If you’re to invest in the energy sector, which historically has included mostly oil and gas companies, buying an energy exchange-traded fund (ETF) is an easy way to do that. With an energy ETF you can buy a cross-section of the industry, letting you play the sector if you think it’s about to rally. An ETF also offers diversification, reducing your risks over buying individual stocks.
What are the main kinds of energy ETFs?
The energy sector is large, and it can be broken down into sub-sectors, depending on how the companies within it operate. So you have multiple ways to invest in the energy industry, and an energy ETF can give you exposure to many of these sectors:
- Exploration and production – This area of the industry is focused on finding, developing and producing crude oil.
- Refining – This sub-sector is focused on turning crude oil into usable products such as gasoline.
- MLP – An MLP stands for a master limited partnership, and it’s a special legal structure typically associated with midstream companies such as pipelines. MLPs often pay large dividends.
- Oil equipment and services – This sub-sector includes companies that supply goods and services to explorers and pipeline companies.
- Crude oil – You can also invest in an ETF that tracks the daily movements of petroleum.
If you’re looking for other types of energy exposure, such as innovative green companies, you can find that, too. Some ETFs are focused on owning clean energy companies, including those in solar or wind energy. So you have many options when it comes to investing in energy ETFs.
Those looking for diversification across industries can turn to some of the best index funds.
What to look for in an ETF
When investing in ETFs, it’s useful to look at a few aspects of each ETF so that you actually buy what you intended to buy. Here are three key things to look for:
- The sub-sector – Each sub-sector may respond differently to conditions in the industry. For example, rising oil prices may help explorers – which sell oil – much more than they help midstream companies, many of which just move it for a fixed fee. So you need to know what kinds of companies you want to own.
- The investment track record – You’ll also want to know the track record of the ETF. Has it outperformed the industry, or has it underperformed during a period of strength? The track record can give you some idea of what to expect from the ETF. But energy companies are volatile and may not show good long-term records.
- The expense ratio – Pay attention to the expense ratio, which tells you how much it costs to own the fund annually as a percent of your total investment in it.
Finally, it’s worth noting that larger ETFs tend to charge lower expense ratios, because they can spread the costs of running the fund across more assets. So the cheapest funds may often be the largest funds, and a low expense ratio is a key measure of what makes a top ETF.
Here are some of the best energy ETFs based on their sub-sectors.
Best energy ETFs
1. Best exploration and production ETF
Energy Select Sector SPDR Fund (XLE)
This ETF intends to represent the energy sector of the Standard & Poor’s 500 index. It includes companies involved in exploration and production such as ExxonMobil and Chevron, as well as companies with exposure to energy equipment and services.
5-year returns (annualized): 2.7 percent (as of Jan. 31, 2022)
Expense ratio: 0.10 percent
Dividend yield: 3.9 percent
2. Best MLP ETF
Alerian MLP ETF (AMLP)
This fund tracks the Alerian MLP infrastructure index, which includes master limited partnerships. Energy MLPs are generally focused on moving oil from one place to another via pipeline. Due to their legal structure, MLPs typically pay out significant dividends.
5-year returns (annualized): -4.3 percent (as of Dec. 31, 2021)
Expense ratio: 0.90 percent
Dividend yield: 7.6 percent
3. Best oil equipment and services ETF
VanEck Vectors Oil Services ETF (OIH)
This ETF tracks an index of U.S.-listed companies focused on providing oil services to explorers and producers, including oil equipment, services and drilling.
5-year returns (annualized): -18.0 percent (as of Jan. 31, 2022)
Expense ratio: 0.35 percent
Dividend yield: 0.7 percent
4. Best crude oil ETF
United States Oil Fund (USO)
This ETF aims to track the daily price movements of light sweet crude delivered to Cushing, Oklahoma. However, it does not directly hold oil but instead uses futures to try to replicate the movements of oil prices.
5-year returns (annualized): -10.3 percent (as of Dec. 31, 2021)
Expense ratio: 0.83 percent
Dividend yield: N/A
5. Best clean energy ETF
iShares Global Clean Energy ETF (ICLN)
This ETF tracks an index of global stocks in the clean energy sector, including those that generate energy from solar, wind and other renewable sources.
5-year returns (annualized): 19.8 percent (as of Jan. 31, 2022)
Expense ratio: 0.42 percent
Dividend yield: 1.3 percent
How to invest in oil and energy ETFs
An ETF can make it easier to invest in the oil sector, but because of the volatile nature of oil prices and the industry dynamics, you’ll still need to know what you want to invest in. Some sectors may perform well while others do poorly, and others may be somewhat resistant to volatility because of the steadier nature of their businesses.
The ETFs listed above give you a liquid way to invest in the energy sector, but how you invest in it is ultimately up to you. For example, some investors wager on the price of oil more directly, while others like to invest in exploration and production companies, because their profits generally will go up faster when oil prices rise than the price of oil itself will.
Other investors prefer the big dividends that are common among energy MLPs, which can often be more steady than other sub-sectors. But even there, the companies have major differences in business models that make them more volatile, so it’s important to know what you’re buying.
It’s also important to know why you’re buying into energy companies. Are you doing so to simply hedge other positions? For example, you may buy an energy ETF to help offset the effect of rising oil prices on your other investments. Or do you expect the investment in an energy ETF to always make a return on your investment? This can also determine which type of ETF you buy.
Investors looking for exposure to the energy industry have several options to play the sector, so it’s important that they know what they’re doing and what returns and risks each ETF ultimately offers. For this reason, some investors stick to basic broadly diversified index funds, such as those based on the Standard & Poor’s 500 index, and leave the trading to the pros.
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Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.