Just ahead of the U.S. peak summer driving season, oil prices are breaking higher. For ETF investors there are several ways to play this trend, or to invest in oil for the longer term. Some ETFs provide exposure to oil through futures contracts on the commodity itself. Others have holdings of oil infrastructure companies. Though less direct, there is a third way to invest in oil: ETFs covering oil-rich countries.
In many countries rich in oil, oil companies themselves are state-owned and therefore not accessible to investors. But the logic here is that if oil does well, economies of oil rich countries overall will benefit. Investment in financial or telecom sectors, which tend to be heavily represented in oil country ETFs, should see gains.
Countries with the largest proven oil reserves are Saudi Arabia, Canada, Iran, Iraq, Kuwait, United Arab Emirates, Venezuela, Russia, Libya and Nigeria, in that order. Of these ten, only Canada and Russia currently have their own focused ETF product. Some of these countries, like Libya, Iraq, and Iran, are virtually impossible for U.S. retail investors to access. Several regionally focused ETFs provide exposure to equities in Kuwait, the UAE, and Nigeria.
How does the performance of ETFs providing exposure to oil-rich countries compare to more traditional oil investment?
The chart below compares the 1-year performance of four ETFs. It show 1) the United States 12-Month Oil (NYSEArca:USL), which offers exposure to oil through staggered futures contracts, 2) the Energy Select Sector SPDR (NYSEArca: XLE), which provides exposure to oil majors like Exxon Mobile and Chevron, 3) iShares MSCI Canada (NYSEArca:EWC), a broad Canadian market ETF, and 4) Market Vectors Gulf States ETF (NYSEArca:MES), providing exposure to non-oil companies in Kuwait, Qatar, and Abu Dhabi.
The chart shows Canada outperforming. The Gulf States ETF is the most volatile of the four in the period shown. MES outpaced more direct investment in oil through October. It fell sharply through February, losing ground against the strict commodity futures ETF USL. Recently MES moved sharply upward. USL shows decent correlation with XLE. Both moved higher with crude (though spot oil increased far more over this period).
EWC's outperformance in the chart is not strictly because of higher oil. Less than 25% of EWC's holdings are in the energy sector. Financial assets make up a third of the fund. Royal Bank of Canada (NYSE:RY) and Toronto Dominion Bank (NYSE:TD) are its the two largest holdings. About 20% of EWC is in the industrial materials sector. Part of the reason EWC has outperformed here is that financial assets were sharply discounted this time last year. In addition to benefitting from higher oil and raw materials prices, oil has also has played a more subtle role in the strength of EWC. It has helped anchor the Canadian dollar. The fund's assets are denominated in Canadian dollars so appreciation of the Canadian dollar means higher U.S. dollar returns.
MES's performance is dominated by the financial sector, which makes up over 60% of the fund. As the chart shows, performance mirrored EWC until the beginning in November, when the Dubai World debt crisis hit, creating uncertainty for financial institutions, particularly in the Middle East. Significantly, however, MES did not crash upon the announcement that Dubai Worlds debt payments were to be delayed. One reason is the fund's holdings are not primarily in the Dubai, though 20% are in the UAE. 60% goes to Kuwait. 15% are in Qatar (not in the top ten countries as measured by total reserves, but on par with Saudi Arabia for oil wealth in terms of size and population). The remaining 5% of asserts are in Oman and Bahrain.
The chart below compares Canada's EWC with ETFs representing Russia and Africa: Russia Market Vectors Russia ETF (NYSEArca:RSX) and Market Vectors Africa (NYSEArca:AFK). Russia's fortunes have always depended on oil and other raw materials to a greater extent than even Canada. The same is true for African countries like Libya and Nigeria.
The volatility in the chart is largely due to the economic crisis. Like other emerging market countries Russia was hurt by the world-wide slowdown. The period shown represents the rebound from the fierce sell-off a year earlier. In terms of oil exposure, when compared with EWC, RSX is more heavily invested in oil. Energy and energy-related equities currently compose about 40% of the fund. Like EWC, RSX is also heavily invested in industrial materials and telecommunications. Financials account for between 10 and 15% of RSX.
Market Vectors' Africa fund AFK has little (about 10%) direct exposure to energy companies. 20% of overall country allocation goes to Nigeria, the most important country in Africa in terms of oil assets. South Africa gets about 30% of the fund. Morocco and Egypt together are about 30% of the fund. The remainder is devoted to smaller African countries, including Equatorial Guinea, Mali and Zambia. AFK has some exposure to the energy sector, though mostly not through Nigerian holdings. At around 7% of the fund, South Africa's Tullow Oil (NasdaqGM:TLW) is its single largest holding.
A list of ETFs representing Oil-Rich countries and their expense ratios follows:
iShares MSCI Canada (NYSEArca:EWC), 0.52%
Market Vectors Russia ETF (NYSEArca:RSX), 0.62%
Market Vectors Gulf States ETF (NYSEArca:MES), 1.0%
WisdomTree Middle East Dividend (NasdaqGM:GULF), 0.88%
PowerShares MENA Frontier Countries (NasdaqGM:PMNA), 0.95%
Market Vectors Africa (NYSEArca:AFK), 0.88%