The energy industry is having a moment this year. Driven by high oil prices, oil companies are posting record profits. That includes Canadian oil companies, which are selling and transporting oil at prices not seen in a long, long time.
It would be dishonest not to mention what is likely driving all or most of this:
The war in Iran.
U.S. strikes on Iran have caused a de facto closure of the Strait of Hormuz, while conflict between Iranian-backed Houthis and Saudi Arabia has severely disrupted shipping in the Red Sea. Both the Strait of Hormuz and the Red Sea are key oil transportation corridors, and the flow out of them has been shut down (Hormuz) or disrupted (Red Sea). As a result, the price of oil has been rising precipitously.
Obviously, there are ethical issues with investing based on the expectation of continued conflict, and those who do it risk losing money when the conflict in question ends. Nevertheless, the Canadian energy sector is very strong right now, and it’s only natural to think about adding some exposure to one’s portfolio. With that in mind, here’s what I think is the best Canadian Energy ETF to own as oil prices surge.
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The iShares TSX Energy ETF
The iShares S&P/TSX Capped Energy Index ETF (TSX: XEG) is an index fund of Canadian energy stocks that focuses exclusively on upstream and integrated energy producers. This focus on upstream and integrated energy companies holds back the fund’s yield and reduces its diversification somewhat, because it excludes pipelines, which usually have very high yields. The flip side of this industry focus is it makes the fund more of a direct bet on oil prices.
Upstream energy means exploration and production. Basically, seeking out oil and gas fields, then extracting and selling the resources they hold. The sector naturally makes money off of higher oil prices. Integrated energy includes upstream as well as things like refining, and can include midstream (i.e., pipelines) too, but is usually mostly upstream and refining. Refining earns its greatest profits when the spread between the oil price and the price of refined products is highest.
Midstream earns its greatest profits when it has many clients paying tolls to use its infrastructure. That situation often correlates with high oil prices, but these contracts are typically very long-term and negotiated far in advance. So midstream energy doesn’t have the same level of near-term correlation with oil prices that upstream and even integrated energy do.
So, if you think that oil prices have a good future, then XEG is the best Canadian energy ETF – or belongs among the best Canadian energy ETFs – to bet on that future.
I should stress once more that it’s both unethical and often financially mistaken to “bet on” wars lasting for prolonged periods of time. Peace is a universal human ideal for a reason. With that being said, the current moment is bringing energy prices front and centre, and while the conversation is being forced upon us, there are reasons apart from war to think that oil prices will remain reasonably healthy for a long time. Two major factors are slowing supply growth along with continued demand, driven by the rise of emerging markets (e.g., India, Africa, Southeast Asia) where renewables aren’t going to be as developed as they are in the West or East Asia for some time. So, getting some Canadian oil exposure in your portfolio can make sense now, and XEG is one of the best ETFs with which to get it.
Fund basics
Before concluding, I should briefly touch on XEG’s most basic fund characteristics.
XEG holds 26 stocks, which is a decent amount of diversification for a one-country sector fund. It has P/E and price/book ratios of 18.5 and 2.6, respectively, which are low. Finally, the fund’s bid-ask spread is usually between 0.03% and 0.07%, which means that trading fees are likely to be minimal.
Taking all of the above into account, XEG looks like a decent fund through which to gain exposure to Canadian oil and gas stocks.
