ETFs to play US oil boom

Jan 28th, 2013 | By | Category: Equities

Topping the list of the big oil and gas stories in 2012 was the dramatic surge is US oil production. In 2013, the US will remain the largest source of new oil growth worldwide aided by the shale boom, but surpassing Saudi Arabia as the globe’s top oil producer by 2020 will be a challenge, according to Ernst & Young’s latest quarterly Oil & Gas outlook.

ETFs to play US oil boom

Some market observers predict the US could become the world’s largest oil producer, upstaging Saudi Arabia, by 2020.

The big turnaround of US oil production brought by new light tight oil developments was fully recognised in 2012, putting to rest the long-held notion that US domestic oil production was in terminal decline.

The rise in US domestic oil output and the expectation that oil development will continue to grow amid high oil prices prompted some market observers to predict the US could become the world’s largest oil producer, upstaging Saudi Arabia, by 2020.

But while US oil output growth is expected to continue to be strong, it’s going to be hard to rival Saudi Arabia. US oil production comes at an extremely high cost. Some anticipated increases in domestic oil production may not materialise if crude prices decline below $80 a barrel.


Energy S&P US Select Sector Source ETF (XLES)

– Tracks the S&P 500 Select Sector Capped 20%
Energy Index, providing exposure to S&P 500 oil
& gas companies

– Index constituents include oil explorers and
producers, oil equipment & services companies,
drilling specialists, and refiners

– Major constituents include Exxon Mobil, Chevron,
Schlumberger, ConocoPhilips and Occidental

– Collateralised swap-based replication, with
full transparency to index constituents and
underlying collateral basket

– UCITS III compliant, London listed, UK Reporting
Status, eligible for ISAs and SIPPs, fee of 0.30% pa,
passported for distribution across much of Europe

In 2013, the global oil supply-demand balance is expected to remain uneasy amid geopolitical tensions and economic uncertainty. Oil markets could face an ugly Arab winter given the unstable political environments in Syria, Egypt and Libya. Meanwhile, Iraqi production continues to grow, currently topping 3 million barrels of oil a day, taking the No. 2 spot among OPEC producers from Iran. The Iraqi increases put significant pressure on OPEC members to cut back their production in order to make room for Iraq’s new output.

The long overdue, super-giant Kashagan project offshore Kazakhstan is expected to start production by mid-year and contribute to the rising global oil supplies from non-OPEC sources. In the US, despite a substantial build-out of the oil transportation infrastructure this year, bottlenecks in the Midwest are expected to continue the pressure on US and Canadian oil prices.

Downstream, profit margins for the US refining business were up across the board in 2012, with Midwest refineries having another stellar year thanks to access to cheaper WTI and Canadian crudes. While expected to diminish somewhat, the structural imbalances in the US Mid-continent are expected to continue this year, prolonging the advantage of regional refiners that have access to cheaper oil supplies.

Globally, refiners had a good year in 2012, but their performance was nowhere near the profitability seen in the US. Going forward, the consensus view is that the economics for refiners outside the US will remain challenging as more refining capacity comes online and plants continue to process relatively more expensive crudes.

Last year was not a bad year for oilfield services companies as rig counts held up and global upstream spending cautiously increased. The US rig count was slightly off as gas-directed drilling slowed and was not fully offset by new oil- and liquids-directed drilling. Oilfield service cost pressures slowed somewhat due to efficiency gains, while labour pressures rose. Offshore, there still are a large number of new-builds coming into the market that are expected to keep a lid on day rates, utilisation and profit margins.

Investors looking to play the US oil boom – or indeed the oil market in general – have a range of options to consider owing to the vast number of exchange-traded products (ETPs) on offer. There are products offering exposure to the oil price (via futures); to petroleum products (via futures); to oil producers; to oil equipment and services companies; and to the energy sector as a whole. Many of these products also exist in leveraged and inverse/short format.

While the depth of products has added a degree of complexity to the investment decision-making process, it has also created tremendous opportunities that were once only available to institutional investors. For example, investors can now trade crack spreads by going long crude products and short products linked to ‘cracked’ derivative petroleum products (and vice versa); they can capitalise on perceived relative value differences between crude oil and producers; or simply gain exposure to targeted segments of the energy sector that they believe to be over- or undervalued.

The entire list of ETFs covering this sector is too long to list. Following, therefore, are few products aimed at UK and European investors that catch the eye. Each of the products featured has a US bias enabling investors to access the US oil boom.

Lyxor ETF S&P 500 Capped Energy Sector (NRGU)
Tracks the S&P 500 Select Sector Capped 20% Energy Index. Constituents are energy companies from within the S&P 500 index weighted by float-adjusted market capitalisation and capped at 20%. The excess weight is distributed amongst all the other uncapped stocks of the given sector index. (Also see featured product).

iShares S&P Commodity Producers Oil and Gas (SPOG)
Tracks the performance of the S&P Commodity Producers Oil & Gas Exploration & Production Index. This index offers exposure to the largest publicly-traded companies involved in the exploration and production of oil and gas from around the world. US firms dominate with a combined weight of approximately 54%.

db WTI Crude Oil Booster ETC (XCT9)
Source Crude Oil Enhanced T-ETC (SEWTI)
The above ETCs offer optimised exposure to WTI oil via indices which adhere to dynamic rolling rules designed to mitigate the potential effects of contango and thereby improve the ability to track spot price performance (contango is when prices for longer-term futures contracts exceed prices for shorter-term contracts and spot prices, thus creating a negative yield, or drag, when contracts are rolled). Conventional commodity indices, which take exposure via near-term futures contracts, can significantly lag spot prices in times of contango. The underlying indices to these products aim to minimise this lag essentially by switching into longer-term futures contracts where the effect of contango is typically less pronounced.

ETFS Daily Leveraged WTI Crude Oil (LOIL)
Provides 2x (200%) exposure to the DJ-UBS WTI Crude Oil Sub-Index.

ETFS Daily Short WTI Crude Oil (SOIL)
Provides inverse (-100%) exposure to the DJ-UBS WTI Crude Oil Sub-Index.

Boost WTI Oil 3x Leverage Daily ETP (3OIL)
Provides 3x long exposure to the Nasdaq Commodity Crude Oil Index.

Boost WTI Oil 3x Short Daily ETP (3OIS)
Provides 3x inverse exposure to the Nasdaq Commodity Crude Oil Index.

While the following ETFs are all listed on US exchanges (and thus non-US investors may incur adverse tax treatment) they are worthy of mention due to their niche exposure offerings.

Energy Producers
iShares Dow Jones US Oil & Gas Exploration & Production Index ETF (IEO)
SPDR S&P Oil & Gas Exploration & Production ETF (XOP)

Oil field services and equipment
SPDR S&P Oil & Gas Equipment & Services ETF (XES)
iShares Dow Jones US Oil Equipment & Services Index ETF (IEZ)
PowerShares Dynamic Oil & Gas Services Portfolio ETF (PXJ)

Small cap
IQ Global Oil Small Cap ETF (IOIL)

Unconventional energy
Sustainable North American Oil Sands ETF (SNDS)
Market Vectors Unconventional Oil & Gas ETF (FRAK)

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