Energy stocks and sector-related exchange traded funds bounced earlier this year on optimism of a recovery in oil prices. However, with crude prices expected to remain depressed, the investors should pare their energy sector expectations.
Energy funds like the Energy Select Sector SPDR (NYSEArca: XLE) and SPDR S&P Oil & Gas Exploration & Production ETF (NYSEArca: XOP) bounced earlier this year after oil bottomed out. However, over the past month, XLE declined 4.1% and XOP dropped 2.9% as more are beginning to realize the energy sector may not experience a swift recovery. [Energy ETF Investors Should Brace for ‘New Oil Order’]
Investors have pulled $140.3 million out of XLE and redeemed $91.4 million from XOP so far this month, according to ETF.com.
Dampening energy companies’ outlook, Saudia Arabia and the Organization of Petroleum Exporting Countries have maintained high output targets in an attempt to defend their market share, even with lower oil prices, reports Bob Pisani for CNBC.
Meanwhile, in the lower oil prices are pressuring exploration and production stocks as the drillers’ value is based on production and assets already sunk into projects. [Energy ETF Investors Grow Wary of Oil Outlook]
Additionally, these energy companies require a lot of capital to keep drilling, and since depletion rates on wells are high, the companies will require cheap capital to keep operations running. However, yields on speculative-grade debt have gone up, raising the cost for companies seeking to expand.
Consequently, E&P companies could issue stock to raise money, which would put additional pressure on their stock prices.
“We expect … E&Ps to issue additional equity in 2H2015 to fund 2016 capex as borrowing bases will be declining and debt metrics deteriorating,” according to Cowen Group.
For those seeking a hedge against further weakness in the energy sector, the ProShares Short Oil & Gas (NYSEArca: DDG) tries to reflect the inverse, or -100%, daily performance of the Dow Jones U.S. Oil & Gas Index. The UltraShort Oil & Gas ProShares (NYSEArca: DUG) takes two times the inverse, or -200%, daily performance of the Dow Jones U.S. Oil & Gas Index. The Direxion Daily Energy Bear 3X Shares (NYSEArca: ERY) reflects three times the inverse, or -300%, daily performance of the energy select sector index. Moreover, the recently launched Direxion Daily S&P Oil & Gas Exploration & Production Bear Shares (NYSEArca: DRIP) takes the -3x, or -300%, daily performance of the S&P Oil & Gas Exploration & Production Select Industry Index. [New ETFs for the Bold Energy Investor]
For more information on the energy sector, visit our energy category.