Energy exchange traded funds (ETFs) primarily are comprised of crude oil. Any by-products of crude oil are also included under the energy ETF family. Gasoline and natural gas are by-products of crude oil and are often included in the ETFs. Coal, diesel fuel, propane and kerosene are also included in the energy ETF family. ETFs are traded on exchanges like stocks so many of the same rules apply.
There are three main groups of energy ETFs that you should consider prior to making an investment decision. The three main types are listed below:
Single Contract Energy ETFs: Single contract energy ETFs are futures contracts that relate to one energy source. For instance, the most popular energy ETF, United States Oil Fund, falls in the single contract category of the energy fund. This particular fund trades approximately 8.8 million shares per day. The energy fund does trade other energy contracts, so some experts do not consider USO a “pure” single contract energy ETF. All futures in a single contract ETF should relate to the performance of oil.
The iPath S&P GSCI Crude Oil Total Return Index is an exchange traded note that is traded on the New York Stock Exchange under symbol: OIL. This ETN often participates in the trading of the West Texas Intermediate (WTI) light sweet crude oil futures on the New York Merchantile Exchange. WTI is the single contract that comprises the majority of the USO commodity ETF. The remaining portion of the ETF consists of other energy complex contracts. For this reason, it is not considered a “pure” single contract ETF. PowerShares DB Oil Fund also participates in the WTI contract.
Multi-Contract ETFs: Multiple contract energy ETFs are comprised of diversified commodities through several futures contracts. The different commodities may include crude oil, coal, gasoline, heating oil and natural gas. There are two types of multi-contract ETFs.
PowerShares DB Energy Fund is traded on the American Stock Exchange (AMEX: DBE) and focuses only on the energy sector but diversified with different commodity types. Commodity types consist of light sweet crude oil, brent crude oil, heating oil, gasoline and natural gas. This fund uses a proprietary formula to select futures contracts that will optimize roll yield and trades 330,000 shares per day.
By contrast, the iShares S&P GSCI Commodity Indexed Trust (NYSE: GSG) is comprised of two-thirds energy futures and one-third is in other commodities. This strategy is diversified across commodities rather than only the energy sector.
Bearish: With a bearish energy ETF, you can buy an ETF but put a short on the ETF as if selling it. In this scenario, you would expect to make a profit from the ETF when the index price falls. An example of a bearish energy commodity ETF is the Claymore MACROshares Oil Down Tradeable Trust that is traded on the American Stock Exchange (AMEX). The ETF profits from the inverse performance of WTI Oil.
Other Energy ETF Types: There are 10 or more other ETF types that you can profit from, but for brevity sake only the most common were mentioned. The emergence of clean energy and alternative fuel types has increased interest in the Van Eck Global Alternative Energy ETF (GEX) and Van Eck Market Vectors Solar Energy (KWT). With the global oil crisis, experts are expecting some alternative energy sources such as solar, geothermal energy and wind to survive and thrive.
You must understand the investment type to select the best investment for your portfolio. If you have a multi-contract ETF and are only watching industry news concerning energy or one type of commodity, you will not get the full picture of what can affect movement in the ETF. Poor decisions will be made. Luckily, advanced low-latency news software can handle most of the analysis and consolidation of news sources, but you still have to react fast enough to execute a profitable trade.