Production Cuts, Better Demand Could Boost Energy ETFs

Energy equities and ETFs are incurring punishment on multiple fronts this year. First, growth stocks are back in style and driving the broader market higher, giving investors reason to repudiate slower growth sectors. Second, supply and demand dynamics currently aren’t in favor of energy stocks.

Those factors are weighing on exchange traded funds such as the Invesco S&P 500 Equal Weight Energy ETF (RSPG). To its credit, RSPG is outperforming the cap-weighted S&P 500 Energy by nearly 130 basis points year-to-date. That could signal that if energy equities rebound, RSPG could take on a leadership role among the related ETFs.

One of the headwinds RSPG is encountering is that while some members of the Organization of Petroleum Countries (OPEC) pared oil production in a bid to boost prices, output is growing in some non-OPEC nations, including Brazil, Canada, Mexico, and the U.S. Couple that with Russian output remaining surprisingly high, and the current supply outlook isn’t overly favorable to assets such as the equal-weight RSPG.

Signs of Hope for Energy ETFs

Investing in the energy patch can be tricky and volatile. With the aforementioned supply glut needing to be worked through, it’s understandable that some investors are happy to eschew the sector over the near term. However, investors shouldn’t write off RSPG in wholesale fashion.

It’s possible that supplies will tighten a bit in the second half of the year. Additionally, value remains in the energy patch despite last year’s torrid run. A case can be made that RSPG embodies that value proposition, as nearly 56% of the fund’s holdings are classified as value stocks. That could encourage some market participants to nibble at a sector that may stall in neutral for the time being.

“There is still likely a period ahead when global GDP growth re-accelerates and the impact of little investment in new production capacity should start to bite. However, the cyclical and the structural outlook do not always align. Over the next six months, we see oil prices broadly stable at about $75 to $80 a barrel for Brent,” noted Martijn Rats, Morgan Stanley’s global commodity strategist.

Other factors that could be supportive of RSPG in the back of 2023 are the energy sector’s increasingly strong balance sheets and commitment to shareholder rewards. Additionally, strong North American production could help the ETF, owing to its exposure to some oil services providers and pipeline operators.

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