The weakness of crude oil has resulted in the price of The United States Oil ETF (NYSEARCA:USO) falling to around $21 - nearly 40% drop from the beginning of the year. While oil inventories in the U.S. continue to go up, this isn't something new. The impact of Saudi Arabia's price war has been talked in the media in length. Another issue to consider is the recent developments in the U.S. oil markets including the changes in supply and demand.
The rise in oil inventories has been the case for the U.S. in recent year. The chart below shows the progress in U.S. oil inventories and the 5-year average over the past several years.
Source of data: EIA
As you can see, current oil inventories aren't much higher than their levels recorded last year. Also, the 5-year average was almost always below current oil inventories levels. Therefore, I think that the progress in oil inventories play a lesser role in the recent plunge in oil prices or the progress on the price of USO in the near term. Another issue to consider is the changes between supply and demand:
Source of data: EIA
The chart above presents the shifts in the gap between the demand and supply in the U.S. during the last couple of years. The supply includes the sum of production and imports per day. The demand includes refinery inputs per day. When the supply is higher than the demand, the blue chart is higher than zero. These changes are over time and don't represent an equilibrium state, of course, because as we were taught back in economics class 101 - in equilibrium the demand is equal to the supply.
As you can see, the supply was well above the demand in the past several weeks - this means the oil markets is loose. At this stage this could suggest the price of USO will remain at its current low level for a long period of time. Moreover, the current Contango in the oil futures markets is likely to result in USO to keep underperform the price of WTI due to roll decay. Even if oil prices were to recover anytime soon, USO is likely to show rally at a slower pace than crude oil WTI.
For USO to bounce back, changes to the supply may occur including U.S. oil production growth rate slowing down, OPEC members eventually decide in the next meeting to cut down oil output or another geo-political change that could bring back up oil prices (Russia the Middle East - too many places to pick from). These changes in supply are likely to take time - plausibly at least half a year unless of course a geo-political event occurs and results in a more immediate market reaction.
But changes in supply aren't the only factors to consider that could bring back up USO. The changes in demand could also occur especially after the current outlooks suggest a slower than previously estimated economic growth in EU, China and Japan - among the leading importers of oil. These countries have been changing their economic polices to recover; if they were to succeed, these regions could eventually present higher than expected growth rates.
The oil market is likely to remain at its current state with USO remaining close to $20. But this state could eventually change in the coming months if the U.S. oil market starts to tighten up or the global economy shows signs of recovery. For more see: USO Investors - Beware of The Contango!
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