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Will the Energy ETFs See a Sustained Rally?

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Oil prices have staged a rally lately with United States Oil Fund LP (USO - Free Report) and United States Brent Oil Fund LP (BNO - Free Report) adding about 2.6% and 3.2%, respectively, past week. The real surge was noticed on Feb 12, when USO and BNO were up 2.5% and 2.8%, respectively. Freezing weather has instigated the oil rally.  

“Winter storm and arctic blast of cold weather that is making its way south to Houston may have some severe impacts on the oil industry.”“Frigid weather means that many oil wells may be shut in. Water is produced along with oil, that water can freeze up equipment,” oil analyst Andy Lipow wrote over the weekend, as quoted on CNBC.

“The cold air affects oil production in Canada, North Dakota, Oklahoma, Texas and elsewhere,” the analyst said. Lipow, president of Texas-based Lipow Oil Associates, also indicated that there are chances that refineries will decelerate operations and brace for outages. Prices also gained as Yemen's Iran-aligned Houthi group said it struck airports in Saudi Arabia with drones, flaring supply concerns in the world's biggest oil exporter.

Notably, USO is up 21% this year. It is now hovering around its highest level since January 2020, or the pre-pandemic level or the $60 level. Brent crude is hovering around a 13-month high. Vaccine distribution and faster global economic recovery have been aiding the oil market.

Along with the commodity, energy stocks have also benefited from the recent run-up in oil prices. Energy Select Sector SPDR Fund (XLE - Free Report) was up 1.5% on Feb 12. VanEck Vectors Unconventional Oil & Gas ETF (FRAK - Free Report) gained even more of about 2.8% on Feb 12.

Can the Rally Last?

First, the vaccine-driven rally looks to have gone a little far and may thus find it tough to add more gains ahead. As far as the OPEC+ deal is concerned, marketsare increasingly anxious that the OPEC+ output cut agreement that has provided enough support to the pandemic-hit oil patch so far, could disintegrate.

During the last OPEC+ gathering, there were separate views of Russia and Saudi Arabia on the output cut decision. Saudi wanted Moscow’s continued participation to make the output cut deal viable. Despite the challenges, Russian producers were finally allowed to increase production in February and March by 65,000 bpd, while Saudi willingly reduced production by one million bpd. Understandably, the fate of such a coalition is unstable.

According to Ronald Smith, a Moscow-based analyst at BCS GM, “as long as oil is $45/bl or below, it is pretty easy to get everyone in OPEC+ on the same page and cut production. And when it is $65-$70/bn, everyone agrees it is time to put oil back on the market. But between $50/bl and $60/bl, that is where the interests diverge,” as quoted on oilprice.com.

Moreover, President Biden's return to diplomacy with Iran on the nuclear deal and lifting of sanctions imposed by Trump means more Iranian oil supply to the market. Venezuela’s oil production is also on the rise despite U.S. sanctions.

To make matters worse, Rystad Energy estimates that if WTI remains in the $50-$55/bl range, U.S. companies could pump up 300,000 bpd in 2021, per an article on oilprice.com. Still, Citigroup expects oil prices to increase another 15% during the year.

ETFs in Focus

Hence, investors need to remain watchful on the future course of oil prices. Exploration & Production (E&P) companies and the related ETFs should offer great returns as long as the winter storm condition stays.

However, return from refineries should be relatively muted as evident from about 0.7% gains noticed in VanEck Vectors Oil Refiners ETF (CRAK - Free Report) on Feb 12. So far this year, XLE and FRAK are up 17.9% and 25.9%, respectively while CRAK has added 9.9%.

If the oil rally loses momentum ahead due to valuation concerns, we believe E&P and oil services companies should still remain in a better-off position as oil pumping would continue. Hence, energy investors could keep a close watch on SPDR S&P Oil & Gas Exploration & Production ETF (XOP - Free Report) (up 29.3% YTD), First Trust Nasdaq Oil & Gas ETF (FTXN - Free Report) (up 23.4% YTD) and SPDR S&P Oil & Gas Equipment & Services ETF (XES - Free Report) (up 19% YTD).

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