Oil ETFs: Short-Term Threat, Long-Term Opportunity?

by: Zacks Funds

As expected, Algeria did not see an output freeze deal in a meeting among the major oil producers. The reason for the repeat show of the Doha meeting in April was the same, with Iran excusing itself from cutting oil output. The Saudi energy minister does not expect any deal to be sealed through discussions over the oil output curb/freeze issue.

Oil prices have been under pressure lately. Higher OPEC production and a rise in the number of rigs operating in U.S. oil fields stoked supply glut concerns in recent times. IEA's recent forecast of a prolonged supply glut also made matters worse.

Why Is Iran Rejecting Output Freeze Proposal?

Iran has been boosting production since the international sanctions on it were lifted in January. This is because Iran was producing below its capacity and pre-sanctions levels since 2011, while the other countries raised their output limit to record levels in the meantime.

So Iran is in no mood to curtail its production levels and in fact indicated lately that would keep pumping oil in the next few months till it reaches pre-sanctions levels. Iranian Oil Minister indicated earlier that it is too early to come to a decision.

However, on a positive note, members are looking forward to the upcoming formal OPEC meeting in Vienna in late November, when output freeze/cut talks can be initiated and a deal could be sealed. Mr. Falih, who supervises Saudi oil policy indicated that "the cartel could move to reduce production, instead of just agreeing to hold it steady" in November.

Iran's present rate of production is over 3.6 million barrels per day (bpd), not far from its pre-sanction levels of over 4 million, or about 12.7% of the OPEC output. Iran will likely reach that level in two-three months.

But other OPEC Gulf members wanted Iran's output to remain below 4 million bpd. Notably, Saudi Arabia and other Gulf OPEC members increased output between 2012 and 2016, when Iran was banned for its nuclear activities.

Any Ray of Hope?

Apart from Iran, several oil biggies including Russia, Algeria and Qatar are in favor of the deal. Saudi, which ramped up its production to 10.7 million bpd from 10.2 million in recent months, wants Iran to freeze output at the level it is producing now to sign such a deal.

However, with Iran fast approaching the target, the country may not be a problem for an output control deal in November. Iran also expects the oil market to rebalance by the fourth quarter of 2016 or the beginning of next year.

Market Impact

As soon as news of Iran's no-to-a-deal spread in the market, oil prices started trending lower. WTI crude ETF United States Oil Fund (NYSEARCA:USO) and the Brent crude ETF (NYSEARCA:BNO) were down about 2.7% each on September 27, 2016.

Among energy ETFs, PowerShares DWA Energy Momentum Portfolio ETF (NASDAQ:PXI) (down 2.45%), PowerShares S&P SmallCap Energy Portfolio ETF (NASDAQ:PSCE) (down 2.32%) and SPDR S&P Oil & Gas Exploration & Production ETF (NYSEARCA:XOP) (down 2.25%) were some of the biggest losers on September 27.

Other Factors to Impact Oil Prices

Apart from the outcome of the oil-producers' meeting, oil inventory data released by EIA will also play an important role in setting the oil price movement, going forward.

As of now, industry data hinted at a surprise withdrawal in U.S. crude inventory for the week ended September 23. The market projection was a 2.8 million-barrel inventory pileup while in reality the scenario is going to be a drawdown of 752,000 barrels. If this holds good, oil prices will shore up as soon as the EIA comes up with the official data.

What Should Be Your Take on Oil & Energy ETFs?

Overall, sentiments are mixed with investors' focus shifting to the November meeting. So, oil is expected to move sideways in the days to come. Though the price is likely to stay muted in the near term, it may take an upturn in November in anticipation of a production cut deal, probably this time for real.

Meanwhile, Goldman Sachs cut its oil price projection for Q4 of 2016 to $43 a barrel from $50 citing a weaker-than-expected demand-supply scenario. Investors can play any dip in oil prices via inverse oil ETFs like Short Oil & Gas ETF (NYSEARCA:DDG), ProShares UltraShort DJ-UBS Crude Oil ETF (NYSEARCA:SCO) and PowerShares DB Crude Oil Double Short ETN (NYSEARCA:DTO). DDG, SCO and DTO were up about 1.2%, 5% and 4.3%, respectively, on September 27.

Direxion Daily Energy Bear 1X Shares (NYSEARCA:ERYY) can also come to investors' rescue in an oil price slump. The product was up over 3.9% on September 27.

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