Alternative ETFs to Hedge Against Further Weakness in the Energy Sector

While oil stocks rallied alongside the broader market on Friday, the energy sector could continue to be depressed on a falling demand outlook. Exchange traded fund investors, though, can turn to alternative strategies to hedge further risks.

The Energy Select Sector SPDR Fund (NYSEArca: XLE) surged 8.2% on Friday, but the rebound may not be sustainable.

“Equity markets are diverging from fundamentals, even as companies warn that their balance sheets are severely stressed and efforts to curb production do little to ease oversupply,” Bloomberg Intelligence analyst Fernando Valle said in a note, according to Seeking Alpha.

The energy market continues to tackle a supply-side glut. For instance, a fleet of tankers full of Saudi Arabian oil is moving toward the U.S. Gulf Coast, potentially inundating a market already saturated with oil, the Wall Street Journal reports. The tankers were already loaded back in March and early April when Saudi Arabia shifted to a strategy of increased output during its recent tussle with Russia.

“We’re going to have some very severe short-term pain,” Mark Papa, the ex-chairman of Centennial Resource Development Inc. and former chief executive of EOG Resources Inc, told the WSJ.

Meanwhile, on the demand side, observers are warning of a severe disconnect. According to the Organization of Petroleum Exporting Countries, global oil demand will plunge by 6.8 million barrels a day in 2020, with the worst of the contraction of 20 million barrels per day in April as a result of travel bans and lockdowns aimed at containing the coronavirus, according to the Wall Street Journal.

“The oil market is currently undergoing [a]historic shock that is abrupt, extreme and at a global scale,” the cartel said.

Traders who are wary of further weakness in the energy segment may turn to inverse ETF options to hedge against further declines. For instance, 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.

For the risk-tolerant or more aggressive trader, the ProShares UltraShort Oil & Gas ProShares (NYSEArca: DUG) takes two times the inverse, or -200%, daily performance of the Dow Jones U.S. Oil & Gas Index, and the Direxion Daily Energy Bear 3X Shares (NYSEArca: ERY) reflects three times the inverse or -300% daily performance of the energy select sector index. Additionally, the Direxion Daily S&P Oil & Gas Exploration & Production Bear 3X ETF (DRIP) provides the -3x or -300% daily performance of the S&P Oil & Gas Exploration & Production Select Industry Index.

For more information on the energy sector, visit our energy category.