The 5 Best Oil ETFs

By Markets Fool.com

Photo by: Getty Images.

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An explosion in ETFs has left investors with so many choices that it's difficult to separate the best ETFs from the worst. I've taken a deep look into many oil exchange-traded funds on the market and determined that these five are my picks for the top funds for oil investors and speculators alike.

ETF Name

Ticker

Type

Expense ratio

United States Oil Fund

USO

Oil index ETF

0.74%

iShares U.S. Oil & Gas Exploration & Production ETF

IEO

Oil stock ETF

0.44%

SPDR S&P Oil & Gas Exploration & Production ETF

XOP

Oil stock ETF

0.35%

VanEck Vectors Oil Services ETF

OIH

Oil stock ETF

0.35%

SPDR S&P Oil & Gas Equipment & Services ETF

XES

Oil stock ETF

0.35%

Source: iShares, U.S. Commodity Funds, State Street Global Advisors.

Here's the case for each ETF listed above, complete with a table to show you how historic fluctuations in oil prices have affected the performance of each fund.

The oil ETF for speculation

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When it comes to speculating on the price of oil, there is no better exchange-traded fund than United States Oil Fund. This fund tracks futures prices for West Texas Intermediate (WTI), sweet crude oil delivered to Cushing, Oklahoma. Commodity nerds should recognize that this is the futures contract quoted frequently on television and in the financial press as a benchmark for oil prices in the United States.

The United States Oil Fund offers direct exposure to the front-month futures contract, or the futures contract nearest to expiration. It holds these contracts all the way up to two weeks until expiration, before rolling them into the next month's futures contract.

The process of rolling over contracts each month creates a somewhat unfortunate decay in the value of the fund over time. Generally, longer-dated futures contracts are priced higher than shorter futures contracts. Thus, January oil futures might sell for $50, while February oil futures are priced at $53 per barrel. When the fund rolls over its positions, it will effectively sell oil at $50 a barrel to buy it at $53. A reliance on futures makes this ETF is only suitable for short-term speculation on the price of oil, as over the long haul, this fund will slowly drift toward $0, a weakness of many commodity ETFs.

Investment/Year

2010

2011

2012

2013

2014

2015

Spot WTI

15.1%

8.2%

-7.1%

6.9%

-45.6%

-30.5%

USO

-0.5%

-2.3%

-12.2%

5.4%

-42.8%

-45.3%

Sources: EIA.gov, Morningstar

An ETF for giant oil producers

The iShares U.S. Oil & Gas Exploration & Production ETF is an excellent investment for risk-adverse oil investors, as it skews toward giant capitalization companies rather than more speculative small cap wildcatters.

Although the fund is diversified -- it held 53 E&P stocks at the time of writing -- it is heavily concentrated among its top five investments, which made up approximately 38% of the portfolio.

E&P stock

Percentage of portfolio

Conoco Phillips

10.2%

EOG Resources

9.7%

Phillips 66

6.9%

Pioneer Natural Resource

5.7%

Andarko Petroleum Corp.

5.3%

Total top 5

37.8%

Source: iShares

The fund's bias toward mega and large-cap companies ensures that it will neither be the best performer during oil price spikes, nor the worst performer when oil falls. You'll notice that it is significantly less volatile than the next ETF, which invests more heavily in small- and mid-cap E&P companies.

Investment

2010

2011

2012

2013

2014

2015

Spot WTI

15.1%

8.2%

-7.1%

6.9%

-45.6%

-30.5%

IEO

19%

-3.3%

4.4%

30.6%

-12.3%

-24.6%

Sources: EIA.gov, Morningstar

An ETF for small and midcap oil stocks

The SPDR S&P Oil & Gas Exploration & Production ETFis a compelling fund for investors who want to own shares of smaller companies that profit from the actual exploration and production of oil. The fund's methodology results in broad diversification, and a portfolio that is more heavily weighted toward small- and mid-cap oil companies.

The fund holds companies with a float-adjusted market cap of $500 million or more, and equal weights each stock in its portfolio. Thus, oil giants such asExxonMobilmake up just as much of its portfolio as smaller companies like SM Energy Company or RSP Permian. (The fund held all three of these companies at the time of writing.)

The impact of the ETF's small cap bias can be seen in its performance by year. Returns vastly exceeded the change in oil prices during a surge in production activity and investor belief that American oil producers could pump profits from the ground for years on end. However, when oil prices declined starting in 2014, small company stocks were hit with losses that vastly exceeded those of major oil company stocks.

Investment

2010

2011

2012

2013

2014

2015

Spot WTI

15.1%

8.2%

-7.1%

6.9%

-45.6%

-30.5%

XOP

28.5%

95%

3.9%

27.9%

-29.5%

-35.7%

Sources: EIA.gov, Morningstar

ETFs for oil services companies

Oil services companies are general more volatile than producers. Though the services industry can remain profitable when E&P companies are losing money, at least for a short period, services revenue and profits sharply follow drilling and transportation needs. Thus, when producers are cutting costs, service company earnings will fall. When producers are spending heavily on new production, service company earnings will rise sharply.

The VanEck Vectors Oil Services ETF is a highly concentrated bet on oil services companies, holding just 25 stocks at the time of writing. The fund's market cap weighting results in a fund where the three-largest positions -- Schlumberger (21.8% of assets), Halliburton Co (15.7%), and Baker Hughes (5.8%) -- will naturally have an outsize impact on its performance.

The SPDR S&P Oil & Gas Equipment & Services ETF may be a better choice as it is more diversified due to its larger portfolio of 34 stocks, and because it weights each company equally. The equal weighting results in a portfolio that is slightly biased toward smaller companies in the services industry. Note, however, that this fund is no true pure-play. Approximately one-third of assets are invested in the drilling sub-industry rather than services alone.

Investment

2010

2011

2012

2013

2014

2015

Spot WTI

15.1%

8.2%

-7.1%

6.9%

-45.6%

-30.5%

OIH

N/A

N/A

2%

25.9%

-23.6%

-24.5%

XES

30.2%

-5.2%

0.6%

27%

-34.7%

-36.5%

Sources: EIA.gov, Morningstar

The right ETF for you

Ultimately, the right ETF is one that matches your particular view on energy. For the speculator who would prefer to trade ETFs than futures contracts, United States Oil Fund is an excellent choice, but it shouldn't be used as a mechanism to speculate on long-term oil fluctuations, due to its natural price decay.

Investors who simply want to add a little extra oil exposure to their portfolio, but not take any undue risks in doing so, should prefer theiShares U.S. Oil & Gas Exploration & Production ETF, as it has a bias toward larger and less-risky oil producers. Those who have a view that oil prices will rise considerably over a long period of time might favor the small-cap bias of theSPDR S&P Oil & Gas Exploration & Production ETF, which naturally has more leverage to oil prices due to the fact that it is heavily invested in smaller companies.

Importantly, these ETFs are relatively inexpensive to hold and have sufficient trading volume to ensure that the price of the ETF follows its underlying index with precision over time.

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of EOG Resources, ExxonMobil, and Halliburton. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.