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Investing in Energy ETFs

As energy stocks fall 3% this week, we consider the longer term outlook for the sector, and the best passive funds to get low-cost exposure

Karen Kwok 26 April, 2017 | 4:27PM

Energy companies’ profits could be at risk if the Conservative Party win next month’s General Election. The Tories have pledged to cap energy prices – with current Prime Minister saying it was “unfair” two thirds of British households were stuck on the most expensive tariffs.

Shares in UK energy providers Centrica (CNA) and SSE (SSE) both fell more than 3% this week as the market digested the news.

Regulation is a key restriction to energy companies’ profits in the UK, according to Charles Fishman, Morningstar equity analyst. Regulators seek to keep customer bills low, while the company tries to increase profits. Investor returns depend on the rates regulators set. In the UK, regulators prefer incentive-based rates that require certain investments and efficiency standards.

Uncertain Oil Prices

Political uncertainty is not the only headwind facing energy companies in the UK; the future of oil price remains uncertain.

Brent crude oil is trading at $52 per barrel today. This is nearly double the oil price in January 2016 – however it is still significantly below the $100 high of two years ago.

Simon Laing, head of US equities with Invesco Perpetual believes a recovery in the oil market is underway, thanks to a pick up in crude oil demand in the US coupled with considerable capital expenditure cuts over the last two years impacting production levels.

Allen Good, senior analyst with Morningstar agreed, saying that OPEC's production cuts and strong demand growth mean the outlook for crude oil is the most promising since oil prices crashed two years ago. However, major increases in US shale production are likely to throw crude markets back into oversupply.

Energy Equities Offer High Dividend Yields

Energy-related equities have already priced in a lower-for-longer outlook for oil, James Butterfill, head of research and investment strategy at ETF Securities said in a recent note.

The MSCI World energy sector is trading on a 20% discount to the materials sector and 40% discount to industrials sector in valuations, data provided by ETF Securities showed. The price-to-book ratios of the energy sector are also cheap compared to the long-term average, said Butterfill.

Meanwhile, the energy sector has a higher forecasted dividend yield at 3.6% than the overall equity market at 2.6%, according to ETF Securities. The energy sector’s balance sheets also look healthier now, supporting energy companies’ dividend pay-out policies going forward.

2 Ways to Invest in Energy ETFs

Valuations of energy stocks look cheap and the outlook for the oil price looks promising – and there are number of passive options for those investors who want to access the sector. Broad-based funds – both active and passive – are lower risk compared to buying a single energy company.

There are currently 21 energy equities ETFs for sale in Europe, according to Morningstar Direct.

Data from Morningstar Direct showed that the energy sector equity ETF sector saw $2.4 billion inflows worldwide in the first three months of the year. Interest from European investors towards energy ETFs have been particularly strong. In November the energy equity ETF sector saw the biggest inflows in five years with €248 million the month alone.

Alternatively, investors can invest in ETF that provides exposure to the commodity itself. ETFS Crude Oil ETC (CRUD) provides exposure to West Texas Intermediate crude oil through the use of near-month futures contracts, said Kenneth Lamont, Morningstar’s passive analyst.

However, Lamont said investors should be aware that because of the concentrated exposure of this exchange-traded commodity, returns can be highly volatile. This product is mostly suitably deployed tactically as part of an already diversified portfolio, Lamont added.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
Centrica PLC138.10 GBX-1.00
ETFS Crude Oil ETC EUR6.89 EUR0.25-
SSE PLC1,309.00 GBX-0.30
About Author Karen Kwok

Karen Kwok  is a Reporter for Morningstar.co.uk