Don’t look now, but crude oil prices are collapsing. After spending much of the back-half of 2016 rebounding from its recent decade lows, oil has reversed course — hard. The reason is that proposed production cuts haven’t exactly panned out.
In the U.S., higher prices have helped producers restart drilling programs and turn-on non-completed wells. Higher prices have been a major benefactor to various energy exchange-traded funds like the Energy Select Sector SPDR (ETF) (NYSEARCA:XLE). The downside is that those higher prices/production have continued to help push supplies of oil up in the U.S.
Meanwhile, OPEC hasn’t exactly been keeping up with its end of the bargain either. Production in major oil nations like Saudi Arabia has actually increased. Naturally, the increase has helped feed the “oversupply” trade and it has sent oil prices lower. West Texas Intermediate crude oil can now be had for just $48.75 a barrel, while Brent crude is going for $51.74 a barrel. These are the lowest points since November of last year.
With the potential for more oversupply issues and lower prices on the horizon, the energy ETFs investors should be looking at aren’t necessarily bullish. At least in the short-term anyway.
Here are three energy ETFs to play the current crash in crude oil.
Energy ETFs to Buy: Direxion Daily Energy Bear 3X Shares (ERY)
Expense Ratio: 1.09%, or or $109 annually for every $10,000 invested
It stands to reason, that as crude oil and natural gas prices plunge, the firms that produce these fuels should also see their stock prices tank as well.
So far, that relationship has held true. The XLE has dropped about 3% over the last month as commodity prices have sunk.
So the best energy ETFs to play the current crash in crude oil could be the ones that short energy stocks. And the best energy ETF to do that is the Direxion Daily Energy Bear 3X Shares (NYSEARCA:ERY).
ERY is the most heavily traded short energy producer fund available for investors. The ETF replicates an inverse return on the Energy Select Sector Index, which is the underlying index of the XLE. This basically creates a short position in popular energy stocks such as Exxon Mobil Corproation (NYSE:XOM) and Halliburton Company (NYSE:HAL).
Even better for scoring greater potential gains is that ERY uses leverage to provide a 300% inverse exposure. So that means if the XLE drops by 1%, then ERY increases 3%. The thing to remember is that this is just for a single day. The ETF essentially “resets” itself each trading day and that could result in magnified gains or losses.
While it is a risky play due to the leverage, ERY is the best way for investors to short energy stocks. Expenses for the ETF run 1.09%- or $109 per $10,000 invested.
Energy ETFs to Buy: ProShares UltraShort Bloomberg Crude Oil (SCO)
Expense Ratio: 0.95%
Perhaps the simplest way to profit from falling crude prices is to bet on energy ETFs that track the commodity. The ProShares UltraShort Bloomberg Crude Oil ETF (NYSEARCA:SCO) provides short exposure to the Bloomberg WTI Crude Oil Subindex.
The index is a measure of West Texas Intermediate benchmarked crude prices. Think U.S. production. The Index rolls its futures contracts over the course of five consecutive business days, starting on the sixth business day of the month. This provides more of a trend for oil prices than just using the front month near-dated contract as many commodity focused energy ETFs do.
Perhaps more importantly, SCO will provide a more accurate return with regards to just how WTI crude oil prices are doing.
When you add in the slight leverage — -2x — from the ETF, SCO provides a powerful way to profit from lower crude oil prices brought on by the expanding glut. Expenses for SCO run at 0.95%. While that may seem high, it really isn’t. Thanks to its intended short holding period, most investors won’t ever pay that expense ratio.
Energy ETFs to Buy: ETRACS 1xMonthly Short Alerian MLP Infrastructure Total Return Index ETN (MLPS)
Expense Ratio: 0.95%
If you really think that the downturn in crude oil prices will be prolonged, you may want to take a bet on the ETRACS 1xMonthly Short Alerian MLP Infrastructure Total Return Index ETN (NYSEARCA:MLPS).
MLPS makes a short bet on master limited partnerships (MLPs). These firms often operate in the midstream or energy logistics sector of the market. Historically, that’s been the safest place to be during oil downturns.
However, with more wildcatters and smaller firms filling their pipeline with crude oil and natural gas, this past oil price recession has been hard. MLPs cratered on bankruptcies, production stoppages and other issues facing the oil producers. Since then, the sector has bounced back.
The play is risky, perhaps even more dangerous than the SCO or ERY. But MLPS isn’t leveraged and will provide a one-to-one short position. That means it can be used as a longer take on the potential downturn for crude oil.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.