Oil ETFs Are Battling Bearish Energy Earnings

Oil sector exchange traded funds are facing some hurdles as major energy producers ready their first quarter results. With overwhelmingly weak expectations after crude prices plunged to near 13-year lows in February, the sector ETFs could surprise if oil producers reveal conditions weren't as bad as previously expected.

Energy traders will be watching for the ConocoPhillips' (NYSE:COP) first quarter earnings announcement on Thursday, April 28, followed by Exxon Mobil (NYSE:XOM) and Chevron (NYSE:CVX) on Friday, April 29.

Since the start of the quarter, estimates for Exxon Mobil declined to $0.31 per share from $0.75 per share a year ago, Chevron estimates dipped to a $0.13 cent per share loss from a positive $0.55 cents a share and ConocoPhillips estimated per share loss fell to $1.05 from $0.19, according to FactSet data.

Of the 39 S&P 500 energy sector companies, 22 are expected to report a loss in earnings per share for the quarter, excluding Chevron.

The energy sector is expected to record its largest year-over-year decline in earnings of all 10 S&P 500 sectors at -110.3%, which reflects an aggregate loss of $1.33 billion in the first quarter, compared to an aggregate earnings gain of $12.92 billion in the first quarter of last year.

With most analysts expecting largely weak results from the energy producers over the first quarter, any signs that conditions are not as bad as previously expected will help lift the sector. Moreover, looking further out, with crude oil prices rebounding over 10% off their February lows, the energy sector could improve in the quarters ahead.

ETF investors may track the energy sector play to capture an ongoing recovery. For instance, the Energy Select Sector SPDR (NYSE:XLE), Vanguard Energy ETF (NYSE:VDE) and Fidelity MSCI Energy Index ETF (NYSE:FENY) all provide market cap-weighted exposure to the energy sector.

XLE tries to reflect the Energy Select Sector Index, which represents the energy sector of the S&P 500 Index. As a market-cap weighted index ETF, the fund is top heavy, with a 18.6% tilt toward XOM, 14.8% CVX and 3.2% COP.

Alternatively, VDE, which tracks the MSCI U.S. Investable Market Energy 25/50 Index, is slightly more diversified, as the index includes small-cap exposure, and comes with a cheaper 0.10% expense ratio, compared to XLE's 0.14% expense ratio. Nevertheless, VDE is still top heavy, with a 20.5% tilt toward XOM, 11.1% in CVX and 3.7% in COP.

Similarly, FENY follows the MSCI USA IMI Energy Index, which also includes small-cap exposure, and comes with a cheap 0.12% expense ratio. However, FENY is newer to the market has has less assets under management. The ETF's top holdings include XOM 25.0%, CVX 13.2% and COP 3.9%.

The energy sector ETFs may also be a good way for investors to realign their equity investment portfolios. After the sell-off in crude oil and producers over the past year, ETF investors with a diversified broad market investment may be underweight the energy sector. At their peak in June 2014, energy producers accounted for 11% of the S&P 500. However, energy companies only make up about 7.2% of the S&P 500 benchmark today. With oil prices rebounding off 13-year lows, investors following a market-cap weighted investment methodology may be under-allocated toward the energy sector.

Investors should also start thinking about positioning in the late-cycle phase. The late-cycle phases had an average duration of about a year and a half, with overall stock market performance of a little over 5% on an annualized basis, according to Fidelity. As the economic recovery matures, the energy sector has done well as inflationary pressures build and late-cycle economic expansion helps support demand.

Nevertheless, for more short-term traders, a poor first quarter result will weigh on the energy sector rebound. If the energy sector was excluded, the blended earnings decline for the S&P 500 would improve to -3.6% from -8.9%.

For those wary of continued volatility in the space, ETF investors can also play the U.S. equities sans oil exposure through targeted options. The ProShares S&P 500 Ex-Energy ETF (NYSE:SPXE) tries to reflect the performance of the S&P 500 Ex-Energy Index, which provides exposure to S&P 500 companies with the exception of those included in the Energy Sector.

Alternatively, ETF traders can also hedge against a turn in the energy sector through bearish inverse or short options. For those seeking a hedge against further weakness in the energy sector, the ProShares Short Oil & Gas (NYSE:DDG) tries to reflect the inverse, or -100%, daily performance of the Dow Jones U.S. Oil & Gas Index. The UltraShort Oil & Gas ProShares (NYSE:DUG) takes two times the inverse, or -200%, daily performance of the Dow Jones U.S. Oil & Gas Index. More aggressive traders can take a look at the Direxion Daily Energy Bear 3X Shares (NYSE:ERY), which reflects three times the inverse, or -300%, daily performance of the energy select sector index. Moreover, the recently launched Direxion Daily S&P Oil & Gas Exploration & Production Bear Shares (NYSE:DRIP) takes the -3x, or -300%, daily performance of the S&P Oil & Gas Exploration & Production Select Industry Index.

This article was provided by our partners at etftrends.com.