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Alluring Fundamentals For Oil ETFs

June 14, 2018 9:22 am
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Alluring Fundamentals For Oil ETFs

The United States Oil Fund (NYSE:USO), one of the most heavily traded commodities exchange traded funds in the U.S., is having an eventful 2018. After a surge that began in February and continued for much of the second quarter, USO is lower by 6.33 percent over the past month.

Oil is still one of this year's best-performing commodities, and much of crude's upside has come against the backdrop of a strengthening dollar and surging U.S. output.

What Happened

In recent months, the spread between West Texas Intermediate, the U.S. oil benchmark, and Brent crude, the global benchmark, has been widening in favor of Brent. That has compelled U.S. producers to take advantage of the wider spreads by exporting more oil.

U.S. shale producers are boosting output as production continues to decline in Mexico. Venezuela, a member of the Organization of Petroleum Exporting Countries, is pumping at multiyear lows due to government interference and poor infrastructure.

“Oil prices will remain relatively high for the rest of 2018 due to ongoing geopolitical tensions and strong demand, and despite indications from Saudi Arabia and Russia that they may start to increase production,” said Fitch Ratings.

Why It's Important

USO tracks front-month WTI futures. The United States Brent Oil Fund LP (NYSE:BNO) provides exposure to Brent futures. Underscoring the strength in Brent relative to WTI this year, BNO is up 18 percent year-to-date, an advantage of more than 550 basis points over USO. The Brent fund has also been less bad than USO over the past month, losing just 2.2 percent.

Some OPEC members are mulling higher near-term output to take advantage of higher prices and to fill the void created by Venezuela's lost production.

“Saudi Arabia and Russia, two main driving forces behind the OPEC+ agreement, indicated they would consider adjusting production quotas at the OPEC meeting scheduled for June 22,” said Fitch. “This should help offset the production declines in Venezuela and a possible drop in exports from Iran after the renewed U.S. sanctions come into force later this year.”

What's Next

Next week's OPEC meeting could affect oil prices and the aforementioned ETFs, but oil bulls may want to be cautious when betting years of more upside. Additionally, the structure of USO, relying on front-month contracts, is such that the fund is not a good buy-and-hold investment.

Fitch said it expects oil prices will decline to $60 per barrel by 2020.

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