Different approaches to crude oil
As we noted in the last part of this series, WTI (West Texas Intermediate) crude oil futures fell by 5.50% between July 20 and July 27. Although retail investors don’t have easy access to the futures market, they can access other safer and low-cost avenues to bet on WTI crude oil prices.
The first avenue would be an energy-commodity ETF like the United States Oil Fund LP (USO). This ETF tracks prompt WTI crude oil futures. USO shares trade on the NYSE like a company stock. The fund fell by 6.23% in the week ending July 27.
The second avenue would be the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). It holds many US energy companies that have exposure to oil prices due to their upstream—oil production—operations. Because of their indirect exposure to volatile oil prices, ETFs like XOP are typically a safer and more diversified option for conservative investors. XOP fell by 7.12% in the week ending July 27.
As you can see in the above graph, USO overperformed WTI crude oil futures initially in the week, but mostly mirrored it as the week progressed. By the end of the week, it diverged. This resulted in lower returns compared to WTI.
In contrast, XOP overperformed both USO and WTI prices for most of the week. However, the fund started falling at the end of the week. It underperformed both USO and WTI crude oil. XOP delivered the lowest returns by the end of our weekly cycle.
XOP’s indirect exposure to crude oil prices through energy stocks should give it better downside protection from a fall in crude oil prices relative to USO. However, given the fund’s equal-weight holdings, many smaller and more volatile companies affect its performance. For example, smaller companies held by XOP include Penn Virginia (PVA), Stone Energy (SGY), and Ultra Petroleum (UPL). They fell ~23%, ~23.20%, and 13.72%, respectively, between July 20 and July 27. All of these companies account for 3.20% of XOP.
You can also gain indirect exposure to energy prices, along with regular income, by investing in MLP ETFs like the Alerian MLP ETF (AMLP). This ETF holds midstream MLP companies like Plains All American Pipeline (PAA), ONEOK Partners (OKS), and Energy Transfer Partners (ETP).
In the next part of this series, you can read about trends in the WTI-Brent spread.