With the bounce in oil prices, the risk from investing in certain ETFs for the sector could be more worthwhile
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Investing in the oil sector is generally known to be risky but with the price of Brent crude topping US$70 recently, some investors may be more open to the idea. For many in the retail space, that means getting exposure through ETFs — though the choice depends on numerous factors and convictions.
“Martin Pelletier, a portfolio manager at TriVest Wealth Counsel, thinks the recent surge in energy prices has a lot do with Saudi Arabia, and the forthcoming IPO of state-owned Saudi Aramco,” reported the Financial Post. “The world’s top oil exporter recently mused that it would be comfortable with prices reaching as high as US$100 a barrel.”
According to Pelletier, current prices likely reflect Riyadh’s short-term willingness to curb market supply — and, consequently, lose market share to Western shale producers — to set a favourable stage for the 2019 IPO. That spells a near-term trading opportunity in oil, whose prices Pelletier thinks will face resistance at US$80 per barrel.
He said investors who want to bet on a sustained rise in oil, however, should consider ETFs with US exposure. Shale producers south of the border face lighter regulation and increased access to markets, which spell better long-term prospects than Canadian oil sands firms.
Daniel Straus, VP of ETFs and financial products research at National Bank of Canada Financial Markets, suggested that bullish short-term traders might want to consider Canada for the added benefit of currency appreciation. Because the Canadian market is already tilted heavily towards energy, the pressure to search for hidden gems shouldn’t be as acute for ETF investors in the region.
But investors looking for the safest bet should look at global energy ETFs, said Straus. Should the greenback take a dive in the next year or so, diversification away from any particular currency exposure would provide some useful cushioning.
Another bullish approach is to invest in ETFs exposed to upstream exploration and production (E&P) companies, which are wholly dependent on the price of oil. The fact that they’re leveraged means that their shares see outsized gains with rising prices, and deeper nosedives when prices fall. “Junior exploration outfits and oil field service providers, meanwhile, offer even more exposure, since they combine the price sensitivity of E&Ps and the volatility of small-caps,” according to the Post.
But conservative investors could go with safer midstream ETF strategies, which are exposed to transport companies and pipeline companies. According to Straus, such firms rise and fall with oil prices, but are more insulated from daily volatility because of the longer-term contracts they’re engaged in. Downstream ETFs with exposure to refiners could even offer a short-term hedge to oil volatility, since refiners can get a temporary boost from a drop in oil prices, which is their main input cost.
Finally, Straus advised retail investors against investing in risky pure-play commodity ETFs, which swing wildly with oil prices — and could even decouple from their energy benchmarks if their exposure comes from futures contracts.
“If they don’t understand the way futures work, they could be in for a surprise, and especially if they’re holding for a prolonged period of a couple of months,” he said.
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