Cold Snap Sparks Sudden Rally In Oil Price: ETFs Surge

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Includes: BHI, BNO, DBO, UCO, UHN, USO, UWTI
by: Zacks Funds

After crashing to below the 12-year low in Wednesday's trading session, oil price spiked nearly 21% over the past two days, representing the biggest two-day rally since September 2008. It has also extended its gains in the early trading session today with both U.S. crude and Brent trading above $32 per barrel (read: Oil Hits 12-Year Low: Short Energy Stocks with ETFs).

The steep increase came on the back of short covering, bargain hunting as well as freezing conditions and snowstorms in parts of the U.S. and Europe that boosted the short-term demand for heating oil. Notably, speculators' short position in WTI dropped 8.4% for the week ended January 19, as per the data from U.S. Commodity Futures Trading Commission.

In addition, weekly data from oil services firm Baker Hughes (NYSE:BHI) showed that the number of rigs fell for the fifth consecutive week by 5 last week to 510, the lowest level since April 2010. Further, hopes of additional stimulus in Europe and Japan, and China comments on no plans to devalue the yuan boosted the confidence in the overall economy, thereby bolstering the case for global oil demand.

ETF Impact

The tremendous trading in oil sent the oil ETFs space into deep green in Friday's trading session. In particular, the United States Diesel-Heating Oil ETF (NYSEARCA:UHN) surged 10% followed by gains of 9.5% for the United States Brent Oil ETF (NYSEARCA:BNO), 8.6% for the PowerShares DB Oil ETF (NYSEARCA:DBO) and 8.3% for the United States Oil ETF (NYSEARCA:USO).

While the returns of these funds are tied to the oil price, they are different in some way or the other. This is especially true as UHN tracks the movement of oil prices while BNO provides direct exposure to the spot price of Brent crude oil on a daily basis through future contracts. DBO provides exposure to crude oil through WTI futures contracts and follows the DBIQ Optimum Yield Crude Oil Index Excess Return while USO seeks to match the performance of the spot price of light sweet crude oil WTI.

Out of the four, USO is the most popular and liquid ETF in the oil space with AUM of $2.3 billion and average daily volume of 34 million. UHN is unpopular and illiquid with AUM of $2.5 million and average daily volume of just 3,000 shares. Further, USO is the least expensive, charging just 45 bps in fees per year from investors.

Meanwhile, leveraged oil ETFs also shot up with the VelocityShares 3x Long Crude Oil ETN (NYSEARCA:UWTI) and the ProShares Ultra Bloomberg Crude Oil ETF (NYSEARCA:UCO) surging 24.6% and 16.8%, respectively. The former seeks to deliver thrice the returns of the daily performance of WTI crude oil while the latter tracks the two times daily performance of futures contracts on WTI crude oil.

What Lies Ahead?

Despite the steep gains, oil price is down 13% so far this year and the long-term fundamentals remain bearish (read: If the Oil Crash Continues, Buy These 5 ETFs to Outperform).

This is because oil production has risen worldwide with the the Organization of the Petroleum Exporting Countries (OPEC) continuing to pump near-record levels, and higher output from the U.S., Iran and Libya. The lift in oil sanctions in Iran would add a fresh stock of oil to the already oversupplied global market as the country is expected to increase its crude oil exports by half a million barrels a day immediately and a million barrels a day within a year of lifting the ban.

On the other hand, demand for oil across the globe looks tepid given slower growth in most developed and developing economies. In particular, persistent weakness in the world's biggest consumer of energy - China - will continue to weigh on the demand outlook. The negative demand/supply imbalance would push oil prices and the related ETFs further down at least in the short term.

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