormy waters, crude remains beaten down and is headed for the biggest yearly fall since 2008. WTI has more than halved in value since June on oversupply fears in the face of weak demand, reaching a five-and-a-half-year low of $46.83 earlier this month.

With crude inventories brimming, the commodity is very well stocked. On top of that, OPEC members (like Saudi Arabia) have made it clear time and again that they are more intent on preserving market share rather than attempting to arrest the price decline through production cuts. Therefore, the commodity is likely to continue its downward journey in 2015.

In the medium-to-long term, while global oil demand is expected to get a boost from sustained strength in China – which continue to expand at a healthy rate despite some moderation – this will be more than offset by sluggish growth prospects exhibited by Japan and the Western economies.

In our view, crude prices in the next few months are likely to exhibit a sideways-to-bearish trend, mostly trading in the $55-$65 per barrel range. As North American supply remains strong and demand looks underwhelming, we are likely to experience a pressure in the price of a barrel of oil. (Read: Any Hope for Gold and Oil ETF Rebound in 2015?)

Natural Gas:  Over the last few years, a quiet revolution has been reshaping the energy business in the U.S. The success of ‘shale gas’ – natural gas trapped within dense sedimentary rock formations or shale formations – has transformed domestic energy supply, with a potentially inexpensive and abundant new source of fuel for the world’s largest energy consumer.

With the advent of hydraulic fracturing (or “fracking”) – a method used to extract natural gas by blasting underground rock formations with a mixture of water, sand and chemicals – shale gas production is now booming in the U.S. Coupled with sophisticated horizontal drilling equipment that can drill and extract gas from shale formations, the new technology is being hailed as a breakthrough in U.S. energy supplies, playing a key role in boosting domestic natural gas reserves. As a result, once faced with a looming deficit, natural gas is now available in abundance.

While December becomes the twelfth consecutive record-breaking month of 2014 in terms of natural gas output, the commodity’s demand has failed to keep pace with this rapid supply surge. Industrial requirement has been lackluster over the past two years with demand rising by a meager 0.5 billion cubic feet per day in both 2012 and 2013.

To make matters worse, mild weather across most of the country through the first months of winter has curbed natural gas demand for heating. As a result, prices continue to suffer.

From a peak of about $13.50 per million British thermal units (MMBtu) in 2008 to below $3 now – sinking in between to a 10-year low of under $2 in 2012 – the plummeting value of natural gas represents a decline of around 80% over seven years. In the absence of major production cuts, we do not expect much upside in gas prices in the near term.

With recent natural gas stock withdrawals continuing to underperform the historical norms on the back of strength in production and moderate temperatures, the commodity’s near-to-medium term fundamentals remain rather lukewarm.

PLAYING THE SECTOR THROUGH ETFs

Considering the turbulent market dynamics of the energy industry, the safer way to play the volatile yet rewarding sector is through ETFs. In particular, we would advocate tapping the energy scene by targeting the exploration and production (E&P) group.

This sub-sector serves as a pretty good proxy for oil/gas price fluctuations and can act as an excellent investment medium for those who wish to take a long-term exposure within the energy sector. While all oil/gas-related stocks stand to move with fluctuating commodity prices, companies in the E&P sector tend to be the most important, as their product’s values are directly dependent on oil/gas prices.

SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP):

Launched in June 19, 2006, XOP is an ETF that seeks investment results corresponding to the S&P Oil & Gas Exploration & Production Select Industry Index. This is an equal-weighted fund consisting of 81 stocks of companies that finds and produces oil and gas, with the top holdings being Matador Resources Co. (MTDR), Synergy Resources Corp. (SYRG) and Penn Virginia Corp. (PVA). The fund’s expense ratio is 0.35% and pays out a dividend yield of 1.49%. XOP has about $1,017.2 million in assets under management as of Jan 9, 2015.

iShares Dow Jones US Oil & Gas Exploration & Production ETF (NYSEARCA:IEO):

This fund began in May 1, 2006 and is based on a free-float adjusted market capitalization-weighted index of 78 stocks focused on exploration and production. The top three holdings are ConocoPhillips (COP), EOG Resources Inc. (EOG) and Anadarko Petroleum Corp. (APC). It charges 0.43% in expense ratio, while the yield is 1.36% as of now. IEO has managed to attract $430.7 million in assets under management till Jan 9, 2015.

PowerShares Dynamic Energy Exploration and Production (NYSEARCA:PXE):

PXE, launched in October 26, 2005, follows the Energy Exploration & Production Intellidex Index. Comprising of stocks of energy exploration and production companies, PXE is made up of 30 securities. Top holdings include Occidental Petroleum Corp. (OXY), Marathon Petroleum Corp. (MPC) and Devon Energy Corp. (DVN). The fund’s expense ratio is 0.64% and the dividend yield is 2.13%, while it has got $110.8 million in assets under management as of Jan 9, 2015.

This article is brought to you courtesy of Zacks.


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