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Profit from Bearish Oil Market with These ETFs

Sweta Killa

Oil price is once again caught in a nasty web of trading, having dropped to the lowest level in seven months with no sign of a rise. This also marks the worst first-half slide in two decades. In fact, the price tumbled 20% from the recent peak reached in late February, which confirms the bear market for oil.

Inside The Pain

Bearish indicators have taken the front seat due to the barrage of negative data flow that point to a period of protracted lower oil prices. This is especially true given that the ramp up of production in U.S., Libya and Nigeria as well as high global inventories has intensified concerns over supply glut despite the OPEC production cut deal. OPEC, which accounts for one-third of the global output, Russia and other producers agreed to curb production by 1.8 million barrels per day in the first half of 2017 and extended it by nine months (read: Saudi, Russia Boost Oil Price: Bet on Leveraged ETFs).

U.S. oil production increased to the highest level since August 2015 to 9.3 million barrels per day over the last eight months, according to the latest report from the Energy Information Administration (EIA). While stockpiles declined by 2.45 million barrels for the week ended June 16, inventories remained above the five-year average.

The agency expects U.S. oil production to increase to 10 million barrels a day next year, breaking 1970 record of 9.6 million barrels a day. Most of the production growth is expected to come from increased drilling activity in U.S. tight oil basins especially those located in Texas as drillers are taking full advantage of the OPEC deal to limit output in a bid to shrink global oversupply.

Libya is currently pumping 885,000 barrels a day per week, roughly three times the year-ago production and aims to raise production to 1 million barrels a day by the end of July. Meanwhile, exports from Nigeria are expected to exceed 2 million barrels per day in August — the highest in 17 months — as the country is on track to recover fully from militant attacks that crippled production in 2016.

Given the increased supply from these three countries, the Bank of Russia in its latest monetary-policy report said that output growth could result in oil prices as low as $25 per barrel by mid-2018. Per the leading global energy market academic, crude price could drop to $30 per barrel if OPEC fails to make additional cuts to production (read: Will OPEC Feud Harm Oil ETFs?).

Added to the woes is the looming cut in Chinese refineries during the peak summer season. Oil refineries in China, the world's top crude importer, are expected to shut nearly 10% of the country’s 15.1 million barrels per day capacity in the third quarter, dampening prospects of global oil demand.

How to Play?

Given the bearish fundamentals, many investors may want to make a short play on the commodity. For those investors, while futures contracts or short-stock approaches are possibilities, there are a host of inverse oil ETF options that prevent investors from losing more than their initial investment. Below, we highlight some of these ETFs and the key differences between them:

United States Short Oil Fund DNO

This is an unpopular and liquid ETF in the oil space with AUM of $15.4 million and average daily volume of 8,000 shares. The fund seeks to match the inverse performance of the spot price of light sweet crude oil WTI. It charges 75 bps in fees per year from investors and has gained about 29.2% in the year-to-date time frame.

PowerShares DB Crude Oil Short ETN SZO

This is an ETN option and arguably the least risky choice in this space as it provides inverse exposure to the WTI crude without any leverage. It tracks the Deutsche Bank Liquid Commodity Index – Oil – which measures the performance of the basket of oil future contracts. The note is unpopular as evident from an AUM of $2.7 million and average daily volume of under 1,000 shares a day. Its expense ratio is 0.75%. The ETN has gained 23.1% so far this year.

ProShares UltraShort Bloomberg Crude Oil SCO

This fund seeks to deliver twice (2x or 200%) the inverse daily performance of the Bloomberg WTI Crude Oil Subindex. It has attracted $119.2 million in its asset base and charges 95 bps in fees and expenses. Volume is solid as it exchanges nearly 1.9 million shares in hand per day. The ETF has returned about 62.7% since the start of the year.

PowerShares DB Crude Oil Double Short ETN DTO

This is also an ETN option providing 2x inverse exposure to the Deutsche Bank Liquid Commodity Index-Light Crude. It has amassed $56.1 million in its asset base and trades in a paltry daily volume of roughly 8,000 shares. The product charges 75 bps in fees per year from investors and is up 63% in the same time frame.

VelocityShares 3x Inverse Crude Oil ETN DWT

This product offers triple (3x or 300%) inverse exposure to the daily performance of the S&P GSCI Crude Oil Index ER. It is a bit pricey, charging1.50% in annual fees, while average daily volume is solid at over 2.5 million shares. It has amassed $56.9 million in its asset base and has delivered whopping returns of nearly 99.4% in the same time frame.

ProShares UltraPro 3x Short Crude Oil ETF OILD

This fund seeks to deliver thrice the daily inverse performance of the Bloomberg WTI Crude Oil Subindex. It has attracted $7.9 million in its asset base since its debut in March and charges 95 bps in fees and expenses. Volume is moderate as it exchanges nearly 56,000 shares in hand per day. The ETF has returned about 35% since its debut (read: What Lies Ahead for Oil & Gas ETFs?).

UBS ETRACS ProShares Daily 3x Inverse Crude ETN WTID

This ETN is linked to the daily compounded 3x leveraged inverse performance of the Bloomberg WTI Crude Oil Subindex ER. It has been able to amass decent level of $44.9 million in AUM since its inception in January but trades in light volume of under 8,000 shares a day. Expense ratio comes in pretty high at 1.85%. The note has surged 83.7% since its inception.

Bottom Line

As a caveat, investors should note that such products are extremely volatile and suitable only for short-term traders. Additionally, the daily rebalancing – when combined with leverage – may make these products deviate significantly from the expected long-term performance figures (see: all Inverse commodity ETFs here).

Still, for those ETF investors who are bearish on oil, either of the above products could make an interesting choice. Clearly, a near-term short could be intriguing for those with high-risk tolerance, and a belief that the “trend is a friend” in this corner of the investing world.

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