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New Oil Subsector ETFs Prove Refined

Roger Nusbaum

Buying OIH, however, can prove problematic for some investors. As with all HOLDRs, its shares can only be bought in round lots of 100, and those shares trade around $150.

Those two factors could make investing in OIH too inflexible for some. Consider that energy makes up roughly 10% of the S&P 500, while oil services makes up only a quarter of the sector, as measured by the Energy Sector SPDR(XLE Quote). As a result, 100 shares of OIH may be too large of a bet for many investors, as the size of the investment could dominate a portfolio.

State Street Global Advisors and iShares have both recently rolled out funds that allow investors to more flexibly capture the exploration and production (E&P) and services portions of the energy sector.

State Street now offers:

• SPDR Oil and Gas Equipment & Services ETF(XES Quote)
• SPDR Oil and Gas Exploration & Drilling ETF(XOP Quote)

iShares now has:

• iShares Dow Jones U.S. Oil Equipment & Services(IEZ Quote)
• iShares Dow Jones U.S. Oil and Gas Exploration & Production(IEO Quote)

Both the State Street and iShares products are so new that there is very little history to examine in this alphabet soup of ETFs, so let's take a broad look.

There is a lot of overlap in the funds. The two E&P vehicles share seven of their respective top-10 stock holdings. The State Street E&P fund does have small weightings in Exxon Mobil and Chevron Texaco(CVX Quote), while the iShares E&P fund avoids those mega-cap names. If you have energy exposure that includes those two companies, you may want to favor the iShares fund, IEO, to avoid duplication.

The two equipment and services funds are also quite similar, having nine out of the top stocks in common. Here I would give the nod to the State Street product, XES, because the largest holding, Schlumberger(SLB Quote), only comprises 3.8% of the fund, compared to 17.6% in the iShares version.

The importance of this portion of the energy sector should be clear. Everyone knows that energy prices are high by historical standards. I believe they will stay high for the simple reason that demand is growing faster than new supply is coming onto the market.

The context of this idea needs to be viewed properly. Too often, when TV commentators talk about this, they narrow the discussion to this year's driving and hurricane seasons. I think the proper context is to think in terms of years. As Ned Davis pointed out in Barron's last weekend, the U.S. uses 25.8 barrels of oil per capita per year; China uses 1.8 barrels, and India 0.8 barrels. Since each of the latter two countries has more than 1 billion inhabitants, even small upticks in consumption in those areas could have a big impact on global demand.

This dynamic makes the energy sector attractive. The biggest threat to a given integrated oil company is dwindling proven reserves, or even the appearance that reserves could be dwindling. This is where E&P and equipment and services come in. Not to be too simplistic, but these companies work with the mega-cap integrated companies you have heard of here at home, and they also work with the national oil companies in all of the other oil-producing countries in the world.

These ETFs allow investors to capture these companies without having to be an expert on the geopolitics of Nigeria or Bolivia. Owning the wrong single stock during a political crisis can cause some damage in a portfolio, whereas the impact of, say, Hugo Chavez, has less impact on an investment product.