Energy ETFs Could be Worth the Risks

Despite a trying set of macro factors and disappointment emerging from last weekend's Doha meeting, the Energy Select Sector SPDR (NYSEArca: XLE ) , the largest energy equity-based exchange traded fund, is higher by nearly 4% over the past month. Some market observers see the energy sector's risk/reward as favorable.

U.S. oil producers may be rallying on more optimistic earnings bets. The energy sector has suffered some of the most pessimistic first quarter projections, which leaves the oil producers a lot of room to surprise on the upside. In fact, some traders are betting on more upside for the once downtrodden energy patch. As oil prices drag on oil company shares, the correlation between stocks and oil potentially weakened to some extent, which may have benefited broad benchmark investments in the event of further crude oil weakness.

However, plenty of skeptics remain regarding oil's fundamental outlook.There might be something to that skepticism as many of the world's major ex-U.S. producers of oil have not displayed a willingness to pare production. Even the output reductions in the U.S. have been modest. The good news is U.S. shale output is slightly declining, but challenges remain on the output front from OPEC producers.

"Our balanced outlook for 2016 is influenced by our macro and commodity outlook (2H17 commodity balancing) in the second consecutive trough year. Our current target prices are based upon $60/bbl, that reflect some recovery value(25% above forward curve) yet also embeds risk represented by the Morgan Stanley commodity team's outlook for $33/bbl in 4Q16. Our downside risk is based upon a $50/bbl implied price, reflecting an historical $20/bbl forward premium to our commodity team's $30/bbl 2016 call," according to part of a Morgan Stanley note posted by Ben Levisohn of Barron's .

The bank's picks among exploration and production firms are "defensive" and include XLE holdings such as Anadarko Petroleum ( APC ) and Occidental Petroleum ( OXY ).

Trending on ETF Trends

Emerging Markets ETFs Show Surprising Oil Correlations

Japan, Europe ETFs Climb Above Long-Term Trend

How Central Banks Could Affect Latin America ETFs

Russia ETFs Surge Thanks to Rebounding Brent Oil

Oil Services Equipment ETFs Gaining Momentum

Oil majors have tightened their belts, reducing costs by laying off thousands of workers and halted many new projects. Large integrated oil companies are expected to hold up better than drilling stocks as these giants have both upstream exploration and production, along with downstream refining operations.

For longer-term investors, Morgan Stanley is even more enthusiastic.

"In each of our recovery scenarios, the upside to NAV reflect the commodity price required to deliver the call on US production in 2019,and is ~166%, 107%, and 40%, in our Bull, Base, Bear cases, respectively. Hence a favorable longer-term risk/reward. The risk/reward is more relevant to investors with a long-term investment horizon, yet it also supports positioning in markets with similarly low near-term conviction in many sectors," according to the bank's note posted by Barron's.

Energy Select Sector SPDR

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article was provided by our partner Tom Lydon of etftrends.com.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.