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Energy ETFs Crash on Rate Cut and New China Tariff

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Oil price saw a tumultuous ride on dual attack by the Fed and Trump that disrupted its five-day winning streak. Both crude and Brent saw their worst daily performance in more than four years, plunging more than 8% each (read: Energy ETFs Look Weak Ahead of Key Q2 Earnings Releases).

Though Fed lowered interest rates for the first time in more than a decade, it dampened hopes of a string of rate cuts to shore up the economy, which is witnessing a slowdown and taking a toll on oil demand. Then, President Trump announced additional tariffs of 10% on the remaining $300 billion in Chinese goods effective September, which intensified concerns over global growth. This will further weaken oil demand.

The oil price crash came despite the two bullish drivers - a bigger-than-expected decline in U.S. inventories and a fall in OPEC production in July.

ETF Impact

The horrible trading in oil sent energy ETFs space into deep red in yesterday’s trading session. Invesco S&P SmallCap Energy ETF (PSCE - Free Report) was hit hard and tumbled more than 8%. SPDR S&P Oil & Gas Equipment & Services ETF (XES - Free Report) , SPDR S&P Oil & Gas Exploration & Production ETF (XOP - Free Report) and VanEck Vectors Oil Services ETF (OIH - Free Report) lost 7%, 6.2% and 6%, respectively.    

Below we profile these ETFs and discuss some of the specifics behind their recent slump:

PSCE

PSCE provides exposure to the U.S. small-cap segment of the energy sector by tracking the S&P Small Cap 600 Capped Energy Index. It holds 29 stocks in its basket with AUM of $21.5 million. The fund trades in average daily volume of 19,000 shares and charges 29 bps in fees per year.

XES

This fund tracks the S&P Oil & Gas Equipment & Services Select Industry Index, which measures the performance of companies engaged in the oil and gas equipment and services industry. Holding 38 stocks in its basket, it charges 35 bps in annual fees and trades in solid volume of 1.3 million shares a day on average. The fund has amassed $166.2 million in its asset base (read: Is an Oil ETF Rally on Middle East Tensions Sustainable?).

XOP

This fund provides exposure to oil and gas exploration companies by tracking the S&P Oil & Gas Exploration & Production Select Industry Index. It has amassed $2 billion and holds 64 securities in its basket. The product charges 35 bps in annual fees and trades in average daily volume of 21.6 million shares.

OIH

With AUM of $738.6 million, this fund tracks the MVIS U.S. Listed Oil Services 25 Index, which offers exposure to the companies involved in providing oil services to the upstream oil sector, including oil equipment, oil services or oil drilling. It is home to 23 stocks and charges 35 bps in annual fees. Volume is solid, exchanging 7.8 million shares in hand on average.

What Lies Ahead?

Oil has been the highest hit commodity due to the trade war, witnessing a roller-coaster ride this year. Per the latest Reuters poll, oil prices are expected to be range-bound near current levels this year as slowing economic growth and the protracted trade dispute between the United States and China curb demand.

Though global growth concerns will weigh on oil demand, tight supply conditions driven by Iran and Venezuela sanctions, Middle East tensions and declining OPEC production drive confidence about the sector. Additionally, OPEC and some non-OPEC producers including Russia have extended their oil supply cut pact until March 2020 to tackle global supply glut and rebalance the oil market. Russia also joined Saudi Arabia to extend existing output cuts of 1.2 million barrels per day, or 1.2% of global demand, until December 2019 or March 2020. All these factors bode well for the sector (read: OPEC Output Cut Extended to 2020: Will These ETFs Gain?).

However, a recent wave of oil reports forecast a big surplus in 2020, sending bearish signals. The International Energy Agency (IEA) stated that oil supply in the first six months of 2019 had exceeded demand by 0.9 million barrels per day. The “considerable oversupply” situation will likely continue in the remainder of this year and 2020, given higher production from the United States and some other countries as well as drop in OPEC demand. In particular, the agency projects 2.1 million barrels per day expansion of non-OPEC oil supply next year while OPEC crude oil demand could fall to only 28 million barrels per day in early 2020.

OPEC also expects global crude demand to drop in 2020 as non-OPEC nations increase production. It estimates global demand at 29.27 million barrels per day of crude from OPEC nations next year, an expected decline of 1.34 million barrels per day from 2019.

PSCE, XES and OIH have a Zacks Rank #5 (Strong Sell) while XOP has a Zacks ETF Rank #3 (Hold).

Given the bearish sentiments, investors may want to consider staying on the sidelines for the time being. However, risk-tolerant long-term investors may want to consider this recent slump a buying opportunity, should they have the patience for extreme volatility.

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