Under the Spotlight Wall St: Energy Select Sector SPDR Fund (XLE)

The current conflict in the Middle East has, for some investors, focused the attention on global oil markets. Crude hit a five-month high on fears of disruptions to shipping through the Strait of Hormuz, only to reverse course as hostilities eased. 

Riding the volatility has been the Energy Select Sector SPDR Fund ($XLE). The world’s largest energy ETF was up 9% for the month as tensions peaked, but has since cooled to gains of 5%.  

The oil giants ExxonMobil ($XOM) and Chevron ($CVX) make up roughly 40% of XLE’s portfolio. Both are stocks that have seen increased interest on Stake in June. XLE also offers exposure to gas producers, refiners and pipelines and charges an annual fee of 0.08%. 

Global flashpoints may affect stock prices. But the long-term energy story is about cash, dividends and buybacks. It’s one reason Warren Buffett has a $US30b bet on the sector (more on this later). XLE yields 3.3% and pays out quarterly. 

Crude awakening

ExxonMobil puts the ‘big’ into Big Oil. The US$460b giant comprises almost a quarter of XLE’s portfolio and tells the story of the U.S. energy sector’s changed ways of capital management. 

We focused on ExxonMobil in November when Trump urged the industry to ‘drill, baby, drill’. CEO Darren Woods pushed back, saying he would run the business to maximise shareholder returns. 

The industry has learnt that chasing production growth depresses oil prices. Today’s focus is on breakeven prices - the price that covers production costs. 

ExxonMobil is targeting US$35 per barrel by 2027, and US$30 by 2030, driven by tech that boosts productivity and cuts costs. Chevron and EOG Resources ($EOG) are on similar paths.

The industry hopes that by lowering breakevens they’ll be able to generate substantial cash even as oil prices face short term pressure from increased OPEC+ production. More cash equals more dividends and buybacks.  

Breakevens need to be low to deal with longer term challenges. These include EV growth, peak Chinese demand and plateauing of shale oil production that’s made the U.S. the world’s top oil producer. This needs investments that maintain reserves, add not too much supply and continue to drive cash flows. 

Buffett’s bet

Warren Buffett is also keen on energy stocks. 

The Oracle of Omaha’s Berkshire Hathaway ($BRK.B) holds two XLE constituents: Chevron and Occidental Petroleum ($OXY)—its fifth and sixth largest holdings. 

Berkshire first bought into Chevron in 2020, doubling down in 2022. Today, Chevron accounts for 7.7% of Berkshire Hathaway’s portfolio, a stake worth around US$19b. 

Chevron, with a 15% weighting in XLE, bulked up in 2023 with the US$53b acquisition of Hess Petroleum. This added acreage in Guyana and assets in the U.S.’ Bakken shale oil region. Increased oil production is coming from operations in Kazakhstan and the Gulf of America.   

What may appeal to Buffett: Chevron’s consistency. It’s raised dividends for 38 straight years and returned US$78b to shareholders over the past three via dividends and buybacks.

Then there’s Occidental. Berkshire owns 27% of the stock, worth around US$13b, and holds options to “materially” boost that further, though Buffett said he doesn’t want full control. Occidental makes up 2.3% of XLE.

Occidental’s appeal? Its vast U.S. gas and oil holdings and investments in carbon capture technology. Buffett has praised CEO Vicki Hollub, saying she ‘does know how to separate oil from rock, and that’s an uncommon talent.’ 

But even Buffett hasn’t always got it right. He admitted in Berkshire’s 2008 letter that he got it ‘dead wrong’ buying ConocoPhillips ($COP) at peak oil prices. 

Gush fund

Energy isn’t sexy like tech. But some analysts think it’s underloved and undervalued. 

Bank of America ($BAC) recently upgraded the sector to 'outperform'. Why? Because no-one likes it. They note it’s out of favour with fund managers and aggressively shorted by hedge funds.

The bank’s strategy team argues energy tends to outperform during times of high inflation and slow growth aka stagflation. Strong cash flows and dividend growth add to the appeal.

U.S. Bank ($USB) agrees. It notes the sector trades at 15x earnings versus 21x for the S&P 500 Index, yet offers a 3.3% yield compared to 1.3% for the benchmark index. 

Pipeline companies are even more appealing with a yield of 7%. XLE offers exposure to operators like Williams Companies ($WMB) and Kinder Morgan ($KMI). 

Drill down

XLE gives investors exposure to leading U.S. producers of the world’s most critical commodity. 

Yes, oil stocks can be high-octane bets as they rise and fall with oil prices. But the industry titans are focused on ensuring the well doesn’t run dry when it comes to delivering a pipeline of cash to investors.    

This is not financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.