Drilling Down Oil and Gas Drillers ETF

United States is undergoing an energy revolution. In any gold rush, there is just as much profits in selling shovels as in mining gold. The same principal applies to the energy boom where the energy service and equipment providers are making hay while the sun is shining and in some cases has considerably outperformed companies in the exploration and production space.

Investors can drive returns from the upstream sub sector of drilling equipment and services from 2 primary ETFs: SPDR S&P Oil and Gas Equipment & Service ETF (XES) and iShares U.S Oil Equipment and Services ETF (IEZ) . There are other ETFs which tracks the drilling sector focusing on companies that specialose on drilling and equipment part of the larger energy exploration and production chain. However XES and IEZ are the 2 largest, most liqudid and well know drilling ETF out there. For investors looking to gain exposure to the sector it is better to also keep it simple.

First lets clear up what is included and not included in the drilling ETFs so investors is for certain ahead of time what they are getting into:

What type of companies are included in Oil and Gas Equipment and & Service ETF?

1. Traditional oil and gas drilling rig providers and related contract services

2. Service providers of offshore drilling services such as Transocean, Diamond Offshore and Seadrill are also included the oil and gas equipment service providers.

Which companies are not included in the above ETFs:

1. Companies in the refining sector (see Invest in Refiners or Oil Refinery ETF?)

2. Energy Infrastructure providers (like Williams Companies)

3. Leveraged oil ETF can be viable option for investors that are looking for direct exposure to oil prices rather than energy sensitive stocks.

On the surface XES and IEZ is very similar. Both are energy equipment and service provider index trackers at a low cost around 0.35% and 0.46% per year but analysis on the underlying ETF presents a very different picture.

Chart below breakdown the holdings of XES which shows a clear pattern where almost 30 companies out of 50 total holdings are held at equal weighting range from 2.75% to 2.25%. The wieght of the remaining 20 position gradually decline to 1% of asset under management.

Distribution of XESETF Holding

Distribution of XESETF Holding

A different picture can be seen from analyzing the holdings of IEZ. Although total number of companies in the ETF is very similar at around 50 holdings. The weights of components are spread more widely than XES . The largest IEZ holding is Schlumberger (SLB) at 18% of the drilling ETF. Combined with Haliburton in IEZ, 2 largest positions adds up to 32% of total ETF. Hence the overall return of IEZ can be seen dependent on 2 companies.

Top 10 holdings of IEZ

Top 10 holdings of IEZ

Top 10 holdings of XES account for 68% of the ETF with remaining 32% in 40 other oil and gas service companies.

Best Oil Drilling Service and Equipment ETF

The Drilling ETFs presents 2 different options for investors to ride the energy boom. The weighting differences of the underlying holdings would account for majority of performance variation of these funds. While past performance does not equal future performance the difference in returns can be attributed to the large difference in holding weights.

Exhibit below presents a clear picture on the best return ETF over the 1 and 5 year timeframe. IEZ outperformed XES by 16% in the last 12 month but and 12% over 5 years. The analysis exclude dividends paid by which is around 1% per annum.

Oil Driller ETF - 1 and 5 Year Performance

Oil Driller ETF – 1 and 5 Year Performance

To see how the oil and gas equipment and service ETF performed within the context of the energy sector we compare the driller ETF with Energy Select SPDR ETF which reflect the broader energy complex. Chart below shows the combined 12 month performance of all 3 ETF.

XLE IEZ XES Drillers vs Broader Energy Index 12 month performance

Drillers vs Broader Energy Index 12 month performance

Over the last 12 month period using a single starting point. XLE returned 26% while respectable it is almost 10% lower than IEZ. IEZ provided the highest return at just above 30% increase in ETF net asset value. XES performed the weakest at 17% increase in NAV. For investors that look for diversification as primary selection criteria XES can still be considered due to almost equal holding for the majority of the portfolio but the cost can be high to achieve the extra level of comfort.

Given the research above. It is clear that IEZ can be considered the best oil driller ETF for those that want direct exposure to the oil and gas service and equipment providers.