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High Output and Weak Demand Hitting Oil ETFs

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After smooth trading in the first half of the year, oil prices have persistently declined over the past few weeks. Brent oil dropped to a 13-month low to below $103 per barrel today while crude oil slipped below the triple-digit mark a few days ago.

Higher production, abundant supplies and weak global oil demand took a toll on the oil prices amid threats of supply disruption from the ongoing turmoil in Iraq, Libya, Ukraine and Gaza (read: 3 Energy ETFs to Watch on Iraq Turmoil).

Higher Oil Production

Thanks to the boom in oil and shale gas business, the U.S. produced 8.5 million barrels per day of oil in July, representing the highest level in nearly 27 years. As such, the Energy Information Administration (EIA) raised the crude production outlook for this year and the next.

The agency expects oil production to grow to 8.5 million barrels per day this year and 9.3 million barrels per day in the next compared to the previous forecast of 8.42 million barrels and 9.27 million barrels per day, respectively. Notably, oil production is expected to reach a 43-year high in 2015.

Output from OPEC (12 members) also climbed to a five-month high of 30.44 million barrels per day driven by higher production in Saudi Arabia and restart of Libya production.

Weak Global Demand

On the other hand, demand for oil is falling due to sluggish global economic growth and the global demand projection was thus cut by the International Energy Agency (IEA). The agency now expects global oil demand to grow only by 1 million barrels per day to 92.7 million barrels per day this year, compared to the previous projection of 1.2 million barrels per day growth. However, growth is expected to accelerate to 1.3 million barrels per day next year.

Further, the IEA stated that oil demand in the second quarter fell to the lowest level in more than two years (read: Is This One Energy ETF You Need to Sell?).

Market Impact

The drop in crude and Brent prices has hurt oil ETFs over the past few days. Rising production, falling demand and fading supply disruption fears would lead to further decline in oil prices at least for the short term. This suggests rough trading for oil ETFs in the coming days and that investors should avoid this corner of investing at present. Basically, the ETFs that deal directly in the futures market are risky investments.

Below, we have highlighted a few popular oil ETFs that does not bode well for investors in the days ahead given unfavorable fundamentals (see: all the energy ETFs here).

United States Brent Oil Fund ((BNO - Free Report) )

This fund provides direct exposure to the spot price of Brent crude oil on a daily basis through future contracts. It has amassed $50.8 million in its asset base and trades in small volume of roughly 34,000 shares a day. The ETF charges 75 bps in annual fees and expenses. BNO lost about 4.1% in past 10 trading sessions and 8.3% since the start of the second half.

United States Oil Fund ((USO - Free Report) )

This is the most popular and liquid ETF in the oil space with AUM of $565 million and average daily volume of around 2.8 million shares. The fund seeks to match the performance of the spot price of light sweet crude oil West Texas Intermediate (WTI) and charges 0.45% in expense ratio. The ETF was down 3.7% in the last 10 trading days and fell 7.4% since the start of the second half.

PowerShares DB Oil Fund ((DBO - Free Report) )

This product also provides exposure to crude oil through WTI futures contracts and follows the DBIQ Optimum Yield Crude Oil Index Excess Return. The fund sees moderate average daily volume of more than 89,000 shares and AUM of $225.4 million. Expense ratio came in at 79 bps. DBO lost 2.6% over the past 10 days and 6.6% in the second half of the year to date (read: Guide to Oil Commodity ETFs).

iPath S&P GSCI Crude Oil Index ETN ()

This is an ETN option and delivers returns through an unleveraged investment in the West Texas Intermediate (WTI) crude oil futures contract. The product follows the S&P GSCI Crude Oil Total Return Index, a subset of the S&P GSCI Commodity Index.

The note has amassed $207.8 million in its asset base and has a good volume of roughly 251,000 shares a day. It charges 75 bps in fees per year from investors. The ETN was down nearly 4% over the last 10 days and close to 8% since the start of the second half.

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