How to Harness Energy By Using ETFs

February 18th at 12:00pm by Tom Lydon

Energy ETFsEnergy powers our lives. You’re using energy to read this right now, you probably used energy to get to work this morning and you’ll use energy to heat your home at night. Exchange traded funds (ETFs) offer a simple and efficient way to capitalize on the world’s energy appetite.

As gasoline prices rise and natural gas prices go through the roof, there is a way to hedge your increasingly exorbitant utility bills. An ETF can help investors hedge rising energy prices, capitalize on profits big oil is making and also give some padding to a portfolio. [For more stories about commodities, visit our commodity category.]

Commodity ETFs vary in their construction: some hold futures contracts, others track a basket of equities. With futures-based ETFs, there are tax consequences to be aware of. Contango and backwardation can affect these funds, as well. [How Contango Affects Oil ETFs.]

Please note how commodity ETFs work, as many are invested in a futures contract rather than actual shares. Some of the futures-invested funds are producing either a positive or negative yield roll, and may not yield the proper results intended. [ETFs to Play the Clean Energy Push.]

Rich White for Investopedia has some ideas:

  • United States Oil (NYSEArca: USO): You can own oil through this ETF without incurring the costs normally associated with storage or transport. USO holds futures contracts. The only costs that you will pay include brokerage fees to buy and sell shares plus a modest management fee. This ETF falls under the “single contract” category of energy fund, although some don’t consider it a pure single contract fund because it invests in other energy contracts, as well.

  • iShares S&P GSCI Commodity-Indexed Trust (NYSEArca: GSG): The ETF has about two-thirds of its total weight in the energy sector and the remaining one-third in other types of commodities. It tracks one of the oldest diversified commodities indexes, giving investors a certain confidence. The underlying index is a basket of futures contracts on 24 different commodities, and energy is the largest allocation with 67% of the holdings. This fund falls under the “multi-contract” category of energy funds. You’re sacrificing a bit of pure play ability for some broad diversification and, it’s hoped, a little less volatility.

  • Energy Select Sector SPDR (NYSEArca: XLE): If futures-based energy ETFs aren’t for you, perhaps an equities ETF might be a better bet. Wild price swings in oil, natural gas and gasoline may take awhile to become evident in these funds, making them slightly less volatile.

For more energy investing ideas, please sign up for our special report on energy ETFs.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.