The world was shocked when the Brazilian energy corporation Petrobras (NYSE: PBR) announced in 2007 the discovery of a massive oil deposit. Buried deep under the Atlantic Ocean, the Tupi oilfield, due east of Rio de Janeiro, was said to contain 5 to 8 billion barrels of oil.

Quite suddenly, this semi-nationalized Brazilian oil company became one of the hottest energy stocks in the world. Petrobras' shares tripled in value from the summer of 2007 to the summer of 2008, pushing its stock market value north of $200 billion.

But this story doesn't have a happy ending. Getting to all that oil proved costly, and it's taking a lot longer to generate production than had been hoped. A once-hot energy stock has since cooled off.

The rise and fall of Petrobras illustrates why many investors who want exposure to the energy-exploration industry are sidestepping direct purchases of individual stocks and buying exchange-traded funds (ETFs) instead. These funds take a broader approach, owning a group of companies that will benefit from the sustained growth in the oil and gas industry.

In fact, some ETFs directly focus on energy prices, bypassing the companies involved in energy extraction, refining and marketing.

Let's take a closer look...

The blue chip producers
The Energy Select Sector SPDR (NYSE: XLE) is a favorite choice for many. This fund charges a measly 0.18% annual expense fee and lets you own a little piece of the industry's best companies. Here's a look at the top five holdings.



The third-largest holding in this ETF, Schlumberger (NYSE: SLB), isn't even an energy producer. The company provides a wide range of services to the top energy producers and tends to benefit when energy prices are firm and energy drilling activity is robust. This fund also owns many of the U.S. firms that are focused on the natural gas opportunities buried in our country's various shale regions.

Other ETFs that focus on energy producers include:

  • First Trust AlphaDEX Fund (NYSE: FXN)
  • iShares Dow Jones U.S. Energy Sector Index Fund (NYSE: IYE)
  • SPDR S&P Oil and Gas Exploration & Production ETF (NYSE: XOP)

The commodity ETFs
As the Petrobras example shows, exploring for oil doesn't always reap sudden profits. It's a cost-intensive business, and profit growth can be elusive while companies ramp up their capital spending. That's why some investors prefer to own ETFs that more squarely focus upon the prices of oil and natural gas. As an example, we saw natural gas prices rise more than 50% since the spring of 2012, but companies that produce natural gas didn't see their share prices rise nearly as quickly.

A quick peek at the U.S. Natural Gas ETF (NYSE: UNG) shows how investors directly profited from spiking natural gas prices.

[See also: How Natural Gas Will Change the U.S. Economy -- and Make a Fortune for Investors]

Just like this fund, there is a corresponding ETF that focuses on crude oil. The U.S. Oil ETF (NYSE: USO) tracks the price movement of crude oil; it delivered robust gains when oil prices shot up in early 2008. Of course, the converse is also true. A sharp pullback in energy prices won't impact the companies' stock prices nearly as much as these commodity-focused ETFs.

Why would a typical investor make such a seemingly bold bet on energy prices? Many people use ETFs like these as a simple hedge to protect other investments in their portfolio. For example, an investor that has a large stake in an airline carrier like Delta Airlines (NYSE: DAL) or Southwest Air (NYSE: LUV) would suffer deep losses if crude oil prices surged and airlines became unprofitable. They'd at least gain some benefit by buying these ETFs, which would rise in price if crude oil prices rallied.

Getting Some Leverage ETF investors are also moving more aggressively into "2X" or "3X" funds. These funds move at twice or three times the rate of the underlying commodity price. For example, the ProShares Ultra Dow Jones Crude Oil ETF (NYSE: UCO) is a "2X" fund, which means it will rise 20% if crude oil prices rise 10%.

Investors also can position themselves against rising energy prices by buying "inverse" funds, which move in the opposite direction of the underlying commodity price. For example, the PowerShares DB Crude Oil Short ETB (NYSE: SZO) moves in the opposite direction of crude oil prices, while the ProShares UltraShort Dow Jones-UBS Crude Oil ETF (NYSE: SCO) will move in the opposite direction of crude oil prices -- at twice the speed.

[See also: Why Natural Gas Could Be 50% Higher in the Next few Years]

Lastly, ETFs that focus on companies operating our nation's energy pipelines have become popular. Many of the companies in this industry are structured as Master Limited Partnerships (MLPs), which means they don't have to pay income taxes at the corporate level. They are known for impressive dividend yields. A popular ETF in this segment is the JP Morgan Alerian MLP Index ETN (NYSE: AMJ), which currently offers a dividend yield in excess of 5%.

Action to Take --> For many investors, the era of stock-picking is coming to an end. Instead of identifying the best company in an industry, many investors now simply prefer to glean exposure to the best industries. In the energy sector, that's proven to be an especially popular strategy, as investors tire of trying to figure out whether ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX), Petrobras or some other firm will be next year's industry leader. Chances are, most of these firms will flourish in tandem, making the ETF path more savvy.

(Author's note: Two funds cited in this article are referred to as an "ETN" or exchange-traded note. They are fundamentally similar to ETFs, though they don't own company stock directly and instead own financial instruments, such as bonds issued by the fund's underwriter).

This article originally appeared on InvestingAnswers.com:
The Best Way To Invest In Energy Right Now

Related Articles
  1. Investing News

    Bank Stocks: Time to Buy or Avoid? (WFC, JPM, C)

    Bank stocks have been pounded. Is this the right time to buy or should they be avoided?
  2. Budgeting

    Blue Apron Review: Is It Worth It?

    Read about one of the top meal-kit delivery services in the United States, and learn more about what it offers and how much it costs.
  3. Stock Analysis

    Why the Bullish Are Turning Bearish

    Banks are reducing their targets for the S&P 500 for 2016. Here's why.
  4. Stock Analysis

    How to Find Quality Stocks Amid the Wreckage

    Finding companies with good earnings and hitting on all cylinders in this environment, although possible, is not easy.
  5. Chart Advisor

    How Are You Trading The Breakdown In Growth Stocks? (VOOG, IWF)

    Based on the charts of these two ETFs, bearish traders will start turning their attention to growth stocks.
  6. Mutual Funds & ETFs

    Pimco’s Top Funds for Retirement Income

    Once you're living off the money you've saved for retirement, is it invested in the right assets? Here are some from PIMCO that may be good options.
  7. Chart Advisor

    Watch This ETF For Signs Of A Reversal (BCX)

    Trying to determine if the commodity markets are ready for a bounce? Take a look at the analysis of this ETF to find out if now is the time to buy.
  8. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  9. Mutual Funds & ETFs

    ETFs Can Be Safe Investments, If Used Correctly

    Learn about how ETFs can be a safe investment option if you know which funds to choose, including the basics of both indexed and leveraged ETFs.
  10. Mutual Funds & ETFs

    The Top 5 Large Cap Core ETFs for 2016 (VUG, SPLV)

    Look out for these five ETFs in 2016, and learn why investors should closely watch how the Federal Reserve moves heading into the new year.
RELATED FAQS
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center