From August 26 to November 18, iShares Dow Jones U.S. Oil and Gas Exploration & Production Index (IEO) fell from the No. 25 position on our ETF Sector Momentum Table to the No. 84 spot. While IEO’s investors have felt the pain of a distinct decline in recent months, the market has begun to reevaluate oil’s new lows and look for opportunities, such as IEO, to get involved in a potential oil upswing in months to come. IEO tracks companies that are involved in several aspects of the oil and natural gas sector, including exploration, extraction, production, refining and supply. IEO represents one of the more liquid oil and gas exploration offerings in the market today, with the fund trading nearly a million shares daily over the last three months. While IEO began the year with a strong start as oil prices surged, the fund has seen a sharp decline in the second half of 2008 as oil sank at nearly the same meteoric speed as it rose.
Analysts at Morningstar have recommended IEO as a more conservative investment in oil for investors since late summer. In an interview on August 28, exchange traded fund specialist Paul Justice recommended IEO as a more diversified oil play when compared to IYE, the iShares Dow Jones U.S. Energy fund that has more than 35% of assets in two holdings. Morningstar reiterated this recommendation on November 7 in a column by analyst Scott Burns.
IEO, in contrast to IYE, has less than 23% of fund assets concentrated in the top two portfolio holdings. The largest holding in IEO’s index is currently Occidental Petroleum Corp. (OXY), with 12.18% of the fund’s assets as of November 21. OXY is an international oil and gas exploration and production company with operations in the United States, the Middle East/North Africa and Latin America. OXY explores for, develops, markets and produces crude oil, natural gas liquids and natural gas. On Monday, November 24, OXY penned a deal with Abu Dhabi’s Mubadala, one of the world’s most active state funds, to develop natural gas fields in Oman. The newly minted proposal set off a wave of speculation across the oil and gas sector as to other potential deals between Middle Eastern and U.S. oil companies in upcoming months.
The second-largest holding in IEO’s portfolio is Devon Energy Corp. (DVN), an exploration, development, production and transportation fund that specializes in oil and natural gas liquids. Concentrated principally within Texas and New Mexico, DVN’s oil and gas properties also include international stakes in Mexico and Canada. The business diversifies its interests through the construction and operation of pipelines and processing plants in North America. An alternative-energy push in the new administration could help to boost DVN, which stands to benefit from an increased interest in American natural gas programs. DVN could also attract in upcoming months more conservative investors that are looking to beat the market over an extended time frame—DVN has beaten the S&P 500 for the ten years that ended in October.
The anticipation of an increased demand for U.S. natural gas has also fueled another potentially profitable deal for IEO’s fourth-largest holding, EOG Resources (EOG). Pecan Pipeline North Dakota Inc., a subsidiary of EOG, has proposed the construction of a $45 million pipeline to feed natural gas from North Dakota into the Alliance Pipeline. The Alliance Pipeline carries natural gas from Canada to Chicago. EOG is currently awaiting approval from the Public Service Commission to begin building but anticipates that the pipeline could be finished by July if given the go-ahead. The proposal of this new deal is a glimmer of hope for many natural gas exploration investors, and a potential indication of increased prospects in the new administration. Commissioner Kevin Cramer noted that with the “increased activity in the oil fields of western North Dakota, and the high demand and price for natural gas, we’re seeing more of that natural gas captured and processed and put into the marketplace.”
While the precipitous decline of oil prices in recent months may make some investors hesitant to dive back into the oil sector, it is a worthwhile area to explore at today’s bargain prices. Oil is a limited resource, and the scarcity of this resource along with the recent push toward U.S. energy independence could help to boost shares of IEO in upcoming months. IEO’s top components have their fingers on the pulse of American energy, including natural gas, which many believe will be a key factor in supplying energy in the future. There has been no place to hide in the recent economic downturn, but IEO could represent a good pick for investors looking to reemerge on the upswing, with trusted U.S. companies vying for the future of energy.