The Best ETFs for Rising Oil

As turmoil sweeps the Middle East, and citizens clash with the governments of major oil-producing nations, the price of crude continues an accelerating upward march. Which investments can help you make the best of these turbulent times -- and which should you avoid?

On The Motley Fool's Twitter feed, Foolish follower @SamDieselPower recently asked:

Oil is set to rise in the near future due to the Middle Eastern conflicts. Any good ETF plays you like?

We posed that question to a trio of Fools and asked for their best ideas for simple investments in response to ever-more-expensive oil. Remember, their ideas aren't highly refined buy recommendations -- just crude ideas that demand your further due diligence.

Coming up short (term)
Dan Caplinger, Fool financial editor
I can think of several exchange-traded funds that might work as short-term trades -- but that doesn't make them suitable for long-term investors.

Energy stocks are an obvious way to play higher oil prices. But as we discovered with the BP oil spill, energy companies face risks that aren't related to the price of oil. That risk led to investors trying to find ways to invest in oil directly, rather than through energy stocks.

Five years ago, the United States Oil Fund (NYSE: USO  ) began trading with the intent of tracking the price of oil. From day to day, it does a reasonably good job of doing so. Similar funds exist for other energy commodities, including United States Natural Gas (NYSE: UNG  ) and United States Heating Oil (NYSE: UHN  ) .

Unfortunately, over the long run, these ETFs haven't tracked the prices of the underlying commodities well. Because the ETFs invest in futures, they're vulnerable to pricing anomalies in the futures markets. And because of a technical condition in energy futures known as contango, the oil ETF hasn't kept up with the price of crude, and the natural gas ETF has lost a huge portion of its value.

If you want to play energy for a short-term trade, these ETFs will get the job done, without the risk that buying shares of energy companies involves. But for a long-term play, a standard energy stock ETF is a better investment than these commodity-linked ETFs.

More on those terrible two
David Williamson, Fool financial editor
In the commodity space, knowing which ETFs to avoid is often easier than finding the perfect match for your portfolio. While the obvious choice for exposure to climbing energy prices would be either the United States Oil or United States Natural Gas ETFs, investors in these funds will likely tell you a sob story.

Because of contango and scheduled rolls, these ETFs are often forced to buy high and sell low – a losing investment strategy if ever there was one. UNG has lost more than 85% of its value in the past three years, and USO is only up 2% in the last 12, during a period in which oil prices have skyrocketed.

You'd be better served finding a fund that invests in energy companies instead of the underlying commodity itself. With holdings spread between integrated majors like Chevron, downstream operators like Sunoco, and small players like Denbury, something like SPDR S&P Oil & Gas E&P (NYSE: XOP  ) should do the trick. And compared to the pure commodity funds, XOP is the clear performance winner. It's returned more than 50% to investors each year over the past two years.

Here comes the sun
Travis Hoium, Fool contributor
When considering how higher oil prices will affect both the economy and global politics, I like to take a long-term view. We learned in 2008 that there's a point where the economy can no longer absorb higher oil prices without seriously hurting economic activity. We may not be there quite yet, but at $100 a barrel, we're getting awfully close.

When oil reaches prices like we're seeing today, it not only changes the economy, but also the political discussion about energy. The "powers that be" will begin looking for ways to reduce our reliance on oil (particularly foreign oil). The best way to do that in the long term involves renewable energy, and solar in particular.

Solar energy is no longer a pipe dream. With major players like efficiency leader SunPower and polysilicon cost leader Trina Solar trading below 10 P/E ratios, there's a lot of value in this high-growth sector.

Market Vectors Solar Energy ETF (NYSE: KWT  ) and Guggenheim Solar ETF (NYSE: TAN  ) are great ways to invest in the shift toward renewable energy without having to pick a specific winner. The Market Vectors fund is my choice, with better diversification than the Guggenheim fund, but both will give you exposure to high-quality companies in solar. As oil prices rise and solar costs fall, the sector is in a sweet spot for investors with a long-term view. That's why it's my pick to combat higher oil prices.

We want your questions!
Thanks to SamDieselPower and all the Foolish followers who've sent us questions via our Twitter feed. If you've got a burning question about personal finance or investing, tweet it to us @TheMotleyFool, or post it in the comments below. Your query could become the subject of a future Fool article!

Chevron is a Motley Fool Income Investor pick. The Fool owns shares of Denbury Resources and SunPower. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Travis Hoium (@FlushDrawFool) owns shares of SunPower, but neither Dan Caplinger nor David Williamson owns shares of any of the companies or ETFs they wrote about. Fool online editor and lead Tweeter Nathan Alderman holds no financial position in any of the stocks or ETFs listed and is glad his car gets around 40MPG on the highway. 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.

Read/Post Comments (1) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 01, 2011, at 2:04 PM, jimmy4040 wrote:

    You DO have to know how to pick and USO isn't very good. However DIG is up almost 100% in the last year. (thank you Jesus!) and it carries a dividend yield of O.63%.

    If you want something very illiquid, BNO is the way to go because it tracks only Brent Crude.

    These are strictly bull market plays however, so when you see things changing, get out!

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