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Oil ETFS Expectations Glum for 2016

The United States Oil Fund (USO) , which tracks West Texas Intermediate crude oil futures, is down more than 45% year-to-date while the United States Brent Oil Fund (BNO) , which tracks Brent crude oil futures, is down nearly the same amount.

That makes BNO, USO and rival oil exchange traded products some of the worst-performing commodities funds this year and that is saying something given investors’ rejection of commodities as an asset class. With 2016 drawing near, commodities investors should temper expectations for a legitimate oil rebound next year. In fact, some analysts see more downside ahead for crude.

Last week, crude oil prices fell to their lowest levels since early 2009 after OPEC’s meeting Friday ended without an agreement to lower production, Reuters reports. OPEC has been fueling a global supply glut in an attempt to maintain market share and squeeze out high-cost oil producers, such as the nascent shale industry in the U.S.

OPEC has kept up production to pressure high-cost rivals, such as the developing U.S. shale oil producers. The International Energy Agency expects it will take several years before OPEC can effectively price out high-cost producers. [Oil ETFs Face World-Record Supply Glut]

However, oil prices, BNO and USO have sharply rebounded this week, but that does not mean investors should expect a lot of the same next year.

“Low commodities prices and uncertainty about the pace of their recovery will continue to limit exploration and production activity in 2016, leading to spending cuts, stalled production growth and volume declines. And these cuts will in turn lead to lower revenue for drilling and oilfield services companies, which will face persistent equipment overcapacity and need to minimize capital expenditures just to operate near break-even cost levels,” according to a Moody’s Investors Service note posted by Amey Stone of Barron’s.

There are reasons for investors to be cautious with volatile energy ETFs. Moreover, if oil prices falls to new lows and the shale industry is unable to turn a profit, the highly leveraged industry may find it harder to repay debt obligations. The IEA said the “massive cushion has inflated” on record supplies from Iraq, Russia and Saudi Arabia.

Investors can utilize a number of inverse or bearish ETF options to hedge against further declining energy prices. For instance, the United States Short Oil (DNO) tracks the opposite moves of the West Texas Intermediate crude oil futures, and the DB Crude Oil Short ETN (SZO) also tracks the simple inverse of oil. [Leveraged ETFs Are Popular Plays Among Swing Traders]

United States Oil Fund

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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