In a recent article we examined the relative merits of investing in an ETF tracking a commodity futures index versus investing in an ETF that tracks the performance of commodity producers’ shares. Here, we take a closer look at one of the investable benchmarks tracking the share price performance of commodity producers—the STOXX 600 Oil & Gas Index, the fundamental drivers of its components’ financial performances, and the ETFs that track it.
Fundamental View
As with other commodity extractors, the shares of oil and gas producers are often most attractively priced at the very bottom of the macroeconomic cycle. At this point, energy prices tend to be on the low side relative to expected future scenarios, as supplies are ample and the demand outlook still uncertain.
It should come as no surprise that the primary driver of the financial performance of oil and gas producers is oil and gas prices. The relationship between the two is far from perfect, however. Many of these companies have extensive downstream operations (refining, petrochemicals, etc.) whose products profit at different times from crude oil or natural gas. Also, each firm has its own cost structures and faces unique company-specific risks.
Production economics will vary depending on the producer’s asset profile. It is far more costly to squeeze a barrel of crude out of Canadian tar sands than it is to pump one out of a massive oil field in Saudi Arabia. Production techniques and technology will also play important roles in determining producers’ relative positions along the industry cost curve.
Company-specific risks can stem from a variety of sources. None is perhaps more relevant at the moment than the risk of an environmental catastrophe. Mitigation and cleanup costs (amongst others) can amount to billions and potentially result in new and costly regulations that affect the entire industry. Many major oil producers also depend heavily on fields in developing countries, where political risk could endanger their operations or profits.
Portfolio
The STOXX 600 Oil & Gas Index is highly concentrated, with the top five constituents comprising 75% of its total market capitalisation. BP, Total, and Royal Dutch Shell alone account for 58% of the index.
Valuation
Morningstar’s equity analysts currently cover 86% of the STOXX 600 Basic Oil & Gas Index as measured by market capitalisation. As of the end of May the fund had a price/fair value ratio of 0.89, based on our analysts’ fair value estimates—implying that the sector is modestly undervalued.
A Look at the ETF Menu
Currently there are eight different ETFs available on European exchanges that track the STOXX 600 Oil & Gas Index. The award for lowest total expense ratio amongst the bunch goes to ComStage ETF’s STOXX 600 Oil & Gas fund—which levies a TER of 0.25%. The most liquid of the offerings is iShares STOXX 600 Oil & Gas fund (the physical replication version), which has seen about EUR 1.3 million in average daily turnover on the Xetra exchange over the past year. The db x-trackers fund also has ample liquidity on the Xetra platform and the Lyxor fund is also fairly liquid on the Paris market. The EasyETF option is very thinly traded on the Euronext Paris exchange. Liquidity for the db x-trackers and ETFX funds on the LSE is minimal at present, and we would advise using limit orders in navigating into and out of these (for more on using limit orders and a more in depth discussion of liquidity click here). Finally, the ETFX fund is also highly illiquid on the Euronext Amsterdam exchange.
