The Energy Select Sector SPDR (NYSEArca: XLE), the largest exchange traded fund dedicated to energy equities, is down nearly 10% year-to-date, underscoring the point that the energy sector is the worst-performing group in the S&P 500 this year.
Some of the struggles of oil and the energy sector this year can be pinned on investors’ concerns regarding the ability of major oil-producing nations, including the Organization of Petroleum Exporting Countries (OPEC), to effectively reduce production. And once again, energy investors will be closely monitoring news out of the cartel of major oil-producing nations over the near-term.
“While we see little surprise potential in terms of the length of the production cut, OPEC might agree to expand the cut, which would be taken positively by investors. Otherwise, we fear the sector could lose further momentum in the short term – since our upgrade, the oil price failed to gain traction despite OPEC and some non-OPEC producers‘ production cuts. Energy equities have not been able to decouple from volatile oil-price movements. The market does not give credit to the fundamental improvements of the companies’ cash flows,” according to a Deutsche Bank note posted by Crystal Kim of Barron’s.
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. Some traders are not convinced and caution about betting on an energy sector rebound.
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.
Investors considering ETFs such as XLE and rival ETFs such as the Fidelity MSCI Energy Index ETF (NYSEArca: FENY) and the Vanguard Energy ETF (NYSEArca: VDE) need to again monitor the dividend situation at energy companies.
“…can it cover its dividends from cash flow even at current oil prices? Many integrated oil companies are making progress on this front, but only a fraction has achieved satisfactory dividend coverage just yet. We are even more selective when it comes to U.S. E&P companies, as they are more prone to oil-price changes and changing financing conditions. We believe they need to have excellent oil fields in order to be investable,” according to a Deutsche Asset Management note seen in Barron’s.
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