Energy stocks faced immense volatility in 2020 as demand plummeted initially and then rose slightly in the aftermath of the initial shutdowns from the pandemic.
Stocks of oil and gas companies collapsed in March, but many rebounded as some employees returned to work and businesses in many states reopened with reduced capacity.
Oil prices have also made a comeback since the spring, propping up stock prices of energy companies. They still remain 25% lower year to date as demand remains low. The oil ministers of OPEC+ — a 23-member group — met on Dec. 3 and said there will be an addition of 500,000 barrels a day of production starting in January. The ministers agreed to lower production cuts to oil supply in 2021.
Energy companies that staved off bankruptcies are surviving by slashing costs, mainly by lowering their capital expenditures and laying off employees. Chevron Corp. (ticker: CVX) said in December it would lower its capital spending by 26% in 2021 and previously announced plans to eliminate about 6,000 jobs globally. Its competitor, Exxon Mobil Corp. ( XOM), also said it would lay off 15% of employees worldwide and lower spending of capital expenditures of $5 billion to $10 billion each year through 2025.
One way for investors to invest is through exchange-traded funds that only hold energy infrastructure stocks since the sector will rebound in 2021, says Rob Thummel, senior portfolio manager at Tortoise Capital Advisors. Most of the stocks in the energy infrastructure sector fell by a much larger percentage than the respective decline in company cash flows.
“These companies trade at discounts to historical valuation metrics and offer investors high dividend yields,” he says. “Energy companies retooled their business models to attract investors and are prioritizing free cash flow generation over growth.”
Here are four energy ETFs that investors can add to a portfolio:
— Vanguard Energy ETF (VDE)
— Energy Select Sector SPDR Fund (XLE)
— Invesco Solar ETF (TAN)
— iShares Global Clean Energy ETF (ICLN)
Vanguard Energy ETF (VDE)
The Vanguard Energy ETF includes large, midsize and small U.S. companies and currently owns 115 stocks — with Exxon Mobil, Chevron and ConocoPhillips ( COP) as the top three holdings as of Oct. 31. VDE has a low expense ratio of 0.1%.
Investors often choose funds since they can offer broad exposure to a sector without “going all in on any one name,” says Mike Loewengart, managing director of investment strategy at E-Trade Financial, an Arlington, Virginia-based brokerage company. “As the energy sector can be characterized by volatility, investors look to ETFs to help smooth out the inevitable bumps in the road, and VDE is an example.”
As the demand for oil slowly increases, prices for crude oil have also been rising.
“Ultimately, it could result in the energy sector outperforming,” he says. “It’s largely thought that the price of oil and energy stock performance work in lockstep. While it sounds simple, the price of oil can swing dramatically, evidenced by the onslaught of COVID-19, so investors need to proceed with caution.”
Despite the sector’s strong rally in recent weeks, energy stocks remain deep into negative territory year to date and lag all other sectors. The energy sector is only 2% of the S&P 500 now compared with 16.2% of the index in June 2008.
The future output decisions from OPEC means that the sector could “face downward pressure, especially if the group does not reach consensus on maintaining current levels of production,” Loewengart says.
“Keep in mind that while supply and demand do play a factor, the price of oil is really determined in the futures market, which could fuel the fire when it comes to price fluctuations,” he says.
Energy Select Sector SPDR Fund (XLE)
The Energy Select Sector SPDR Fund owns large-cap U.S. energy stocks and is based off the Energy Select Sector Index, a benchmark. Investors own the largest stocks in the sector, but nearly 44% of the fund is comprised of Chevron and Exxon Mobil, which can add more risk, says Michael Underhill, chief investment officer of Capital Innovations in Pewaukee, Wisconsin.
Energy is still an attractive sector based on more normalized oil prices of $55 to $60 a barrel for WTI over the next 18 months compared to current levels of $44 a barrel, Underhill says. The industry has been “more financially disciplined” over the past four to five years and is much more focused on return on invested capital and only allocating capital to high-return projects, he says.
“Overall capital spending is down 40% to 50% from peak levels a few years ago, generating increasing amounts of free cash flow to reinvest in more renewable sources of energy, reduce debt, increase dividends and repurchase shares,” he says.
Investors could balance XLE by adding international oil stocks, a high beta oil service ETF, a U.S. exploration ETF or a midstream ETF for income, or consider sticking to a fund with more leverage to oil prices.
“The energy sector has gone through a near-death experience since 2014 and has found new discipline, which will serve investors well,” Underhill says.
Invesco Solar ETF (TAN)
The Invesco Solar ETF focuses on global technology and utilities stocks that should benefit from demand for solar for renewable energy. The ETF tracks around two dozen solar energy companies such as First Solar ( FSLR) and SolarEdge Technologies ( SEDG).
Solar stocks are popular among investors, including retail and institutional ones.
Since TAN owns fewer companies, the price can be more volatile than other renewable energy funds with a larger number of holdings. Investors can benefit because the ETF is diversified and liquid and includes U.S., Chinese and European companies, says Todd Rosenbluth, head of ETF and mutual fund research at CFRA, a New York-based investment research company.
[See: 7 Energy ETFs to Buy Now.]
iShares Global Clean Energy ETF (ICLN)
The iShares Global Clean Energy ETF provides exposure to solar, wind and other renewable energy companies and tracks the S&P Global Clean Energy Index. The ETF includes companies that produce solar, wind and other renewable power sources globally, including power generation players. The top three holdings are Meridian Energy (MEL), Plug Power ( PLUG) and Verbund (VER).
This is a well-diversified ETF that “captures the dynamism of renewables through global, multi-country exposure to renewable electricity, semiconductor equipment, electrical equipment and solar technology stocks,” Underhill says.
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