Time to Buy Oil and Gas Services ETFs?

Source: Zacks ETF Research  (5/21/12)

"The influx of hydraulic fracturing created a shale gas production boom in the U.S., and new drilling technologies are playing the key roles in the growth of oil and gas equipment companies."

Earlier this year, the energy sector, specifically in the oil space, was one of the more popular segments in the market. Crude oil was surging and any company related to this sector was on the rise as a result.

However, recent events have made many investors pause when it comes to investing in the space. Many European countries are already in a recession while there are concerns building over the health of not only the American market, but the pace of growth in Asian nations as well.

Yet despite these worries, the space could be promising for a long-term, or even medium-term outlook. This is especially true when one takes a closer look at the oil equipment space in particular.

Strong Oil and Gas Outlook

The ongoing tension in Iran over its nuclear program, supply disruptions in South Sudan and Syria, along with dwindling supplies from traditional fields are keeping oil production under pressure.

Some respite comes from continued strength in the major emerging markets like India, China and Brazil along with growth in developing nations where oil consumption is on the rise. The supply constraint in the backdrop of growing demand will boost oil prices higher, particularly in spring and summer.

Since the discovery of new energy reserves is expensive, unconventional sources of energy such as shale oil, deepwater drilling and bitumen production have become the new source of fuel for the world’s largest energy consumers. Shale gas production is booming in the U.S. market with the influx of hydraulic fracturing. The discovery of shale gas and new drilling technologies are playing the key roles in the growth of oil and gas equipment companies (read: Market Vectors Launches Unconventional Oil and Gas ETF [FRAK]).

Additionally, due to how closed-off many American and Western firms are from emerging market oil fields, a bigger focus on domestic supplies has begun to take place with special care to this shale market. This has acted as a huge catalyst for oil and gas equipment companies and it could help to power these firms to further growth in the months ahead.

Furthermore, although oil prices have been weak, natural gas has finally started to bounce back suggesting that this market could begin to attract more attention in the future as well. Given both the importance of domestic supplies and the more bullish environment in natural gas, it could be an interesting time to take a closer look at the oil and gas equipment space as a way to play growth in the space.

While there are a number of individual securities that target the sector, an ETF approach may be a lower risk way to target the often volatile space. For these investors, any of the following ETFs could be worth a closer look:

Market Vectors Oil Services ETF (OIH)

Investors seeking exposure to oil equipment and service firms may find Van Eck's OIH an intriguing option for playing the segment. With AUM of more than a billion dollars, this ETF is the largest and most widely traded in this category at more than 4.7 million (M) shares a day.

Initiated in December 2011, the fund seeks to match the price and performance of the Market Vectors US Listed Oil Services 25 Index, before fees and expenses. The product holds 27 oil service companies in its basket with 72.2% exposure in top 10 holdings. The top three companies include Schlumberger Limited (SLB - Analyst Report), Halliburton Company (HAL - Analyst Report), and National Oilwell Varco Inc. (NOV - Analyst Report).

The fund is highly exposed to the U.S. with 76% of the total, followed by Europe in countries like Switzerland, Norway, Italy, United Kingdom, and Netherlands. The fund delivered outstanding returns of 6.1% in three-month period with an attractive dividend yield of 4.29% per annum. Additionally, it is the low cost choice in the energy space with 35 bps in annual fees and a small bid/ask spread (read: Play An Oil Bull With These Three Emerging Market ETFs).

Dow Jones U.S. Oil Equipment & Services Index Fund (IEZ)

The fund, launched by iShares in May 2006, seeks to replicate the performance of the Dow Jones U.S. Select Oil Equipment & Services Index. With total assets of $428.1M, the product holds 45 stocks of companies that supply oil equipment and services to oil fields and offshore platforms such as drilling, exploration, engineering, logistics, seismic information services and platform construction.

The fund allocates 66.3% of the assets in top 10 holdings, which includes Schlumberger, Halliburton and National Oilwell as top three firms. While giant and large-cap stocks account for nearly 54% of the assets, mid- and small-cap hold the remaining (read: For Europe ETFs, It Is Hard To Beat Switzerland).

The product is relatively expensive as the product charges 47 bps in fees per year. Trading in small numbers of 200,000 per day on average, the fund delivered negative returns of 20.7% over the last year (ending March 2012). Additionally, it pays a minimal dividend, representing a small 0.26% yield per annum.

SPDR S&P Oil & Gas Equipment & Services ETF (XES)

This fund, issued by State Street in June 2006, seeks to replicate the performance of S&P Oil & Gas Equipment & Services Select Industry index. The product only holds $266.2M of assets and is less liquid than some of the others on the list.

With total holdings of 43 securities in its basket, the fund is least concentrated in the top 10 companies with 27% exposure. The top three holdings include Core Laboratories NV (CLB - Analyst Report), Helix Energy Solutions Group Inc. (HLX - Snapshot Report) and RPC Inc. (RES - Snapshot Report). The majority of these stocks are U.S. mid and small caps, as these segments constitute more than 82% of assets in the basket (see more ETFs in the Zacks ETF Center.

The product underperformed the market over the past one-year period (as of March 2012), producing negative returns of 19.5% and lower annual dividend yield of 0.22%. However, the fund charges a paltry fee of 35 bps a year and has small bid-ask spread and a low level of tracking error.

Dynamic Oil & Gas Services Portfolio (PXJ)

Launched in October 2005, PXJ is designed to provide capital appreciation or returns of the U.S. oil and gas services stocks. With total assets of $139.5M, the fund is a more volatile and less liquid ETF in the energy space and tracks the Oil & Gas Services Intellidex Index.

The stocks in the fund are evaluated on good investment merits such as price momentum, earnings momentum, quality, management action and value. The ETF uses a full replication strategy, holding all 30 stocks in the index (read: Oil Bull Market Is No Place for MLP ETF Investors).

The product allocates about 46% of its assets in top 10 firms, including Diamond Offshore Drilling Inc. (DO - Analyst Report), Schlumberger and FMC Technologies Inc. (FTI - Analyst Report) as top three companies. This ETF is appropriate for investors seeking broad exposure to the U.S. oil and gas markets with a focus on all cap equities.

The product is a high-cost choice in the energy space as it charges 63 bps in fees per year. The fund produced negative annual returns of 20.9% over the last year (as of March 2012) and yields a paltry annual dividend of 0.01%.

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