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Oil ETFs: Short-Term Bane, Long-Term Boon

Sanghamitra Saha

Relief in the oil patch seems far-fetched. As if brimming U.S. supplies were not enough, oil prices received another blow from Russia. As per an article published on Bloomberg, Russia will likely disapprove any talks related to deepen the oil output cuts in the meeting slated on July 24 beyond the current limit effected by OPEC and some other oil producers (read: How to Trade Oil with ETFs After Surging U.S. Output).

In the meeting, OPEC and other nonmembers will discuss on how to reduce global supply glut, as oil prices are still subdued despite the extension of the output cut deal in May thanks to huge U.S. shale output. Of late, several analysts including Goldman Sachs Group Inc. have stressed on the need to cut output further to stabilize the oil market, if we go by the Bloomberg article.

Rising exports by the OPEC have also made matters worse. OPEC exported 25.92 million barrels per day (bpd) in June, 450,000 bpd more than in May and 1.9 million bpd more than a year earlier, as per Reuters.

Hurt by these news, oil prices registered an acute drop on July 5 after their longest rally in more than five years. WTI crude ETF United States Oil USO lost about 3.9% while Brent crude ETF United States Brent Oil BNO dropped about 3.5%.

How Has Oil Price Been So Far This Year?

Reduction of the output quota started this January. In May, the output cut deal was extended to the first quarter of 2018. But in mid June, the liquid commodity slipped into the bearish territory hurt by surging U.S. supplies and lower Chinese refinery activity (read: Oil in Bear Market: 4 Country ETFs to Shun).

Against these doldrums, news of diminished U.S. output led to an oil rally in late June. Including sharp losses recorded on July 5, USO and BNO are up about 3.4% and 3.1% in the last 10 days. Overall, USO and BNO are down about 21.1 % and 19.2% so far this year (as of July 5, 2017).

What Lies in the Second Half of 2017?

Oil is presently sitting on the fence with possibilities and perils carving out its future run.

Key Positives

According to an UBS commodity analyst, oil is to rally more than 20% with WTI at $58 and Brent at $60 by the end of the year. The analyst believes that “supply growth will lag behind demand growth in the third quarter and that we should see large inventory declines.”

International Energy Agency’s (IEA) monthly report also indicated that ‘demand outstripped supply in the second quarter, and that shortfall should be “significant” in the second half of 2017”. Additionally, the demand profile is still strong from the heavy trucks and freight point of view as the segment is yet to enact high fuel efficiency standards fully.

The agency says that only four countries – Canada, the U.S., China and Japan – have fuel efficiency standards for heavy trucks, while 40 countries have rules in place for passenger vehicles.

IEA highlighted that growth in oil demand from trucks has outperformed all other areas including passenger cars, aviation, industry and petrochemical feedstocks. So, trucking is a huge demand driver of oil. And with the global economy on the mend, demand should shoot up from here.

Looking at the U.S. front, talks of higher inventory draw and lower production has gathered steam lately. Baker Hughes data show a decrease in U.S. oil-rig count for the first time in about six months in the June 30 week. EIA data shows that domestic crude inventory fell 6.3 million barrels for the week ended June 30, beating the S&P Global Platts estimate of a decline of 1.6 million barrels.

Key Negatives

The Russia issue seems to be a short-lived glitch as oil soon recovered on solid demand in the U.S. American Petroleum Institute (API) recently hinted at 5.8 million barrels of decline in U.S. crude inventories in the week to June 30 (read: Profit from Bearish Oil Market with These ETFs).

Still, analysts remained skeptical. Bank of America Merrill Lynch lowered its WTI forecasts to an average $47 per barrel this year and $50 in 2018, down from $52 and $53 previously. The agency found OECD total oil inventories still above 3 billion barrels which is unexpected given the output cut. Plus, recovery in Libyan and Nigerian supplies will keep the market overflowed with oil in the coming days.

As per Morgan Stanley, U.S. output is unlikely to decline substantially unless WTI remains in low $40s. The bank sees WTI price at sub-$50 per barrel to mid-2018.

ETFs in Focus          

Overall, sentiments are mixed. So, oil is expected to move sideways in the days to come. Investors can play any dip in oil prices at the current level via inverse oil ETFs like United States Short Oil Fund DNO, PowerShares DB Crude Oil Short ETN SZO, ProShares UltraShort Bloomberg Crude Oil SCO and VelocityShares 3x Inverse Crude Oil ETN DWT.

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US-OIL FUND LP (USO): ETF Research Reports
US BRENT OIL FD (BNO): ETF Research Reports
PRO-ULS BB CRUD (SCO): ETF Research Reports
DB CO SH (SZO): ETF Research Reports
US-SHRT OIL FD (DNO): ETF Research Reports
VS-3X IN CR OIL (DWT): ETF Research Reports
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