Trading oil and gas ETFs after Diamond Offshore bankruptcy filing

Yet more pain in the oil patch.

Smaller oil companies have been hit hard after a historic week for oil prices, which saw West Texas Intermediate crude futures turn negative for the first time in history. On Sunday, Diamond Offshore Drilling filed for bankruptcy, citing “precipitously” falling demand.

As oil prices collapsed again Monday, some strategists recommended that investors steer clear of smaller-cap names for the time being.

“We haven’t seen a lot of flows on the small-cap side,” Jason Bloom, director of global macro ETF strategy at Invesco, said Monday on CNBC’s “ETF Edge.”

Invesco’s small-cap oil and gas ETF products include the Invesco S&P SmallCap Energy ETF (PSCE) and the Invesco Dynamic Oil & Gas Services ETF (PXJ).

“Obviously, those are the firms that are typically the most at risk of insolvency or bankruptcy in this environment,” Bloom said. “So, for clients who are looking for ways to play the rebound in energy prices through an … energy equity, we’ve been recommending larger-cap exposure for those companies that have the balance sheet to weather the storm but will still benefit from higher prices down the road.”

Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA Research, agreed with Bloom, saying the debt-heavy position of some smaller-cap oil companies was “driven home” by Diamond Offshore’s bankruptcy filing.

“If you look at some of the more market-cap-weighted-oriented products in exploration and production like IEO, which is heavily weighted towards ConocoPhillips and EOG Resources, those are companies that have much stronger balance sheets that are likely to survive the volatility that we’re seeing within the oil markets than these smaller companies,” Rosenbluth said.

IEO is the iShares U.S. Oil & Gas Exploration & Production ETF. ConocoPhillips and EOG together account for nearly 27% of its overall holdings.

Tom Lydon, CEO of ETF Trends and ETF Database, acknowledged that “you’ve got a lot of situations where balance sheets are in tough shape” in the energy sector.

“However, there are some smaller-cap companies that actually … [are] in better shape,” Lydon said in the same “ETF Edge” interview.

“A lot of investors are looking for … hope down the road, and when things do turn, smaller companies are actually more nimble. They can ramp up more quickly. And right now, they’re closing down more quickly, hopefully saving as much cost as possible,” he said.

Bloom saw reason in Lydon’s take, even though he maintained that larger-cap companies were likely safer bets.

“The key with the smaller-cap names is to be diversified,” Bloom said. “[Lydon]’s absolutely correct that when the turnaround, the bottoming, occurs, those names that survive will be very well poised to profit handsomely. And from a total return standpoint, obviously, the upside is bigger than in the large-cap names.”

U.S. crude prices were down 10% Tuesday morning after plunging 24% Monday.

Disclosure: Invesco is the sponsor of CNBC’s “ETF Edge.”

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