The ETF That’s Holding You Back

Just a few months ago, oil prices sat near multi-year highs.

Then they did an about face, dropping like a stone, even as equities picked up.

That’s held back many of the oil and gas names from Exxon Mobil to Chevron.

But if you want to take advantage of the steep drop in oil and natural gas prices, you need to hear what we’re about to say. 

Because the first ETF that comes to everyone’s mind for oil and gas exploration, even for financial pros, isn’t the one you should hold.

We promise an ending with a twist.

Key Facts About XOP

• Net assets: $3.3 billion
• 12-month trailing yield: 2.62%
• Inception: June 19, 2006
• Expense ratio: 0.35%
• Number of holdings: 60

The oil and natural gas industry comprises three parts: exploration and production, transportation, and refining and marketing.

State Street’s XOP ETF invests in companies involved in exploring and producing natural gas and oil using an equal cap-weighted approach.

This top part of the supply chain lives and dies by the price of oil and natural gas, much as gold miners do by the price of the yellow metal.

While integrated companies like Exxon play in all three areas, the XOP focuses on those companies whose primary focus is exploration and production.

Source: StateStreet

However, because there is overlap in these companies’ business models, the sub-industry allocation has about 80% dedicated to purely E&P.

Source: StateStreet

Performance

The oil and gas industry changed dramatically in 2014 when U.S. fracking took hold, increasing energy supplies and disrupting global competition.

Prices for oil and gas plummeted, remaining depressed until the pandemic.

From the pandemic low to the high in 2022, the XOP jumped almost 600%, excluding dividends. The high coincided with Russia’s invasion into Ukraine.

Since then, the XOP has moved largely sideways, trading between $120-$155.

Source: StateStreet

You can see how all these historical inflection points play into the performance of each lookback period.

For example, ten years back takes you to before the 2014 energy price collapse.

Back three years puts you in a post-pandemic bull market.

Competition

Exploration and production are just two ways to play in the energy sector.

Here are several other ETFs that invest in different parts of the supply chain.

• Energy Select Sector SPDR Fund (XLE): The XLE invests more broadly into energy companies, regardless of where they exist in the supply chain, giving you a more diverse and complete portfolio.
• First Trust ISE-Revere Natural Gas Index Fund (FCG): If you want to play just natural gas prices, then the FCG is your vehicle. This fund invests in companies that derive a substantial portion of their revenues from natural gas E&P.
• VanEck Vectors Oil Services ETF (OIH): The nuts and bolts that make the energy chain function, the OIH invests in companies that support oil drilling and related activities.
• iShares U.S. Oil & Gas Exploration & Production ETF (IEO): Similar to the XOP, the IEO invests in oil and gas E&P companies. However, it uses a market-cap weighted approach.

We want to focus your attention on the XOP and IEO.

How did the IEO outperform the XOP so dramatically?

The IEO uses a market-cap-weighted approach. This allows larger companies to account for a bigger portfolio share as they grow.

The XOP keeps all its holdings the same size.

You only need to look at the performance difference to see the truth.

If you want to make money in the oil and gas industry, you invest in the big boys.

Our Opinion 2/10 

We’ve covered the XOP in the past. But this was the first time we did an analysis on the IEO.

And the results stunned us.

We loved the XOP.

Now, it’s obvious that if you want to play oil and gas exploration and production, the IEO, despite lower liquidity, is the best choice.