The energy sector is struggling as oil prices slide, a scenario that is pressuring equity-based exchange traded funds such as the Energy Select Sector SPDR (NYSEArca: XLE). XLE, the largest equity-based energy exchange traded fund, is down 7.3% year-to-date.
The challenge for energy equities is that some oil market observers see more declines coming for crude. Oil traders are concerned over how fast U.S. shale oil producers will increase production to capture the rising prices.
Rig counts have recently ticked higher and with credit and earnings issues improving for some U.S. shale drillers, those companies may seize the opportunity to exploit higher pricing in the near-term. Global energy ETFs are struggling, too. Just look at the iShares Global Energy ETF (NYSEArca: IXC), which is down more than 5%.
Energy is one of a small amount of sectors that still trades at a noticeable discount relative to long-term averages. Additionally, the energy sector is usually among one of the largest sector weights in value ETFs, underscoring the point that the group is attractively valued relative to some defensive sectors, which trade at lofty multiples.
Some analysts believe the energy sector’s growth prospects remain attractive following the dip to start 2017.
“If European oil majors need $50-60 per barrel oil to generate enough free cash flow to maintain dividends, then they seem to be at a cost disadvantage compared to American producers. Bloomberg reports that oil prices would have to fall to $30 per barrel or less to hurt the finances of some U.S. shale producers because many of them are well-hedged against potential negative oil price shocks for the next several years,” according to Investopedia.
The $956.1 million IXC devotes over 56% of its weight to U.S. oil stocks, but European oil majors are important drivers of the ETF’s returns. For example, Royal Dutch Shell (NYSE: RDS-A), BP Plc (NYSE: BP) and France’s Total (NYSE: TOT), Europe’s three largest oil companies by market value, combine for almost 20% of IXC’s weight.
Interestingly, European oil majors are pricey relative to U.S. equivalents such as Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX).
“Looking at valuations of the European companies compared to some large U.S. peers on a 2017 price-to-earnings (P/E) ratio basis shows that the Europeans are trading at much lower multiples. On average the European companies trade with a 2017 P/E of 14.6 compared to an average figure of more than twice that for the U.S. based producers,” according to Investopedia.
For more information on the oil market, visit our oil category.