Two ETFs for Energy Exposure

09/25/2013 9:00 am EST


Stephen Leeb

Founder and Research Chairman, Leeb Group

The energy patch has been a good one to be in recently. Not only have nearly 60% of energy companies in the S&P 500 beat earnings expectations for the second quarter, but US production has gone through the roof, reports Stephen Leeb, editor of Cash Cow.

The bellwether S&P Energy Select Sector (XLE), has done very well so far this year, keeping pace with the overall market's push upwards; XLE remains a buy.

Roughly half of its $8 billion in assets are allocated to integrated oil and gas firms, and a further 21% to exploration and production companies.

Equipment and services providers make up 16%, and refiners a further 8% . This is the one fund to own for exposure to the whole energy sector in a single, liquid, inexpensive ETF.

However, the highest leverage in the sector does not come in the integrated oil companies, but rather in the oil-service firms.

These are the companies that provide the equipment, transportation, materials, technology, and tools necessary for energy companies to do what is an increasingly difficult, complex job. If you're bullish on energy prices and energy production, this sub-sector is where you want to be.

The best ETF for oil-services stocks is Market Vectors Oil Services ETF (OIH). With $1.61 billion in assets and over four million shares traded per day, it is liquid and large.

The portfolio is concentrated, holding the 25 largest oil-service firms in the world by market capitalization. Indeed, the top five positions account for 44% of assets, led by a 20% position in oilfield giant Schlumberger (SLB).

XLE contains some of these same firms; overlap between the two ETFs is roughly one-sixth, so investors in XLE are certainly participating in the oil-service area.

However, while XLE is ahead of OIH for one-year performance at the moment, the two are tied for two-year returns, and OIH is solidly ahead over a five-year horizon.

The increasing cost and complexity of producing oil today, including ultra-deepwater and hydraulic fracturing operations, means a tailwind for OIH's portfolio companies for the next several years.

What to do now: Keep XLE as a stalwart, one-size-fits-all energy sector play. Buy OIH for a leveraged play on the most dynamic aspect of the energy patch.

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