Oil ETFs in 2017
Let’s be honest here, oil companies haven’t been the nicest to income investors over the past two years. The downturn in commodity prices has pushed many oil and gas companies deep into the doldrums. Some have even cut back their dividends. However, it could still be rewarding to have some exposure to the oil and gas sector, which is why we are now going to take a look at the top oil ETFs for 2017.
Exchange-traded funds (ETFs) are investment funds that trade on stock exchanges. ETFs can hold different types of assets, such as stocks, bonds, and commodities. Worldwide, there are more than 4,000 ETFs, and some of them provide exposure to the oil and gas sector.
Why Invest in Oil ETFs?
One of the reasons why investors may want to consider oil ETFs is the changing commodity price environment. Yes, oil prices have plunged dramatically since the summer of 2014. But, more recently, they have somewhat stabilized. And, with the Organization of Petroleum Exporting Countries (OPEC) setting a production ceiling, certain oil ETFs could start rewarding income investors.
Of course, individual companies in the oil and gas sector could still be risky. In fact, a few dozen companies have gone out of business during the commodity price downturn. That’s why it’s important to diversify. An ETF typically holds tens—and sometimes hundreds—of companies in its portfolio. Investing in oil ETFs allow investors to achieve diversification without having to worry about which stocks to buy and the transaction costs involved in buying individual stocks.
Are Oil ETFs Good Investments?
When it comes to finding the best oil ETFs, investors should take into account their investment goals and risk profile. This is because there are different types of oil ETFs.
For instance, United States Oil Fund LP (NYSEARCA:USO) is an ETF that tracks the future prices for West Texas Intermediate (WTI) crude. The price of WTI crude is often considered a benchmark in oil pricing. USO ETF is designed to track the daily price movements of WTI crude and invests primarily in crude oil futures contracts.
Because USO ETF offers exposure to the front month futures contracts, it can be a great choice for people who want to speculate on short-term price movements in WTI crude. But for income investors who are thinking long-term, this oil ETF may not be the best choice.
This is because, first, USO ETF does not pay a dividend. What’s more important, though, is how this fund operates. The ETF owns the front month futures contracts on WTI crude. If the near month futures contract is within two weeks of expiration, the fund rolls them into the next month’s futures contracts. And since longer dated futures contracts are generally priced higher than shorter ones, the fund could be selling contracts at a lower price than they purchase at. Therefore, crude oil ETFs like USO are not really suitable for long-term investors.
So, what are good oil ETFs for income investors?
Well, as is the case with any good dividend ETF, energy ETFs that are suitable for income investors consist of energy stocks that pay dividends. Yes, despite the downturn in commodity prices, there are still oil and gas companies with handsome dividend payments. And, since we are talking about ETFs, investors should also take into account a fund’s management expense ratio (MER).
Now, let’s take a look at the five best oil ETFs for income investors to consider in 2017. Investors wishing to learn more about ETFs should also check out best dividend stocks and best dividend ETFs for 2017.
List of Oil and Gas ETFs
| ETF Name | Ticker Symbol | Dividend Yield | MER |
| Vanguard Energy ETF | NYSEARCA:VDE | 2.45% | 0.1% |
| iShares U.S. Oil & Gas Exploration & Production ETF | NYSEARCA:IEO | 0.98% | 0.4% |
| SPDR S&P Oil & Gas Exploration & Production ETF | NYSEARCA:XOP | 0.82% | 0.4% |
| Alerian MLP ETF | NYSEARCA:AMLP | 9.82% | 0.9% |
| SPDR S&P Oil & Gas Equipment & Services ETF | NYSEARCA:XES | 0.84% | 0.4% |
Best Oil ETFs to Invest in
1. Vanguard Energy ETF
Vanguard Energy ETF (NYSEARCA:VDE) aims to track the performance of the MSCI U.S. IMI Energy 25/50 Index. The fund follows a passively managed, full-replication approach. It currently holds 130 stocks in its portfolio.
VDE ETF’s three largest sectors are “Integrated Oil & Gas” (38.70%), “Oil & Gas Exploration & Production” (27.50%), and “Oil & Gas Equipment & Services” (16.40%). Despite owning shares of a large number of companies, the fund may not be as diversified as it appears to be. This is because VDE ETF is heavily skewed toward mega-cap oil and gas companies. The fund’s three largest holdings—Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX), and Schlumberger Limited (NYSE:SLB)—make up 41.7% of its portfolio. (Source: “Vanguard Energy ETF,” The Vanguard Group Inc, last accessed April 3, 2017.)
Vanguard Energy ETF is currently yielding 2.45%, which is pretty decent, given that the average dividend yield of S&P 500 companies is at 1.94%. What makes this ETF really stand out is its low management fee. At just 0.10%, VDE ETF’s expense ratio is 93% lower than the average expense ratio of funds with similar holdings.
