Portfolio Manager Perspectives

Jeff Benjamin

Energy sector to stay white-hot?

Jan 21, 2011 @ 2:48 pm

By Jeff Benjamin

The trend is your friend in the energy sector, where the rising price of oil appears to be laying the foundation for a prolonged investment opportunity.

According to the latest research from Standard & Poor’s Financial Services LLC, oil prices are expected to climb steadily for at least the next two years.

Currently at more than $90 per barrel, the price of oil has bounced back more than 160% from the February 2009 low of $34.

That low point, however, represented a 77% decline from the July 2008 peak of $147 per barrel.

While the driving forces behind oil prices are never easy to analyze, the realities of supply and demand are known to be a core component.

“We think the trend will be higher oil prices because the expectations for real [gross domestic product growth] are becoming rosier, and that’s a big factor for oil prices,” said S&P equity analyst Stewart Glickman.

“When GDP is up, companies are spending more and consumers are spending more,” he said. “In a lot of ways, oil is like the lifeblood of the economy.”

Beyond supply and demand, past oil price fluctuations have been driven by such factors as market speculation, as well as a declining U.S. dollar, which tends to move in an inverse relationship to the price of oil.

The run-up in the price of oil helped the energy sector of the S&P 500 gain 18.9% in 2010, compared to 12.7% for the overall index.

The energy sector gained 19.8% in the final 13 weeks of 2010.

One way to tap into the oil rally is through some targeted exchange-traded funds that provide exposure to the sector’s integrated oil and gas subcategory.

The $8.6 billion Energy Select Sector SPDR Ticker:(XLE) is the largest ETF in the integrated category — made up of 39 stocks, half of which are in the integrated oil and gas space.

An integrated company, such as Exxon Mobil Corp. Ticker:(XOM), includes both upstream exploration and production, and downstream refining operations.

Of the six energy sector subcategories, the integrated category accounts for 55% of the energy sector.

Along with XLE, Mr. Glickman identified the Vanguard Energy ETF Ticker:(VDE), the iShares Dow Jones U.S. Energy Ticker:(IYE), and the iShares S&P Global Energy Ticker:(IXC).

“We think of those ETFs as a way to aggregate integrated energy stocks,” he said. “They provide easy, relatively liquid ways to gain exposure to the energy sector.”

Of the four examples, XLE offered by State Street Global Advisors, has the lowest expense ratio at 21 basis points, followed by VDE at 24 basis points.

Both IYE and IXC, from BlackRock Inc., charge 48 basis points.

And IXE offers the most exposure to international integrated energy companies.

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