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Is the Worst Over for Oil ETFs?

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Oil price showed a strong rebound last week, registering a weekly gain of 19%. This is primarily thanks to production cuts by major oil producers and signs of recovery in demand as some business lockdowns have been lifted globally. Notably, U.S. crude futures rose to the highest in nearly six weeks, representing a marked increase from the dive in crude futures for May to negative $40 on Apr 20 (read: Top ETF Areas of Last Week).

Current Trends

The supply and demand balance is tightening. Saudi Arabia has pledged to reduce its oil production by an additional one million barrels per day starting in June, in addition to cuts outlined in the deal between the Organization of the Petroleum Exporting Countries (OPEC) and its allies that kicked in on May 1. The move has led to investors’ optimism and will balance out the oil market in June and July. The OPEC+ is expected to extend overall production cuts beyond May and June when the group meets next.

Additionally, the stockpile is declining slowly, easing a storage crisis. U.S. crude inventories fell for the first time in 16 weeks for the week ended May 8. The International Energy Agency (IEA) forecast lower global stockpiles in the second half of 2020, even as worries remain over a second surge in coronavirus infections in the coming months. It expects crude inventories to fall by about 5.5 million barrels per day in the second half of this year.

Per the latest data from Baker Hughes, the number of active U.S. oil rigs drilling dropped by 34 to 258 last week. The oil-rig count has now fallen for nine weeks in a row, suggesting declines in domestic crude output ahead (see: all the Energy ETFs here).

On the demand front, the latest data showed that China’s daily crude oil use rebounded in April from a 15-month low in March as refineries ramped up operations. For 2020, the IEA now expects global crude demand to fall by 8.6 million barrels a day versus its April forecast of a decline of 9.3 million barrels a day.

Moreover, the oil futures market points to a shrinking contango (a condition where later-dated futures are priced higher than nearby contracts), which indicates constrained supplies. In particular, Brent crude futures for July are trading at the smallest discount to the contract six months in the future since March.

How to Play?

Improving supply/demand trends have compelled many investors to look into the oil commodity world. For them, we have highlighted a few popular oil ETFs that could be interesting plays to directly deal with in the futures market in the coming months.

United States Oil Fund (USO - Free Report) : This is the most-popular ETF in the oil space with an AUM of $4.1 billion. The historic oil price collapse last month compelled the fund to change its strategy and move away from the near-term futures oil contract. Now, USO invests approximately 40% of its portfolio in crude oil futures contracts for June, approximately 55% of its portfolio in contracts for July, and approximately 5% of its portfolio in crude oil contracts for August. The ETF has 0.73% in expense ratio (read: Oil Price Rebound, USO ETF & More).

United States Brent Oil Fund (BNO - Free Report) : This fund provides direct exposure to the daily price movements of Brent crude oil through futures contracts. It has amassed $354 million in its asset base and charges 90 bps in annual fees and expenses.

Invesco DB Oil Fund (DBO - Free Report) : This product provides exposure to crude oil through WTI futures contracts and follows the DBIQ Optimum Yield Crude Oil Index Excess Return. The fund has AUM of $433.4 million and charges 78 bps in annual fees.

United States 12 Month Oil Fund (USL - Free Report) : USL provides investors with exposure to the daily price movements of West Texas Intermediate light, sweet crude oil. USL's benchmark is the near month futures contract to expire and the contracts for the following 11 months, for a total of 12 consecutive months. If the near month futures contract is within two weeks of expiration, the benchmark will be the next month contract to expire and the contracts for the following 11 months. USL is unpopular and less liquid with AUM of $286.4 million and expense ratio of 0.82%.

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