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The iShares U.S. Energy ETF (NYSEARCA:IYE) is a US energy ETF that is focused more on integrated and E&P oil companies, and therefore has more commodity exposure. The situation in oil markets is pretty favourable in particular from the supply side, but with some demand side headwinds for investors to worry about, we think that the iShares North American Natural Resources ETF (IGE) might be a better pick for investors thanks to its higher earnings yield and more diversity into less commodity exposed and cyclical stocks. We think that safety deserves a premium which IGE doesn't have relative to IYE.
The breakdown of IYE is as follows.
Sector Breakdown (iShares.com)
There is a lot of exposure to integrated oil and also oil E&P, so a lot of stuff that is pretty commodity exposed, but also to refinery and some oil logistics stocks.
Our view on oil is very favourable where supply dynamics support the oil price above pre-COVID levels, even though the price has retreated somewhat over the last few weeks and contributed to an easing of inflation. Refinery capacity is similarly limited with some of it being demised over the years as oil went underinvested, and refinery assets being converted for other purposes like renewable diesel. Nonetheless, both these buckets of stocks trade in relation to the oil price, where a decline in oil prices is usually connected with falling run-rates of refineries due to lower spreads, and obviously lower margin above breakevens for crude producers. Refinery is somewhat more resistant in fundamental terms to oil price declines as crude is its input, but crude declines usually signal issues with volumes.
Our concern is that the softer macroeconomic environment could become a further problem for the demand side of oil. So far, consumer pessimism is rampant, and corporate pessimism could soon follow, which might initiate an unemployment spiral. This is obviously not a desirable situation, and would hurt oil demand through channels like aviation, which is currently supporting oil's revival in the reopening.
We think that there are other stocks out there that provide the necessary margin of safety for whatever commodity risks investors might face in the oil segment of the market. But if you'd still like to consider an ETF, we might point to the IGE ETF. It is similar to IYE but it has more exposure to oil logistics and transport stocks, namely pipelines, which we like a lot. Moreover, it has other countercyclical exposures like gold. With more weight towards commodity agnostic stocks, we are surprised by its PE which is 16x vs the 18x on IYE. Generally, the safer economics would be given a premium on the market. Also the use of logistics in the US for oil is more agnostic to oil prices in relation to the lower breakevens shared by the US shale producers, which was the main concern for oil during the worst of the 2020 market situation. Overall, we prefer IGE on that basis, and think that at least with the current market setup, it is a strictly wiser idea than IYE.
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