After Wild Ride, ETF Investors Pump the Brakes on Energy Funds

Who even has the energy anymore?

Oil prices have risen and fallen at a dizzying pace this year amid uncertainty over the war with Iran, touching $90 a barrel last week, as US forces marked nearly two weeks of strikes against the country. A pause in attacks this week, without an official ceasefire, sent prices downward: The United States Oil Fund (USO) dropped 8% over five days. But that shouldn’t necessarily spook investors, particularly those in the wider energy sector and the exchange traded funds focused on it, according to Michael Arone, a chief investment strategist for State Street Investment Management.

“What many investors overlook is that energy was actually rallying prior to the outbreak of the conflict at the end of February,” he said. Thanks to factors like loosened regulations, capital discipline and more innovation around oil production and exploration, “year over year, [companies’] profit margins have almost doubled.”

Nuclear Winter

Despite the mind-boggling needs for more energy to power artificial intelligence data centers, nuclear energy has not been having a great year as a whole. Meanwhile, clean energy has performed better, with tailwinds in particular for, well, wind power. Overall, there is potential for energy in the coming months, thanks to those AI buildouts, Arone said. And for those worried about tech companies’ enormous capital expenditures, allocations to energy, with its strong fundamentals, are an alternative, he noted. “This gives investors an opportunity to diversify away from some of the AI concentration.”

Still, the performance figures show that things are far from equal for categories and subcategories:

• The $2 billion USO is up 75% year to date, while the $3.5 billion State Street SPDR S&P Oil and Gas Exploration and Production ETF (XOP) is up 29% and the $39 billion State Street Energy Select Sector SPDR ETF (XLE) is up 26%.
• The $3.9 billion VanEck Uranium and Nuclear ETF (NLR) is down 20% so far this year, while the $2.3 billion iShares Global Clean Energy ETF (ICLN) is up about 1% and the $280 million First Trust Global Wind Energy ETF (FAN) is up 10%.

Foot Off the Gas: The energy sector has climbed 13% this year, which is about as much as the airline industry has fallen, Raymond James Chief Investment Officer Larry Adam wrote in a July 24 commentary. After funneling nearly $12 billion into US equity energy ETFs during the first three months of the year, investors pulled money during each of the three months in the second quarter, totaling about $4.5 billion, per data from Morningstar Direct. Flows into energy master limited partnership ETFs have been positive every month of the year but have slowed down.

“Once a diplomatic off-ramp emerges, we expect oil to cool and these trends to reverse,” Adam wrote. “That supports our positive view on consumer discretionary and industrials, while remaining underweight energy.”