Is there any correlation between Oil Prices and Energy Companies?

marathonic

Take for example, this ETF:

https://www.spdrs.com/product/fund.seam?ticker=xle

It has an annual expense ratio of 0.18% and invests in a wide range of energy related companies, with the top holdings being Exxon, Chevron and Schlumberger.

If there was a direct correlation, in that a 10% rise in oil prices would result in a 10% rise in this ETF, then one could purchase a holding in this ETF to hedge against a rise in the price of their home heating oil.

I'm guessing that gauging the correlation would be very difficult and that the index would probably rise by more than the actual rise in oil prices given that the companies fixed expenses should remain relatively stable regardless of oil prices.

How could you, or could you, hedge against oil price changes by investing in these companies?

Looking at the top holdings, they appear to increase their dividends by approximately 10% per year. Perhaps you could use this, combined with the expected growth in capital value as a result of increased profitability.

Let's say you spend £1,000 per year on oil and want to hedge a little against this expense. If you invested £10,000 in the top two companies in the index, you'd have a dividend yield of 2.75% (or £275).

If oil rose by 10%, you might expect the companies profits to rise by 20%, half of which would be distributed as an addition to the current dividend. The remaining half would be invested within the company and should result in share price growth.

Therefore, your home heating oil might rise by £100 but you'd get an extra dividend of £27.50 as well as some growth in the capital value of your holding.

The problem I see with the above is that, in year two, you might get no rise in oil prices meaning that you still have to pay the £100 extra and only get the extra £27.50 dividend, i.e. no capital appreciation in the underlying shares.

I know that, should one invest enough that the dividends would cover your home heating oil, you'd be more than hedged. However, this would be beyond the reach of most investors, especially when the requirement for a diversified portfolio is taken into account, i.e. at a 2.75% yield, a £1,000 annual heating oil bill would require an investment of £36,363.

For what it's worth, I'd never consider putting more than 20% of my portfolio as a whole into the energy sector - and only that high a level if I considered it to be EXTREMELY undervalued.

I just find it interesting that, with an investment of about £9,000, it's possible that an investor could consider themselves 25% hedged against rises in the cost of an annual £1,000 fuel bill.

Jegersmart

Hey

Well, I won't go into why someone would need a hedge against heating bills in general, it would be very likely that one would need FX hedges before thinking about energy bill hedges...but in any case......

In this case, if one wanted to hedge or speculate on rising energy prices it would be far more correlative to do so by buying a Crude Oil Long ETF or similar, as there is a reasonable correlation between gas prices and crude oil - not total but a reasonable one.

The scenario you describe is more like buying gold mine equities to take advantage of rising gold prices.....and.....the correlation is quite.....errrmmm.....weak....:)

imho

J

marathonic

The problem with Crude Oil ETF's, like USO, is the fact that it invests in oil futures meaning that, every time it rolls those futures foward, you lose a little.

If oil stayed flat for a year, you could expect USO to drop quite a bit. The same effect is seen in Natural Gas ETF's, like UNG, except to a greater extent.

Ark_Welder