U.S. Energy ETFs

Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The U.S. is constantly in a state of change, and it can be very difficult to find clear and accurate information about the state of the economy. Railroads form one of major parts of the nations' transportation networks, and their week by week data provides an up to date and accurate look at which  sectors are growing and which are shrinking. Turning on the television or visiting any news site can easily lead to information overload. Within the modern "always online" mentality, differentiating between monstrous amount of useless and useful information is very challenging. By looking at railroad data we gain accurate and pertinent information that helps to cut through the stream of opinions.

<table> <tbody> <tr> <td> </td> <td> <p>Cumulative, 44 Weeks,</p> <p>Ending November 3, 2013</p> </td> </tr> <tr> <td>Coal</td> <td>-10.3%</td> </tr> <tr> <td>Grain</td> <td>-9.0%</td> </tr> <tr> <td>Petroleum Products</td> <td>44.1%</td> </tr> <tr> <td>Motor Vehicles & Equipment </td> <td>17.0%</td> </tr> <tr> <td>Estimated Ton-Miles</td> <td>-2.1%</td> </tr> </tbody> </table>

(Data from the Association of American Railroads)

Coal

Coal traffic is down more than ten percent relative to last year. This is due to the fraking boom, which has pushed natural gas prices very low and thus caused utilities to switch to natural gas where possible. U.S. exports of coal have increased over the past couple years, but exports are still less than domestic consumption. Natural gas prices have started to come out of the downturn, but in the meantime many coal miners are selling at depressed prices.

Investing in coal through ETFs is rather difficult, as Market Vectors Etf Coal Etf Usd (NYSEMKT: KOL) is one of the best coal ETFs available for U.S. investors but has a large amount of exposure to Southern Asia. This heavy exposure to Asia is a negative as the energy markets are somewhat localized. The dynamics between increasing U.S. natural gas prices and increasing U.S. coal prices is unique to the U.S. market. Given the lack of North American LNG facilities, there is not a strong convergence between Asian energy prices and U.S. energy prices. Even with an average P/E ratio of 10.83 and a reasonable price to book ratio of 1.34, KOL's Asian exposure decreases its attractiveness. 

Petroleum 

Petroleum products saw a major increase of 44.1% relative to the first 44 weeks of the past year. This is totally understandable with the continued growth in the oil sands and other non-traditional resources coupled with the lack of pipeline development. Given the lack of pipeline capacity some firms are finding it cheaper to place their oil on tanker cars and pay 31$ a barrel to transport their petroleum directly to the refineries in Louisiana, as opposed to sending it to Cushin,g Oklahoma via pipeline. 

A good way to invest in the oil industry is to consider ETFs like Energy Select Sector SPDR (NYSEMKT: XLE). This ETF has a focus on the larger and more diversified oil firms. As the recent IEA report states, the U.S. energy sector is bound for strong growth over the coming decades. The oil majors are well positioned to benefit from this growth, as their large capital base and experience in upstream, midstream, and downstream operations gives them the ability to weather the business cycle and come out on top. Their refineries are able to benefit from pricing variation between different types of crude which helps to lessen the decrease in revenue from their lower prices which their non-traditional petroleum resources receive. Exxon and Chevron come in at 19.37% and 15.17% of the sector holdings, respectively, and have a good mix of upstream and downstream assets. 

Other ETFs like United States Oil Fund LP (NYSEMKT: USO) and United States 12 Month Oil (NYSEMKT: USL) should be avoided. USO invests in front month oil futures contracts. This allows the ETF to track daily changes in WTI, but this is not a sustainable method to invest in oil over the long term. The monthly rollover costs decrease performance of the fund and make it better suited for short term speculation. The expense ratio of .45% is reasonable, but it does not change the underlying fundamentals.

USL invests its' funds over a 12 month period and thus helps to decrease some of the short term volatility found in the oil price. Still, the fund is forced to pay roll over costs which decreases its performance over the years. The .60% expense ratio is a full 15 basis points higher than that of USO and should make long term investors think twice about placing their funds here. 

Conclusion

Recent railroad data shows major changes in the volumes of coal and oil. As new energy sources come online, the diversity of the oil majors allows them to generate strong ROE from upstream and downstream operations. In the midst of the current difficulties of transporting oil sands oil to market, the downstream segments are able to help stabilize earnings. U.S. coal miners are returning to profitability as natural gas prices edge upwards, but it is easier to invest in individual U.S.-based coal miners than find a coal ETF based on the U.S. market. Looking at the hard numbers offers a quick and simple way to see what is actually happening in the economy and where the investment trends are. 


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