XLE: You can Trust this Energy ETF, Both for Growth and Dividends 

Looking over a longer period comprising the March 2020 market crash, it is evident that the S&P 500 Energy sector as shown in the yellow chart below still trails the broader S&P 500 index. For its part, the SPDR Energy Select Sector ETF (XLE) has delivered an 11.56% gain during the last two years with most of the upside occurring in 2021.

Source: Trading View

Looking ahead, according to the U.S. Energy Information Administration (EIA), spot Brent crude prices are expected to average $79 this quarter. This is down from the current value of $87.7, but the EIA further adds that “developments in the global economy and the many uncertainties surrounding the pandemic” in the coming months could push oil prices up or down from its price forecast.

These uncertainties need to be understood in the context of the supply-demand paradigm.

The supply-demand paradigm

Here, the EIA’s statement that “U.S. natural gas consumption in 2021 was nearly the same level as 2020, and this will remain virtually flat in 2022 and 2023” is noteworthy as it means that there will be less oil-to-gas switching to clear any excess in the amount of oil produced. Thus, in addition to Brent’s spot price itself, the demand for natural gas also constitutes a tailwind for XLE. This said the ETF’s share price is also influenced by two other factors.

First, there is the ongoing sector rotation into energy, finance, and consumer sectors which have started in the second quarter of 2021 and gained momentum from November, which should also determine energy stock returns throughout this year.

Second, the global economic recovery after the drop in activity during the Covid-led confinements created a strong demand from September last year, while inventories, especially in Europe were low. These factors were responsible for the prices of natural gas skyrocketing in Europe as from October 2021 with the fuel-substitution effect being contagious to spot oil prices. This explains the bounce seen in energy sectors’ ETFs including the Vanguard Energy Index Fund ETF (VDE) from that period.

Gauging the supply side, a series of problems weighed on capacity including some countries seeing their production drop due to maintenance delays caused by the pandemic as well as failure to make timely investments in aging upstream infrastructure. This supply shortage was exacerbated by governments, (especially in China and Europe) giving priority to renewables projects and carbon credits while their “green energy” experts failed to foresee the imbalance between supply and demand.

The imbalance to persist

This imbalance is likely to persist in 2022, despite OPEC’s continued production increase and uncertainty associated with the Omicron variant impacting travel. Understandably, some smaller oil companies have been reticent to pump out more oil.

There may be some temporary respite in oil prices as from the start of February when China, together with the U.S. and some other major consumers, will release crude oil from their national strategic stockpiles. This coordinated action aimed at reducing global prices will induce some volatility in XLE, but this will be only for a limited period.

The reason is that the imbalance will persist with one of the reasons being the recovery in international travel.

In this respect, according to Statista, the total fuel consumption of commercial airlines worldwide which increased each year from 2005, reached a maximum of 98 billion gallons in 2019 before falling from 2020 due to Covid. It decreased to 57 billion in 2021. Now, there has been optimism that has been prevailing since the start of the year that the Omicron strain may prove to be less damaging to the health of people and by ricochet the economy.

This optimism is also backed by data, which indicates that despite Covid infection rates reaching an all-time high, the actual death rate is trending lower. Whatever the reasons for this, be it a higher vaccination rate or a less dangerous variant, more people are willing to take a flight. This is in turn proven by the number of international flight departures rapidly inching back up to 2019 levels according to the Bureau of Transportation statistics.

Thus, glancing back at the above chart, XLE could again climb back to its April 2019 high of $68-69 levels by the second quarter of 2022. Even if this upside is somewhat delayed due to volatility, the SPDR ETF pays substantial dividends.

The dividends

Holdings include oil supermajors Exxon Mobile (XOM) and Chevron Corporation (CVX) with a combined weight of 43.4% of overall assets. These are integrated oil and gas companies operating in every segment of the industry. Activities include extraction/production, midstream, petrochemical manufacturing, refining, and, even downstream activities like marketing and distributing refined petroleum products. People buy these companies primarily for their dividends.

The other holdings which are drilling, refining, or equipment provider plays also pay regular distributions to shareholders. This culminates in XLE paying a 3.62% yield. Here investors will notice that distributions that are paid on a quarterly basis reached the highest point in the fourth quarter of 2019 at $3.58.

Source: Chart prepared using data from Nasdaq.com

This was followed by a period of fluctuating quarterly payments around the $0.5 mark, before eventually rising from the third quarter of 2021. With oil prices remaining sustainably high, energy companies should continue to benefit from higher profitability which in turn enables them to sustain dividend payments and perform share buybacks.

Finally, with demand outstripping supply, the imbalance should persist in 2022. Inflationary pressures may slightly affect demand, but, here, recent fund flows indicate that XLE is inversely correlated to the broader market (SPX). Thus the energy sector ETF seems to be acting like an inflation hedge, a role which is also supported by its ability to pay above-average dividends yields. Consequently, XLE can be trusted for further upside and higher quarterly dividend payments too.

Disclosure: I/We are long XLE. This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.