Energy has taken quite a pounding the last two weeks as evidence of decreased oil demand begins to appear over the industrialized world, and a slowdown in growth even in emerging economies becomes apparent. If you are still bullish on energy, however, there are several exchange-traded funds (ETF) that grant exposure to the group if you feel the long-term case for energy is still intact. This is a low cost and efficient way to play a rebound in the energy sector, while avoiding security specific risk.

An ETF is a financial instrument that represents a basket of securities that corresponds to an index. It is different from a mutual fund, since the ETF will change price during the day based on the minute-to-minute performance of the underlying index, while a mutual fund is priced once a day. ETFs also usually have lower expenses and fees than mutual funds. Investors had put $608 billion into various ETFs by the end of 2007. (For more on the difference between ETFs and mutual funds, check out Mutual Fund Or ETF: Which Is Right For You?)

There are hundreds of ETFs that have been created that track everything from stocks to bonds to commodities, both international and domestic. Here are four ETFs in the energy sector:

  • Energy Select Sector SPDR (AMEX:XLE)
    This ETF tracks the total return performance of the S&P Select Energy Index, and comprises energy companies in all underlying sectors. The Energy Select SPDR is market capitalization weighted and is therefore dominated by the major international oil companies with Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP) comprising approximately 36% of the index.

  • S&P Oil & Gas Exploration and Production SPDR (AMEX:XOP)
    This ETF tracks the total return of the S&P Oil & Gas Exploration & Production Select Industry index. Although this index also contains the major international oil companies, it is an equal weighted market capitalization index meaning that Exxon is weighted nearly the same as its much smaller competitors in the index.

  • SPDR S&P Oil & Gas Equipment & Services (AMEX:XES)
    This ETF tracks the total return performance of the S&P Oil & Gas Equipment & Services Select Industry index. This index is also an equal weighted market capitalization index, so Schlumberger (NYSE:SLB) and Halliburton (NYSE:HAL), the two largest capitalization names in the index, have the same weight as smaller members.

  • iShares Dow Jones US Oil & Gas Exploration Index (NYSE:IEO)
    This ETF tracks the Dow Jones U.S. Select Oil Exploration & Production index. This index is market capitalization weighted like the Energy Select Sector SPDR, but because it excludes the international oil majors from the index, the two largest members are Occidental Petroleum (NYSE:OXY) and Devon Energy (NYSE:DVN).

The damage to all four of these ETFs has been considerable since the peak in price in late June 2008. As of the close of trading on August 7, 2008, the declines range from 19-28%.

Energy ETF Price Movement in Mid-2008
- Closing Price
June 23, 2008

Closing Price
Aug. 7, 2008

Percent Change
XOP $71.38 $51.96 -27.2%
XES $51.70 $40.94 -20.8%
IEO $87.90 $63.43 -27.8%
XLE $89.14 $72.20 -19.0%

Bottom Line
There have been so many ETFs created over the last few years that some have very little trading volume and wide spreads, making them hard to trade in and out of. Fortunately, liquidity isn't a problem with the ETFs mentioned above. Another advantage of ETFs is that you avoid security specific risk. If you own a single security in the energy sector, and that company misses earnings or has a dry hole on a high profile well, the price may decline precipitously, leaving an investor with large losses. While this loss will impact the ETF also, the effect will be much smaller due to the broad based nature of the ETF.

If you are still a long-term bull on the energy sector, these and other ETFs are an excellent low cost and liquid way to play a bounce after the recent selloff.

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