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

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 : 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 (NYSE:GS). have stressed on the need to cut output further to stabilize the oil market, if we go by the Bloomberg article.

Reuters .

Hurt by these news, oil prices registered an acute drop on July 5 after their USO lost about 3.9% while Brent crude ETF United States Brent Oil (AX: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 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 ‘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 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.

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Key Negatives

The Russia issue seems to be a short-lived glitch as oil soon recovered on Profit from Bearish Oil Market with These ETFs ).

Still, analysts remained skeptical. Bank of America Merrill Lynch (NYSE:BAC) 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 (NYSE:MS) , 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 (OL:DNO) , PowerShares DB Crude Oil Short ETN DWT .

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Written By: Zacks Investment Research