Top Dividend ETF: Should You Follow Its Lead on Oil Stocks?

The Energy Select Sector SPDR Fund (XLE) has long been a favorite among investors seeking exposure to the oil and gas sector. With a portfolio heavily weighted towards some of the industry's leading players, XLE offers a diversified bet on the energy market. But should individual investors follow the ETF's lead and buy these top oil stocks? Let's dive into the key factors driving the performance of these companies and assess whether they are worth adding to your portfolio.

Market Dynamics and Oil Stock Performance

The performance of leading oil stocks is influenced by a myriad of factors, including geopolitical tensions, OPEC+ production cuts, supply and demand dynamics, economic growth, technological advancements, and regulatory changes. These factors collectively shape the overall market dynamics, making the oil sector highly volatile and sensitive to various external influences.

# Geopolitical Tensions and Trade Wars

Geopolitical tensions and trade wars significantly impact the oil market. For instance, escalating trade tensions between the United States and other countries have tilted macro risks to the downside, affecting oil demand growth. This uncertainty can lead to volatility in oil prices and, consequently, in the performance of oil stocks.

# OPEC+ Production Cuts

The decisions made by OPEC+ regarding production cuts play a crucial role in market dynamics. The IEA report mentions, "OPEC+ producers agreed to begin their first round of reduced oil production targets and additional voluntary production cuts in April 2023." These cuts aim to stabilize oil prices, but any changes in these policies can lead to significant fluctuations in the market.

# Supply and Demand Dynamics

The balance between supply and demand is a critical factor. The IEA report highlights that "global oil supply is on track to increase by 1.6 mb/d to 104.5 mb/d in 2025, with non-OPEC+ producers accounting for the bulk of the increase if OPEC+ voluntary cuts remain in place." This increase in supply can put downward pressure on oil prices, affecting the performance of oil stocks. Conversely, any disruptions in supply, such as those caused by sanctions on Russia and Iran, can lead to price increases.

# Economic Growth and Oil Demand

Economic growth rates and oil demand are closely linked. The IEA report states, "Weaker-than-expected 4Q24 demand came despite a drop in temperatures, which affected all OECD regions as well as China." This indicates that economic conditions and oil demand are interdependent, and any slowdown in economic growth can negatively impact oil demand and, consequently, the performance of oil stocks.

# Technological Advancements and Capital Discipline

The oil and gas industry's focus on capital discipline, digital transformation, and strategic acquisitions has contributed to a 7% rise in net income from 2014 to 2023, despite an 18% drop in oil prices. This strategy is crucial for the long-term performance of oil stocks. For example, the report mentions, "In the coming year, companies will likely adapt their strategy to address challenges including low oil prices, peaking productivity gains, and the forecasted resurgence in global liquids consumption that is expected to increase by 1.5 MMbbl/d in 2025."

# Regulatory and Policy Changes

Changes in energy policies under new administrations can also influence market dynamics. The report notes, "Some energy policy changes can be expected under a new administration following the 2024 US elections." These changes can impact the regulatory environment for oil companies, affecting their operations and, consequently, their stock performance.

Company Spotlights

Let's take a closer look at some of the top oil stocks in the XLE ETF and what makes them attractive investments.

# Exxon Mobil Corp. (XOM)

Exxon Mobil is the top holding in the XLE ETF, making up 22.8% of the fund. The company expanded its presence in the Permian Basin with the acquisition of Pioneer Natural Resources, more than doubling its production volume in this key region. Exxon Mobil's focus on carbon capture and storage, hydrogen, lower-emission fuels, and lithium positions it well for the energy transition. Despite the push for decarbonization, Exxon remains a core fossil fuel producer, straddling the line between traditional energy and cleaner technologies.

# Chevron Corp. (CVX)

Chevron is the second-largest holding in the XLE ETF, accounting for more than 15% of the fund. Like Exxon, Chevron is a vertically integrated major oil and gas company, involved in extraction, transportation, refining, and selling petroleum products. Chevron has favored investing in lower-carbon solutions over renewable power generation, leveraging its deep pockets to spend big on cleaner technologies. This strategy aligns with the expectation that oil and gas will continue to be in demand for decades, even as renewable energy projects advance.

# ConocoPhillips (COP)

ConocoPhillips rounds out the top three holdings in the XLE ETF, at 7.6% of the fund. The company is involved in exploration and production, as well as the transportation and marketing of crude oil, natural gas, and liquified natural gas. ConocoPhillips returned $11 billion to shareholders in the form of dividends and share buybacks in 2024, demonstrating its commitment to returning value to investors. This dividend and buyback strategy has been important to investors who in the past got fed up with oil and gas companies focusing more on drilling and producing more oil, even if it was at diminishing returns during lower-oil-price environments.

Dividend Yields and Income Investing

The dividend yields of the top oil stocks in the XLE ETF are generally higher than the broader market. For instance, Exxon Mobil Corp. (XOM) has a forward dividend yield of 3.3%, Chevron Corp. (CVX) offers 4.2%, ConocoPhillips (COP) provides 2.8%, Williams Cos. Inc. (WMB) has 3.4%, Schlumberger Ltd. (SLB) offers 2.5%, EOG Resources Inc. (EOG) provides 2.9%, and Oneok Inc. (OKE) has 3.8%. These yields are significantly higher than the average dividend yield of the broader market, which is typically around 1.5% to 2%.

This higher dividend yield has several implications for investors seeking income. Firstly, it provides a steady stream of income, which can be particularly attractive in a low-interest-rate environment. Secondly, it offers a level of stability and predictability, as these companies have a history of consistent dividend payments. Lastly, the higher dividend yield can act as a buffer against market volatility, as the income from dividends can help offset potential losses in the stock price.

Should You Buy These Leading Oil Stocks?

Given the current market dynamics and the performance of leading oil stocks, there are both opportunities and risks to consider. The higher dividend yields and the potential for capital appreciation make these stocks attractive for income investors and those looking for exposure to the energy sector. However, the volatility and uncertainty in the oil market, driven by geopolitical tensions, OPEC+ production cuts, and regulatory changes, pose significant risks.

Investors should carefully weigh these factors and consider their risk tolerance before deciding to follow the XLE ETF's lead and buy these top oil stocks. For those who are comfortable with the risks and see the potential for long-term growth, these stocks could be a valuable addition to their portfolio.