Exchange traded funds focusing on shares of exploration and production companies, such as the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEArca: XOP), have been among the worst offenders during oil’s bear market and these ETFs are at risk if a low oil price environment is the “new normal” for the commodity.
Concerns over Chinese oil demand also pressured prices. China revealed that its service activity expanded at a slower-than-expected pace, which has fueled pessimism over a potential slowdown in the second largest oil-consuming country in the world. [China ETFs Suffer New Year Hangover ]
Additionally, the international outrage over Saudi Arabia’s execution of a Shi’ite cleric ended speculation that Organization of Petroleum Exporting Countries could come together on a production cut, reports Simon Falush for Reuters. [Oil ETF Bears Continue Aggressive Forecasts ]
XOP is off nearly 53% over the past year. There are reasons for investors to be cautious with volatile energy ETFs. Moreover, if oil prices falls to new lows and the shale industry is unable to turn a profit, the highly leveraged industry may find it harder to repay debt obligations. With the U.S. dollar strengthening and the Federal Reserve looking at tightening its monetary policy, the various U.S. market sectors and related exchange traded funds could behave differently in a strong USD environment.
“U.S. production reached a peak of 9.6 million barrels a day in April 2015, six months after OPEC moved to a market-based strategy that sent prices skidding. U.S. oil output was lifted by the industry’s recently completed projects, and production was also supported by hedging, ready financing and technology gains. But financing is no longer easy, and some producers face real hardship, including fire sales or bankruptcy,” according to CNBC.
At issue are declining hedging positions, particularly for some of the well-known names found in exploration and production ETFs like XOP.
This isn’t the first time the energy sector has been forced to tighten their belts. Through 1987 to 1997, companies suffered through an extended period of lower prices and responded by cutting costs, which ensured “earnings grew strongly,” according to Bernstein research.
“The longer prices stay low, the longer it will take to reverse the effects across the industry of cutbacks in production, capital spending and staffing,” adds CNBC.
SPDR S&P Oil & Gas Exploration & Production ETF
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.