Short-term gain, longer-term pain for crude oil
Crude oil has settled into a relatively tight range above $80/barrel, with forecasts weighing short-term upside risks against the potential of slowing demand growth and rising non-Opec production.
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We had an action-packed oil market leading to a market rally after the Opec meeting last month. Implied options volatility, a way of measuring uncertainty among crude oil traders and investors is at its highest since the run. The Opec meeting in Austria concluded with oil ministers supporting a tentative agreement to boost output to an acceptable degree.
Opec and several allied non-Opec countries intend to increase their oil production markedly in the second half of the year. The aim is to compensate for the fall in output in Venezuela and bring the oil market back into balance. This intention could be counteracted by other production losses and the US’s demand for all oil imports from Iran to be stopped from November onwards.
Crude oil prices did not come under pressure after the Opec meeting despite the deal to increase output. On the contrary, Brent rallied back to its 3½-year high, while WTI tracked the same momentum as well.
Chart: Brent and WTI at 3½- year highs
Data from the Energy Information Administration on Thursday, July 5, showed that US crude stockpiles rose by 1.2 million barrels for the week of June 29, 2018. While another contributing factor to higher supplies was Baker Hughes US rigs drilling for oil. The chart below clearly shows that the number of active rigs rose to 863, the highest level since 2014.
Other than acquiring exposure in oil futures contracts, we can see an increasing number of investors looking at other popular ways to get portfolio exposure in oil and energy related ETFs (exchange traded funds).
The Opec decision supported a surge in oil futures. The United States Oil Fund LP (USO) jumped 12% and marked its best intra-day gain since April 18, while the Energy Select Sector SPDR ETF (XLE) rallied 10% since mid of April 2018. Additionally, S&P 500 index's energy sector was the best performer among the benchmark's 11 sectors. From the chart above we can clearly see that the Energy index and XLE US is still lagging the market oil rally.
An examination of prices in the volatile oil market reveals that inverse/short Oil ETFs were other instruments through which investors could gain exposure to oil's decline. The chart below demonstrates that these ETFs have produced returns during a period of extremely rapid declines in oil prices.