Three ETFs for the Unconventional Oil Revolution


"While the situation may seem dire in many of these important oil markets, North American oil production is actually on the rise as of late thanks to new technologies in the space."

While economic weakness and a strong dollar have kept oil prices depressed for the time being, many are still long-term bulls on the vital commodity. The world population grows at a rate of roughly 1% per year while surging economic growth in the BRIC bloc-- as well as other emerging nations-- looks to keep pressure on oil prices well into the future.

Beyond this, many of the world's key oil fields are reaching or have gone past their peak production levels, suggesting that many of the top spots for the commodity will see declining rates of output in the near future. This trend has already begun to take place in Saudi Arabia's massive Ghawar Field, Mexico's Cantarell Field, and Alaska's Prudhoe Bay, forcing many major oil companies to look elsewhere for large amounts of recoverable supplies (see Two Energy ETFs Holding Their Ground).

While the situation may seem dire in many of these important oil markets, North American oil production is actually on the rise as of late thanks to new technologies in the space. According to representatives from the DOE, domestic production is up 15% year-over-year pushing the total output to the highest level in more than a decade.

This has largely been the result of greater use of fracking technologies and better processes to unlock oil from oil sands and shale. North America has massive quantities of both of these types of oil and with prices significantly elevated from a decade ago and new technology hitting the market, these once irrecoverable oil deposits are now capable of hitting the market (see 11 Great Dividend ETFs).

In fact, between shale and sands, total reserves could approach the equivalent of several trillion barrels of oil, enough to completely alter the landscape in terms of hydrocarbon production. Conoco Phillips' CEO said as much during a recent OPEC conference, stating that North America could become self sufficient in oil by 2025.

Obviously if we can ever see this happen or even oil production reach anywhere close to this figure, a greater focus on unconventional oil sources will have to be taken. Investment in the space will need to increase and technology will also have to improve from its current levels, but even the fact that such a prominent CEO can put this in the realm of possibilities is certainly promising.

While playing the beginning stages of this trend is certainly possible via any number of individual stocks, this approach could produce high levels of volatility and miss out on some of the big winners as well. Instead, many investors may be better served by taking an ETF approach in the market instead, in order to get wide exposure to the space across a number of different firms (see Three ETFs for The Energy Efficiency Boom).

Luckily for investors, the ETF market has been growing by leaps and bounds over the past few years and a number of products exist that hone in on the space. In particular, we believe that the following three ETFs could be big winners from the coming energy revolution in the North American market:

Market Vectors Unconventional Oil & Gas ETF (FRAK)

FRAK tracks the Market Vectors Unconventional Oil & Gas Index, which is a rules based benchmark designed to track the overall performance of the unconventional oil market. The firm has this include firms that are engaged in any of the following businesses; coalbed methane, coal seam gas, shale oil, shale gas, tight natural gas, tight oil and tight sands.

This produces a fund that holds about 45 companies in its basket while the vast majority is in exploration and production companies. This sector accounts for nearly 80% of the total, leaving just a fraction for integrated oil companies, pipelines, and the coal sector (read Play An Oil Bull with These Three Emerging Market ETFs).

Top individual names in this market cap weighted fund include Anadarko, Occidential, and Canadian Natural Resources. Overall, the entire portfolio is in North American firms with a 73/27 split that favors the U.S. over Canada.

Volume is somewhat light in this fund that just debuted in February but the product has already accumulated a decent amount of assets in the short time frame. However, the fees are a few basis points higher than others in the category at 54bps and dividends could be lighter thanks to a heavy focus on the exploration and production segment.

Sustainable North American Oil Sands ETF (SNDS)

This relatively new product looks to track the most liquid U.S. and Canadian firms that are investing in Canada's oil sands market. This includes companies that are engaged in any of the following aspects of the market; oil exploration, production, refinement, marketing, storage, transportation and services.

Currently, the ETF holds 32 securities in its basket and it has a heavy focus on integrated oil and exploration/production firms. Beyond these securities, pipeline & distribution stocks, as well as engineering, trading, and equipment, round out the rest of the product.

Investors should also note that the fund is almost entirely focused on large cap blend stocks with some giant caps making their way into the product such as ConocoPhillips, and Chevron. However, a number of more targeted small caps also find their way into the product including Nexen and Oil States International.

In terms of volume, SNDS still trades at a light level, suggesting that bid ask spreads may be quite wide. However, expenses are reasonable at 50 basis points a year and the yield is likely to be pretty solid thanks to the inclusion of a number of large cap oil stocks and big dividend paying pipeline securities (also read Inside The Forgotten Energy ETFs).

Guggenheim Canadian Energy Income ETF (ENY)

This ETF takes a slightly different approach to the sector, offering up a mix between royalty trusts and oil sands producers by tracking the Sustainable Canadian Energy Income Index. This looks to combine the highest yielding Canadian energy securities with the most highly focused oil sands producers with exposure based on crude oil prices.

When crude oil is determined to be in a bull market, the product has a 70% weighting to oil sands and puts just 30% in the royalty trust space. Meanwhile, when oil is in a bear phase-- when the current quarter's price is below the four quarter moving average price-- the focus shifts towards high yielding securities in a 70%/30% split.

At time of writing, the fund is skewed towards exploration and production companies as these account for nearly 60% of assets while integrated firms make up another 26%. Top individual weightings go to Imperial Oil, Suncor Energy, and Canadian Oil Sands, all of which make up about 7% of total assets each.

It should also be noted that pretty much the entire fund is denominated in Canadian dollars so there is some foreign currency risk as well. However, this could make it more of a pure play on the Canadian oil boom, something to consider if investors are looking for a broad play on the North American oil market or just a bet on the Alberta oil sands and related areas.

Thanks to the more involved rebalancing strategy, this product is the most expensive on the list, coming in at 70 basis points a year in fees. However, it is also the most popular with $91 million in AUM and solid volumes that can help keep the bid ask ratio at a decent level.

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Author is long ENY.

Eric Dutram
Zacks Investment Research

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