Energy ETFs

Energy serves many purposes in our daily life ranging from cooking a meal to heating the house and from running machinery in a factory to flying a plane. Energy is in short supply and the rapid increase in population is not helping matters any. Oil has been the major source of energy, but in recent times other sources of energy have also been tapped. So today we generate energy not only from running water but also the sun, the wind and even some agricultural products.

In a situation where the demand for energy is so high, it is surely not available cheap. As an individual investor if you want to cash in on this huge demand, investing in energy is a good idea. Though investing in energy commodity futures and energy company stocks has been prevalent for a long time, energy ETFs have now become quite popular.

‘Energy ETFs’ can mean Energy Commodity ETFs or ETFs of energy related stocks.

Energy Commodity ETFs:

These energy ETFs are funds invested in energy commodities like oil or natural gas. These funds don’t actually hold stock of this commodity and invest in the commodity futures.   These ETFs could be single commodity ETFs such as an ETF for light sweet crude oil, an ETF for heating oil or Natural Gas ETF. They could also be multiple commodity ETFs wherein the investment is in more than one energy commodity.

Advantages of Energy Commodity ETFs:

  • Investing in energy ETFs serves as a hedge against inflation. This is because in times of inflation the percentage rise in energy prices is much higher than the rise in the inflation rate.
  • Energy ETFs can also be used as a hedge against variation in currency values as energy prices and the dollar usually move in opposite directions.
  • Emerging economies like China and India are growing at a very fast pace. One way to participate in their growth is to invest in energy ETFs as energy consumption in these countries is very high.
  • Since energy ETFs invest in the respective commodity futures contracts, at the time of contract expiration, it has to be rolled over i.e. the expiring contract has to be sold and the contract of the next month or period has to be bought. In the case of energy commodities, the rolling over usually yields a profit called backwardation as longer term contracts are priced lower than the near-term contracts. Rolling over of other commodity futures generally causes a loss known as ‘contango’.

ETFs of Energy Related Stocks:

These are also energy ETFs but instead of investing in energy commodities they invest in stocks of companies involved in exploration and production of energy products like oil, natural gas and coal. The basis of weightage is decided upon and investment is spread over various companies. The volume of investment across companies may be equal or could be based on market capitalization of these companies or fundamentals like earning performance.

Alternative Energy ETFs:

‘Go Green’ is the slogan these days. In addition to environmental concerns there is also the problem of the decline of the world’s oil reserves and the demand for energy exceeding supply, both factors pushing up oil prices. So, technologies have been developed to generate energy from alternative sources like the wind and the sun. Bio-fuels and nuclear energy are also much in demand. Alternative Energy ETFs invest in the stocks of companies producing energy from these alternative sources.    The demand for energy will not come down anytime in the foreseeable future and energy ETFs would prove to be profitable investments for individual investors.