ERX: Turbocharging Your Portfolio With Traditional Energy Exposure

The traditional energy sector has been the place to be in 2022. While all the leading stock market indices have posted double-digit percentage declines, oil and gas stocks have soared. The bottom line is earnings are a function of oil and gas prices which remain at multi-year highs.

WTI and Brent crude oil futures rose to over $130 per barrel earlier this year on the back of the war in Ukraine. However, prices had been rising before Russian troops crossed Ukraine’s border because US energy policy handed the pricing dominance back to the oil ministers of OPEC, the international oil cartel. Moreover, Russia is the most influential non-cartel member, causing production policy to be a function of decisions in Riyadh, Saudi Arabia, and Moscow. While crude oil ran out of upside steam, and the price recently dropped to below the $80 per barrel level on nearby NYMEX WTI futures, and under $83 on nearby Brent futures, the energy commodity remains at a multi-year high. Higher oil prices are fueling Russia’s war effort, filling the coffers of OPEC members, and causing record earnings for international oil-related companies. Simultaneously, the high oil and gas prices fuel supply-side inflationary pressures that present roadblocks to the central bank’s attempt to address inflation with monetary policy.

The late Mark Rich, the founder of global commodities giant Glencore, once said that oil is the blood that flows through the world’s veins. The greener path toward energy production and consumption inhibits oil and gas in favor of alternative and renewable fuels, but the world still runs on fossil fuels.

Energy prices have come down from the highs, and oil-related stocks have corrected. The closer oil and gas prices come to a bottom, the more attractive the Direxion Daily Energy Bull 2X Shares product (NYSEARCA:ERX) becomes. ERX is a short-term trading tool that behaves like the Energy Sector Select SPDR Fund (XLE) on steroids.

Crude oil has come down, but oil-related stocks have done better

On Monday, Nov. 21, crude oil prices moved towards a test of the late September low.

The short-term chart shows the January NYMEX crude oil contract fell to $75.27, only 31.0 cents above the September 28, $74.96 low.

Meanwhile, the longer-term continuous NYMEX contract fell below the late September $76.25 per barrel low. At around the $81.40 level on November 22, the energy commodity was still 8.2% above the Dec. 31, 2021, $75.21 closing price. Crude oil fell 37.6% from the March 2022 $130.50 high as of Nov. 22.

The chart of the S&P 500 Energy Select SPDR (XLE) shows that at $92.44, the ETF was only 2.4% below the recent November $94.71 high, which was the highest level since September 2014. The XLE closed at $55.50 on Dec. 31, 2021, and was 66.6% higher on Nov. 22.

Shares of crude oil-related companies have outperformed the overall stock market and the oil price in 2022. Higher prices throughout the year have caused explosive earnings after years of austerity, where the leading oil companies tightened their belts. The rise in energy prices has created a profit boom for the sector, which has outperformed this year.

The prospects for higher oil prices

Four compelling factors point to higher oil prices over the coming months, despite the recent selloff:

• The SPR releases are scheduled to end in December, with the total sale reaching 180 million barrels. A significant supply source will end unless the Biden administration authorizes more sales.
• The Biden administration has said it will look to replace SPR sales at the $70 per barrel level, which could put a floor under the energy commodity.
• On Nov. 21, a rumor that OPEC is considering a production increase was quickly denied by the Saudi oil minister, who said that a production cut is more likely. OPEC and Russia have done no favors for the US regarding production policy, and that is not likely to change.
• When China finally emerges from its COVID-19 protocols, the worldwide demand for crude oil could soar.

Meanwhile, the oil market is in the heart of the offseason for gasoline demand. In early 2023, the market will begin to reflect the upcoming 2023 driving season, lifting gasoline and crude oil prices. Moreover, distillate prices remain at the highest price in history in November, at near the $3.50 per gallon wholesale level. Gasoline crack spreads at over $20 per barrel and distillate refining spreads above $60 per barrel are bullish factors for the crude oil price, demonstrating elevated demand and supply concerns.

Crude oil remains in a bull market

The crude oil bull market that began with the April 2020 low remains intact in late November 2022.

The chart illustrates that if the energy commodity remains above Brent’s December 2021 $65.72 low, the trend remains higher. With the US government a lurking buyer at the $70 per barrel level, the odds of breaking the bullish trend are low.

Crude oil continues to be the energy commodity that powers the world. Even though the US and Europe intend to take a greener path for energy production and consumption, gasoline-powered cars far outnumber EVs, and China and India remain massive traditional energy consumers.

The XLE tracks shares of the leading US oil companies

The top holdings of the S&P 500 Energy Select SPDR (XLE) include:

US oil giants Exxon Mobile (XOM) and Chevron (CVX) comprise 42.39% of the XLE’s portfolio. Earnings have been explosive, and at the $80 per barrel level, the leading traditional energy companies are likely to continue to report substantial profits.

Meanwhile, any sudden downside spike in the oil price or end-of-the-year profit-taking could cause a correction in the XLE. Market participants looking to jump on the bullish trend in oil company earnings on a correction could consider the short-term Direxion Daily Energy 2X Shares (ERX).

ERX turbocharges is the XLE

The fund summary for ERX states:

The bottom line is ETX is the XLE on steroids. The XLE rallied from $68.66 on Sept. 26 to a high of $94.71 on Nov. 14, a 37.9% rise.

Over the same period, ETX moved from $42.06 to $78.08 per share, or 85.6%, over double the percentage gain in the XLE. At the $74.56 level, ERX had $561.57 million in assets under management and traded an average of over two million shares daily. ERX charges a 0.95% management fee.

ERX and its bearish counterpart (ERY) are leveraged products that can suffer from time decay when the XLE moves in a contrary direction or sits at the same level for too long. ERX is only appropriate for short-term risk positions on the long side of the traditional energy company asset class. Any downside spikes in crude oil or significant tax-related end-of-the-year selling in oil-related shares could be an optimal time to consider ERX. When trading this product, a time and price stop are appropriate, as timing is critical for success. ETX is not a buy-and-hold product.

I expect the traditional oil companies to continue to fill their coffers with earnings. Gridlock in Washington, DC, will likely preclude the administration’s desire to put a cap on profits or tax the leading oil companies as their earnings grow.