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Oil Price Slumps: What Lies Ahead for Energy ETFs?

The dual attack of a spike in COVID-19 cases worldwide and a rise in U.S. dollar has taken a toll on oil price lately. U.S. crude has dropped more than 7% and Brent has slumped more than 5% during the past six days, representing the longest losing streak since February 2020.

This is especially true, as the Delta variant of COVID-19 cases has been increasing rapidly, stoking concerns about waning demand for oil. The U.S. 7-day moving average of daily virus cases on Aug 19 surpassed 130,000 for the first time since February, according to data from the Centers for Disease Control and Prevention. Additionally, a slowdown in China — the second biggest oil consuming nation — is weighing on demand.

Meanwhile, strengthening of the U.S. dollar against major rivals has made oil expensive for foreign buyers, diminishing the appeal for the liquid commodity. The greenback is expected to rise further as the Fed signaled in its latest minutes from the July meeting that it would scale back stimulus measures.

ETF Impact

The slump in oil price led to rough trading in the energy sector, pushing ETFs down over the past week. In particular, Invesco S&P SmallCap Energy ETF PSCE has been the biggest loser, plunging 13.2%. Invesco DWA Energy Momentum ETF PXI, SPDR S&P Oil & Gas Exploration & Production ETF XOP and First Trust ISE-Revere Natural Gas Index Fund FCG shed more than 12% each. Below we profile these ETFs in detail:

PSCE

This fund provides exposure to the U.S. small-cap segment of the energy sector by tracking the S&P Small Cap 600 Capped Energy Index. It holds 33 stocks in its basket with AUM of $119.1 million. The fund trades in an average daily volume of 753,000 shares and charges 29 bps in fees per year (read: Small-Cap ETFs That More Than Doubled in a Year).

PXI

This fund tracks the Dorsey Wright Energy Technical Leaders Index, which is designed to identify companies that are showing relative strength (momentum). It charges 60 bps in annual fees and trades in a solid volume of 111,000 shares a day on average. The fund has 37 stocks in its basket with AUM of $106.8 million.

XOP

This fund provides exposure to 54 oil and gas exploration and production companies by tracking the S&P Oil & Gas Exploration & Production Select Industry Index. It has accumulated $3.3 billion in its base and trades in an average daily volume of 7.3 million shares. The ETF charges 35 bps in fees per year (read: Buy These 7 Amazing ETFs Trading at Low P/E Ratios).

FCG

This fund offers exposure to U.S. stocks that derive a substantial portion of their revenues from the exploration and production of natural gas. It follows the ISE-REVERE Natural Gas Index and holds 38 stocks in its basket. The fund has amassed $221.3 million in its asset base while charging 60 bps in annual fees. Volume is good with 1.4 million shares exchanged per day on average.

What Lies Ahead?

Despite the slump, the energy sector is still outperforming the broad market. Notably, the S&P 500 Energy Index is up nearly 20% year to date compared to gains of 17.3% for the S&P 500. The outlook for the energy sector looks uncertain at present given waning demand and rising supply.

The increasing COVID-19 cases have caused people to halt their travel plans thereby hurting the demand for oil. The International Energy Agency recently cut its 2021 global oil demand growth forecast by 100,000 barrels a day. On the other hand, U.S. shale oil output is expected to rise to 8.1 million barrels per day in September, the highest since April 2020, according to the latest Energy Information Administration (EIA) monthly report.

Additionally, the Organization of the Petroleum Exporting Countries (OPEC) and its allies agreed to phase out 5.8 million barrels per day of oil production cuts by September 2022 at their latest meeting. The cartel will increase monthly crude oil production by 400,000 barrels per day starting August. Accelerating transition toward cleaner alternatives is also a major headwind for the sector.

However, global oil demand is set to return to pre-pandemic levels by the end of 2022 despite the renewed COVID-19 outbreak and low vaccination levels in developing countries, per the International Energy Agency (read: Will 2021 be the Best Year for Energy ETFs in Three Decades?).

The above-mentioned funds also have a Zacks ETF Rank #2 (Buy) or 3 (Hold), suggesting room for upside.

Given the solid long-term outlook but somewhat bearish near-term sentiments, investors may want to consider staying on the sidelines for the time being. Nevertheless, risk-tolerant, long-term investors may want to consider this recent slump as a buying opportunity, should they have the patience for extreme volatility.


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SPDR S&P Oil & Gas Exploration & Production ETF (XOP): ETF Research Reports
 
First Trust Natural Gas ETF (FCG): ETF Research Reports
 
Invesco S&P SmallCap Energy ETF (PSCE): ETF Research Reports
 
Invesco DWA Energy Momentum ETF (PXI): ETF Research Reports
 
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