Energy ETFs: An Overview
An energy exchange-traded fund (ETF) is one way for an investor to get exposure to a broad sector of the economy that deals in oil, natural gas, alternative energy products, or all three.
The choices include ETFs that track a broad sector index, domestic or international energy producers, energy equipment manufacturers, or sub-sectors like coal. The investor can even choose a point along the value chain to focus on.
Understanding Energy ETFs
The energy sector represents a significant part of the global economy and touches virtually every business. Nearly all investors with balanced portfolios already have some exposure to energy companies. Energy's heavy representation in the broad market averages like the S&P 500 is evidence of its importance.
- There are more than 60 ETFs offered in the U.S. that specialize in the energy sector.
- An energy ETF may reflect the industry broadly or focus on a specific segment such as oil or alternative energy.
- In general, energy stocks are more volatile than most, offering bigger ups and downs for their investors.
The largest energy ETF at this writing is the Energy Select Sector SPDR Fund (XLE), which has an estimated $8.3 billion in assets as of September 2020. This ETF seeks to mirror the Energy Select Sector Index, which itself reflects the energy companies represented in the S&P 500 Index.
Specialized Energy ETFs
The sector encompasses a highly complex and sophisticated network of companies that are involved in the production and distribution of the energy that is needed to power everyday life and routine business.
Supply and demand for global energy is an outsized factor in sector performance, but the demand is not static. Oil and gas producers typically outperform when oil and gas prices are high, and earn less when the value of the commodity declines.
On the other hand, when crude prices drop, oil refiners can benefit from the falling cost of feedstock to produce petroleum products like gasoline.
The sector also is unusually sensitive to politics, which often drives changes in oil prices.
Prominent Energy ETFs
There are more than 60 energy ETFs trading in the U.S., and each gives its investors exposure to a different corner of the sector. For example:
- The SPDR S&P Oil & Gas Exploration & Production ETF (XOP) is focused on companies engaged in upstream oil and gas exploration.
- The VanEck Vectors Coal ETF (KOL) is an entry to the coal industry.
- Investors who want access to the growing alternative energy market might consider the Guggenheim Solar ETF (TAN).
Reviewing the fact sheet and prospectus for an ETF is a prudent move for any investor, especially when considering volatile commodities like energy.
ETFs provide diversification, but there are risks to consider, as in any investment. Any specialized sector-based ETF like one that tracks energy stocks can add volatility to a portfolio.