Energy ETFs face a low-carbon future

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Investing in oil and gas with established production offers predictable margins and profitability as demand for electricity continues to grow. But a lot of noise surrounds the industry.

The Caisse de depot et placement du Quebec, most Canadian universities and many religious organizations are among the 1,500 institutions representing nearly $40 trillion in assets that have pledged to eliminate some or all carbon emitters from their portfolios, according to the Global Fossil Fuel Commitments Database. But will divestment change corporate behavior?

Divestment transfers ownership to investors less concerned about emissions, while any chance of influencing management via proxy voting is lost. If stock prices go down or the cost of capital goes up, private debt and value-oriented investors always go up. Divestment is not like a boycott, which creates real economic pressure; it’s about appearing to be ESG aware rather than effecting change.

Planet-friendly energy sources are expected to eventually overtake carbon-based energy sources as rising oil and gas prices make more technologies viable. Integrated producers are already adjusting their investment plans to diversify their prospects. Upstream spending, which should be booming given the current strength in oil, has been modest. At the same time, Canada’s energy sector has become more concentrated — and therefore more risky.

ETF options

Should investors avoid energy altogether and/or participate in potentially sustainable technologies with their inherent risks?

Owning a broad index ETF captures both the performance of energy and the diversification of increasingly uncorrelated returns from energy. Although Canada’s 13.4% energy weighting versus 3.6% in the S&P 500 hurt long-term performance, active managers underperformed both indices over time, so passive exposure is better. Here are three ways to approach a low-carbon future.

  1. Long in an S&P/TSX or S&P/TSX 60 Composite ETF and short in the Energy Index or a leveraged Oil or Natural Gas ETF: Eliminates exposure to energy, but takes advantage of the volatility that erodes the sector’s compound returns.
  2. Long position in a higher cost ESG rated ETF with energy exposure: offers energy exposure plus engagement potential.
  3. Long position in a broad market ETF and in Horizons’ or Ninepoint’s carbon credits ETFs, which are based on the future price of carbon credits: correlated to oil prices, credits will follow demand to offset carbon emissions and could be an elegant way to capitalize on industrial success (reducing credit supply) and failure (increasing credit prices to meet targets).

Traditional oil and gas companies could end up like tobacco: highly profitable with attractive dividends, but shunned by ESG investors. Exploiting new energy opportunities will be important to the survival of the Canadian energy sector, so watch for alternative approaches in new ETFs.

Table 1: TSX-listed energy and commodity ETFs (shaded)

Energy ETFs listed on the TSX RFG Dividend Assets
iShares S&P/TSX Capped Energy Index ETF (XEG) 0.61% 2.20% 22
BMO Equal Weight Oil & Gas ETF (ZEO) 0.61% 3.07% ten
Horizons S&P/TSX Capped Energy Index ETF (HXE) 0.27% 1
Horizons BetaPro S&P/TSX Capped Energy -2x Daily Bull (HEU) 1.53% 1
Horizons BetaPro S&P/TSX Capped Energy -2x Daily Bearish (HED) 1.53% 1
Horizons Enhanced Income Energy ETF (HEE) 0.84% 4.32% 33
CI Active Utility & Infrastructure ETF (ISP) 0.65%* 3.92% 26
Horizons Pipelines & Energy Services Index ETF (HOG) 0.64% 3.45% 14
Horizons Crude Oil ETF (HUC) 0.89% 1
Horizons Natural Gas ETF (HUN) 0.88% 1
Horizons BetaPro Crude Oil Leveraged Daily Bull ETF (HOU) 1.39% 1
Horizons BetaPro Natural Gas Leveraged Daily Bull ETF (HNU) 1.41% 1
Horizons BetaPro Crude Oil Reverse Leveraged Daily Bear (HOD) 1.45% 1
Horizons BetaPro Natural Gas Reverse Leveraged Daily Bear (HND) 1.40% 1
TSX-listed sustainable energy ETFs RFG Dividend Assets
BMO Clean Energy ETF (ZCLN) 0.40% 75
First Trust NASDAQ Clean Edge Green Energy ETF (QCLN) 0.79% 1.64% 45
Harvest Clean Energy ETF (HCLN) 0.40%* 40
Horizons Carbon Credits ETF (CARB) 0.75%* 1
Horizons Global Uranium Index ETF (HURA) 0.85% 1.42% 40
Horizons Global Hydrogen Index ETF (HYDR) 0.75%* 25
Ninepoint Carbon Credit ETF (CBON) 0.75%* 1
Purpose Global Climate Opportunities Fund (CLMT) 0.75% 0.70% 56

*Management fees only

Mark Yamada is President of PUR Investment Inc.a software development company specializing in risk management and defined contribution retirement strategies.

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