2. iShares U.S. Oil & Gas Exploration & Production ETF
iShares U.S. Oil & Gas Exploration & Production ETF (NYSEARCA:IEO) seeks to track the investment results of the Dow Jones U.S. Select Oil Exploration & Production Index. The fund gives investors exposure to American companies that are in engaged in the exploration, production, and distribution of oil and gas. It has an annual dividend yield of 0.98% and a management fee of 0.44%.
Since the Dow Jones U.S. Select Oil Exploration & Production Index is weighted by float-adjusted market capitalization, IEO ETF is skewed toward large-cap oil and gas companies rather than small-cap ones.
Right now, the fund owns shares of 54 oil and gas exploration and production companies. Its top five holdings are ConocoPhillips (NYSE:COP), EOG Resources Inc (NYSE:EOG), Phillips 66 (NYSE:PSX), Anadarko Petroleum Corporation (NYSE:APC), and Pioneer Natural Resources (NYSE:PXD). Together, these five companies accounted for more than 39% of the fund’s portfolio. (Source: “iShares U.S. Oil & Gas Exploration & Production ETF,” iShares, last accessed April 3, 2017.)
3. SPDR S&P Oil & Gas Exploration & Production ETF
SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP) tracks the investment results of the S&P Oil & Gas Exploration & Production Select Industry Index. The fund has an expense ratio of 0.35% and an annual dividend yield of 0.82%.
XOP ETF gives investors exposure to oil and gas exploration and production companies, just like IEO ETF from iShares. However, there is a big difference between the two funds’ approaches. While IEO ETF’s holdings are weighted by market cap, XOP ETF follows an equal weight index.
The fund currently owns shares of 63 companies. By following an equally weighted index, a mega-cap oil company and a small driller could have similar weights in XOP ETF’s holdings. For instance, the fund owns similar-sized stakes in mega-cap Exxon Mobil Corporation as it does in Laredo Petroleum Inc (NYSE:LPI), which is a much smaller company. (Source: “SPDR S&P Oil & Gas Exploration & Production ETF,” State Street Global Advisors, last accessed April 3, 2017.)
By having a larger exposure to smaller drillers, XOP ETF was able to generate impressive returns during production expansions. In the past 12 months, the fund returned 25.5%, making it one of the best-performing oil and gas ETFs during this period. But higher returns also come with higher risk. By having a sizable exposure to smaller companies, the ETF suffered sizable losses during the oil price downturn in the summer of 2014.
4. Alerian MLP ETF
Readers of this column would know that I’m a big fan of master limited partnerships (MLPs). These partnerships are in the business of managing the storage and transportation of oil. MLPs don’t need to worry too much about the price of oil because they are not drilling new wells. They are exempt from corporate taxes and are required to distribute almost all their cash to investors. That’s why some of them can offer much higher yields than regular stocks.
The good news is, other than oil company ETFs, there are also ETFs that focus exclusively on MLPs. Alerian MLP (NYSEARCA:AMLP) is an ETF that tracks the Alerian MLP Infrastructure Index. With total net assets of $10.8 billion, it is the largest ETF in its category. (Source: “Alerian MLP ETF,” ALPS Advisors Inc., last accessed April 3, 2017.)
The fund currently owns units of 26 MLPs and is market-cap-weighted. Therefore, its portfolio is skewed toward the biggest MLPs. Its top three holdings—Magallan Midstream Partners, L.P. (NYSE:MMP), Enterprise Products Partners L.P. (NYSE:EPD), and Energy Transfer Partners LP (NYSE:ETP)—make up more than 30% of its portfolio.
Alerian MLP ETF has an annual dividend yield of 9.82%, which is truly impressive in today’s market. Note that the fund is actually structured as a “C Corporation,” so it is subject to income taxes at the corporate level.
The fund has a management expense ratio of 0.85%.
5. SPDR S&P Oil & Gas Equipment & Services ETF
SPDR S&P Oil & Gas Equipment & Services ETF (NYSEARCA:XES) tracks the performance of the S&P Oil & Gas Equipment & Services Select Industry Index. The index represents the oil and gas equipment and services sub-industry portion of the S&P Total Market Index.
The fund currently owns shares in 37 companies. Since XES ETF is tracking an equal-weight index, it invests similar amounts in each of its holdings.
One thing to note about XES ETF is that it is not a pure play. Only 66.52% of the fund’s assets are invested in “Oil & Gas Equipment & Services.” The fund also has 33.45% of its assets invested in “Oil & Gas drilling.” (Source: “SPDR S&P Oil & Gas Equipment Services ETF,” State Street Global Advisors, last accessed April 3, 2017.)
XES ETF has an annual dividend yield of 0.84%. Its management expense ratio is at 0.35%, which is low compared to ETFs that focus on oil and gas equipment and services.