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Oil & Energy ETFs Rallying on Output Cuts, Can the Rally Last?

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Oil prices jumped on Tuesday as tensions flared up following Iran's seizure of a South Korean vessel and Saudi gearing up to cut output in February. The South Korean government on Tuesday demanded the early release of an oil tanker which was seized by Iran's Islamic Revolution Guards Corps (IRGC) in the Gulf as they claimed the fact to be "repeated violations" of environmental protocols.

The move is deemed to have risen out of Seoul’s freezing of Iranian funds in Korean banks due to U.S. sanctions. Meanwhile, Saudi Arabia pledged incremental and voluntary oil output cuts of one million barrels per day (bpd) in February and March above its current quota — while OPEC’s allies will boost production.

The OPEC+ agreed on the production levels for February as well as March. The decided production level for March will mark an additional increase of 120,000 barrels per day over the February levels, or 195,000 bpd over the January levels, per oilprice.com. With March production quotas already set, the February meeting will determine the output quotas for April.

Russia and Kazakhstan will be permitted to beef up their output by a decent combined 75,000 bpd in February and a further 75,000 bpd in March. Such decisions by OPEC pushed United States Oil Fund LP (USO - Free Report) by about 4.9% on Jan 5 while United States Brent Oil Fund LP (BNO - Free Report) added about 5.7% on the day.

Can the Rally Last?

After a prolonged cut, Russia and Kazakhstan had pressed for the group to boost production by 500,000 barrels per day (bpd) for February, just as it had done for January, while others did not want an increase.

But the new variants of the coronavirus have resulted in renewed containment measures across the globe, including full lockdowns. These are threats to oil demand in 2021. Full demand recovery will take time. So, Saudi found voluntary cuts may be a good way to block the huge inventory pile-up.

Oil Prices Likely to Remain Range Bound in 2021 Despite Vaccine Rollout

Several factors including OPEC’s output decision and shale production will rule the oil market in 2021. As of now, shale output is rising with falling costs of hydraulic fracturing or “fracking,” and rising commodity prices.

Per a Forbes article, a recent survey by the Dallas Federal Reserve reported that shale firms needed less than $30 a barrel in most fields to make up for their operating expenses for existing wells. Companies could operate profitably in West Texas’ Permian basin for less than $40 a barrel, including drilling costs.

On the other hand, Iran is planning to sign agreements worth $1.2 billion to boost the nation’s crude output. All these factors may result in higher oil output and could put pressure on prices even in a scenario of demand recovery.

“Amid the hopeful signs, the outlook for the first half of 2021 is very mixed and there are still many downside risks to juggle,” said OPEC Secretary-General Mohammad Barkindo, as quoted on oilprice.com.

Against this backdrop, investors should keep a close tab on oil and energy ETFs like Energy Select Sector SPDR Fund (XLE - Free Report) , iShares Global Energy ETF (IXC - Free Report) , Invesco DB Oil Fund (DBO - Free Report) and United States 12 Month Oil Fund (USL - Free Report) .

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