How This OPEC Fracas Will Affect Oil ETFs

On Wednesday, 111 exchange traded products hit all-time lows. Of that group, 23 were dedicated energy exchange traded funds and that does not include the plethora of diversified commodities and emerging markets ETFs with heavy energy exposure that also all-time lows yesterday.

The United States Oil Fund USO narrowly missed joining the all-time low club yesterday, but the United States Brent Oil Fund BNO was not so fortunate. Escalating tensions between Saudi Arabia and Iran, two titans of the Organization of Petroleum Exporting Countries (OPEC), are not helping oil prices.

“The recent break in diplomatic relations between Saudi Arabia and Iran adds another complication to the already chaotic environment of Middle East geopolitics. While the sectarian differences between the two nations are capturing the public’s attention, there’s an equally important economic struggle taking place: a prisoner’s dilemma game of sorts that has big implications for oil prices in 2016,” said BlackRock Chief Investment Strategist Russ Koesterich in a new note. 

The iShares MSCI Saudi Arabia Capped ETF KSA, the only ETF exclusively dedicated to tracking stocks in OPEC's largest member state, has struggled despite a low energy weight as oil prices have tumbled. There is no comparable ETF for Iranian stocks.

Inability to fully access international credit markets could deal a blow to Saudi Arabia's efforts to open its financial markets to foreign investors and those investors' hopes that the kingdom could eventually join the widely followed MSCI Emerging Markets Index. For now, the kingdom is not even included in some of the most popular frontier markets benchmarks.

“Funding its ballooning deficit, which can’t be plugged with asset sales and debt issuance alone, and improving its economic situation are partly why Saudi Arabia, the largest producer in the OPEC oil cartel, disagreed to any cut in production at the December OPEC meeting, and more recently has been discounting the price of oil to its customers,” notes Koesterich.

Although oil prices are flirting with $30 per barrel and with some analysts forecasting additional downside, Saudi Arabia has consistently been reluctant to lower production, prompting some market observers to opine that the kingdom is comfortable with continuing to pump amid falling prices as a way of sticking it to rival Iran.

“Another reason for Saudi Arabia’s surprising oil supply moves: geopolitics. In my view, Saudi Arabia doesn’t want to cede any market share to its long-time rival, Iran. In other words, the Saudis seemingly would like to impede Iran’s potential new revenue source by maintaining the supply of oil, or even driving it higher,” adds Koesterich.