American drilling is down, but oil inventories are 10% higher than last year as the rest of the world keeps pumping.
It's been a bad week for energy investors. Essentially all of the large energy company-focused ETFs finished the week down, with these three being the best -- or should I say least-worst -- performers:
What happened this week
Oil futures were up and down this week but finished roughly flat, with West Texas Intermediate just above $40 and Brent, the international benchmark, ending below $45 on Friday. Natural gas prices continued to fall, with the Henry Hub benchmark wholesale price finishing the week down 11% to $2.13 per MMBtu.
However, there was some potential "good" news for oil and gas prices on Friday. Baker Hughes Incorporated released its weekly rig-count report, and rig counts continue to decline globally. North American onshore and offshore rig counts declined by 20 from last week, leaving 943 oil and gas rigs operating. That's 60% fewer than were active one year ago. International rig counts fell about 3% from the last count between September and October and are down about 10% from a year ago. Almost all of that decline is happening in South America, while the Middle East continues to drill and pump oil at high levels -- at least for now.
According to the most recent Energy Information Administration weekly petroleum report, crude oil inventories are at levels the U.S. hasn't seen in some 80 years for this time of year, when demand is typically in a seasonal decline. Oil stocks are up about 10% from last year. That surplus of oil is a big reason oil prices have fallen in the second half of 2015:
Brent Crude Oil Spot Price data by YCharts
As to natural gas, even with the significant reduction in natural gas drilling rigs over the past year, U.S. production was up 2% from last year. Furthermore, there have been recent changes in the global supply-and-demand picture, with forecasts for expected Chinese consumption reduced by as much as 25%, which could mean that demand for exported gas won't be as robust as many have anticipated.
Impact on energy ETFs
iShares S&P Global Energy Sector ETF (IXC -0.80%), Energy Select Sector SPDR ETF (XLE -0.94%), and First Trust North American Energy Infrastructure Fund (EMLP -1.11%) all own shares of midstream giant Kinder Morgan Inc. (KMI -0.88%), while the first two ETFs are also heavily invested in two of the biggest integrated oil majors, ExxonMobil Corporation (XOM -0.57%) and Chevron Corporation (CVX -0.86%). Here's how those companies' stocks did over the past week:
These companies' stocks largely moved this week in relation to a lack of good news for the industry. There really wasn't anything material reported about ExxonMobil, Chevron, or Kinder Morgan, which make up well more than 30% of the holdings in both the iShares S&P Global Energy Sector ETF and the Energy Select Sector SPDR ETF. Kinder Morgan makes up almost 8% of First Trust North American Energy Infrastructure Fund, which invests in companies in the midstream segment of the energy business.
Looking ahead
The oil and gas markets continue to roil, and there's no clear end in sight. Some are predicting that OPEC producers will soon be forced to start cutting production to push prices up, but that song and dance has been playing at times for more than a year, with no result. Factor in impending increases in production from Iran soon, and it's possible that OPEC's output could increase before it falls.
At the same time, many of the companies owned in all three of these ETFs operate in segments that are less affected by oil or gas prices, while many of the producers continue to refine their operations and develop lower-cost techniques to extract oil. And the companies that can't figure out how to produce profitably at the current price will eventually get acquired or fail, while the ones that can, will grow.
This is one of the benefits of investing in these high-quality energy sector ETFs -- you gain exposure to many of the largest and best companies out there. Those are the ones that should benefit from new technology and a recovery in prices. Stay tuned for another update next week.
