The fundamentals of the energy market have been improving on the back of tightening supply and reducing inventory. A major catalyst is the historic output cut deal, wherein OPEC, Russia and other producers have agreed to curb production. It is now paying off with the global oil market on its way toward balancing, by draining out some of the excess inventory. The pact has now been extended to the end of next year.
Additionally, accelerating global economic growth since the financial crisis, with a consumption boom in both developed and emerging markets, has raised the appeal for the commodity. Further, geopolitical tensions in Saudi Arabia, supply outages in Iraq and Libya, a possible strike in Nigeria, and economic uncertainty in Venezuela are driving prices higher (read: Geopolitics Brew in Middle East: ETFs in Focus).
Moreover, after three long years, the oil market has been in a state of backwardation, where later-dated contracts are cheaper than near-term contracts, for months. This signals that the oil market is tightening and demand is robust, paving the way for an oil rally. This trend is likely to persist at least in the near term, acting as the biggest bullish catalyst for the commodity.
Added to the latest strength is the threat of supply disruption in the North Sea. This is especially true as the Forties pipeline has shutdown for a number of weeks due to cracks found on it. Notably, the pipeline, which carries about 40% of North Sea crude oil, pumps over 400,000 barrels of crude oil per day. The closure has halted production from about 80 British oil and gas fields, and some Norwegian ones and benefited the Brent more than WTI.
As a result, Brent oil climbed to above $65 per barrel on Dec 12, its highest price since mid-2015. The Forties pipeline is important for the global oil market because the crude it carries normally sets the price of dated Brent, a benchmark used to price physical crude around the world and underpins Brent futures, according to Reuters.
The jump in Brent prices has widened its premium to WTI prices to as much as $7, the highest in more than two years. This makes U.S. oil exports more attractive. Cheap WTI is the result of rising U.S. production, which has jumped more than 15% since mid-2016 to 9.71 million barrels per day, levels not seen since the early 1970s. A strong dollar also added to the woes. On the other hand, Brent oil is the least affected by these headwinds (read: What's Next for Oil ETFs After Fresh OPEC Output Cut?).
Given this, let us evaluate ETFs tracking the movements of both Brent and WTI crude prices. Though the duo might appear similar at a glance, there are a number of key differences between the two that are detailed below:
United States Brent Oil Fund (BNO - Free Report)
It provides direct exposure to the price of Brent crude oil on a daily basis through futures contracts. It has amassed $99.4 million in its asset base and trades in solid volume of around 143,000 shares a day. The ETF charges 90 bps in annual fees and has surged 9.3% year to date (read: Brent ETF Hits New 52-Week High).
United States Oil Fund (USO - Free Report)
This is the largest and actively traded ETF in the oil space with AUM of $2.2 billion and average daily volume of around 22.1 million shares. The fund provides investors with exposure to front-month oil futures contract traded on the NYMEX. Expense ratio comes in at 0.72%. USO is down 3.4% so far this year.
Positive Roll Yield
As traders need to roll from one futures contract to another in order to avoid delivery, both ETFs are susceptible to roll yield. Notably, roll yield is positive when the futures market is in backwardation (see: all the Energy ETFs here).
Given that rising U.S. oil production will continue to weigh on WTI prices, Brent oil ETF looks more compelling. While this is true, BNO lagged USO in terms of investor preference. First, BNO charges 18 bps higher in annual fees. Second, it has some hidden costs in the form of bid/ask spread as the ETF trades in a lower volume than USO. However, the higher cost seems justified by the solid performance of BNO.
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