Scotia’s, JPMorgan’s deals on energy confirm investors’ interest in oil stocks despite volatility

By Emma Trincal

New York, Aug. 10 – Some of the largest offerings to price last week were bets on the Energy Select Sector index, an index that measures the performance of the energy sector of the S&P 500 index.

Bank of Nova Scotia priced $35.87 million of digital notes due Nov. 3, 2023 tied to the Energy Select Sector index paying 17% if the underlying finished above 80% at maturity. The notes offered a 20% geared buffer. The agent is Scotia Capital (USA) Inc.

JPMorgan Chase Financial Co. LLC priced $31.25 million of 0% capped enhanced participation equity notes due Nov. 3, 2023 linked to the Energy Select Sector index.

The payout at maturity will be par plus 400% of the index gain capped at 44.8%.

Investors will be fully exposed to any index decline.

J.P. Morgan Securities LLC is the agent.

Simon as a dealer

Simon Markets LLC, a broker-dealer affiliated with Goldman Sachs & Co. LLC, is cited as a dealer in both filings.

“This is interesting. Simon usually doesn’t put their name on the docs. Now they’re part of iCapital. I wonder why iCapital didn’t list themselves in the filing,” a market participant said.

iCapital announced in May the acquisition of Simon Markets. But the transaction was only completed on Tuesday, according to a press release.

Oil prices proxy

The underlying is heavily weighted in oil and gas stocks, which represent more than 92% of the index. The index is concentrated around the heavyweight players in the field. Exxon Mobil Corp. and Chevron Corp., the two largest U.S. oil companies, have a combined weighting of 45%.

“There is a high correlation between this index and oil prices. They tend to move in tandem. Both have declined in the second half of June,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

“Oil futures are pointing to $80 a barrel. We’re currently in the neighborhood of $90.”

Seasonal trends

The causes for the decline in oil prices vary.

“It’s a combination of more supply. Oil from the Strategic Petroleum Reserve is now hitting the market. We still import from other countries,” he said.

With the summer, prices may go up, he said.

“Any seasonal disruption can have an impact even if it’s short term. The summer is hurricane season. That’s upside. Demand for oil increases in the summer too. Another tilt toward the upside.

“On the other hand, Russia’s cutting off natural gas in Europe will cause prices to rise especially as we move into the winter months.

“Finally, an end to the conflict in Ukraine would be a major disruption, a serious downside risk,” he said.

Income play, inflation hedge

One reason to get exposure to the Energy Select Sector index is also income, he noted.

“The index constituents are dividend stocks. Big oil companies have all increased their dividend. They’re paying nice yields. People buy it for income,” he said.

Exxon has a 3.88% dividend yield. Chevron pays a 3.65% annual dividend.

Investors buying notes tied to the Energy Select Sector index are looking for protection against inflation, the market participant said.

“People continue to seek exposure to energy as a key inflation hedge,” he said.

“While the last CPI figures are slightly lower, inflation is still elevated, and it shows no signs of subsiding even with the rate hikes.”

The July consumer price inflation report released on Wednesday showed an 8.5% year-over-year increase. It was flat compared to June.

“Oil has gone down from its highs of March and June. That gives you a little margin of error,” he said.

High volatility

Herb Blank, senior quantitative analyst at ValuEngine, pointed to some risks on the downside.

“This is an index that could be much lower and much higher. The ETF has the highest level of volatility among all the SPDRs.”

The Energy Select Sector SPDR ETF (XLE) tracks the performance of the Energy Select Sector index.

The three-year standard deviation of the ETF is 43.5%, he noted.

“It’s an especially volatile index. I think there is more potential downside than upside.

“Oil is coming down from its highs. All supplies have increased. There may be opportunities to drill offshore, in Alaska. We could also reach a deal with Iran or Venezuela. A major negative for oil prices would be an end to the war in Ukraine.

“That’s why I would be cautious with this index,” he said.

Both offerings priced on Aug. 1 and settled on Monday.

The Cusip number for the Scotia notes is 06416DBR6 and the fee is 0.92%.

The fee for the JPMorgan deal (Cusip:48133L6J6) is 1.25%.

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