In the beginning of the year, oil prices witnessed smooth sailing. This was largely thanks to a chilly winter and escalating geopolitical tensions, which helped to buoy prices. However, the favorable demand-supply conditions, which once led crude oil prices to trade above the triple-digit mark, are now waning.
Last week Brent oil slumped to a two-year low of $96.72, while West Texas Intermediate (WTI) futures slipped to $90.43 – the lowest level since May 1, 2013. Slowing global demand on the back of rising supplies is believed to be the main culprit for bringing oil prices back to the double digits, which had crossed above $115 not so long ago in June. In fact, Brent oil is down roughly 11% in the third quarter.
What’s Behind the Slump?
Global slowdown primararily in Europe and China is believed to be the cause of dwindling demand. European manufacturing index fell to 50.7 in August – the lowest level in 13 months. Europe is already reeling under deflationary pressure and slowing growth. Making things worse, manufacturing activity is also slowing in the second largest oil consuming nation – China.
Moreover, the U.S. government's Energy Information Administration (EIA) and the Organization of the Petroleum Exporting Countries (OPEC) also recently cut their forecast for oil demand following lackluster growth in these nations. Paris-based IEA also lowered its prediction for global oil demand.
While, the situation is worsening on the demand front, we have solid oil supplies. The EIA recently reported that U.S. crude oil production increased by 3 million barrels per day between January 2011 and July 2014 – exceeding the global unplanned supply disruptions of 2.8 million barrels per day. Rising oil production is supported by the shale gas boom which has created a huge surplus in the Atlantic Basin and Asia.
Further, a stronger greenback also contributed to the slide. This is especially true as commodity prices are inversely related to the dollar and a rising dollar makes them more costly for users of other currencies. Also, easing geopolitical worries in Ukraine and in Iraq further quelled oil supply worries, supporting the downturn.
Can the Slide Continue?
The sharp sell-off in crude oil prices, however, took a breather recently on some bargain hunting by investors and on news that OPEC, which accounts for 40% of the world’s oil supply, could trim output to reduce a global supply glut.
OPEC Secretary General Abdullah al-Badri recently stated that the group expects to reduce its 2015 output target to 29.5 million barrels per day (bpd) from 30 million bpd when it next meets in late November. If true, this would mark the first cut by the cartel since 2008.
Experts also believe that the slide in oil prices is temporary and that it will start consolidating soon as many OPEC countries require oil prices to stay above the $100 a barrel mark to meet their budget requirements.
However, another group of analysts believe that U.S. oil production is expected to continue rising through 2019 and this is believed to keep a check on oil price increasing massively.
But after 2019, U.S. oil production growth might not be sufficient enough to meet the increased global demand levels expected in the future. This might lead world oil prices to increase to $141 per barrel by 2040.
Nonetheless, it can’t be denied that any worsening of the geopolitical tensions between Russia and Ukraine could cut down global crude supplies. The U.S. and the EU have already imposed fresh sanctions on Russia, which might reduce oil production in the long term.
Moreover, if the political crisis in Libya heightens, this could again disrupt crude oil output from the nation. In fact, Libya’s state-run National Oil Corp has slightly reduced production on fresh rivalry in the country.
Thus, in short, slumping global demand together with rising U.S. oil production, might keep oil prices under pressure for the time being, though, most of the experts believe that prices are unlikely to fall below the $90 mark.
However, if OPEC indeed decides to slash production in its November meeting or if there is any further supply disruptions from geopolitical tensions, oil might again start trending upwards.
Thus, investors should closely monitor this volatile space and play accordingly. Below, we have highlighted a few popular oil ETFs that might be in focus in the coming days as a result of some of the factors highlighted above:
United States Oil Fund (USO)
This is the most popular and liquid ETF in the oil space with AUM of $549.9 million and average daily volume of around 3.4 million shares. The fund seeks to match the performance of the spot price of West Texas Intermediate (WTI) light, sweet crude oil and charges 0.45% in expense ratio. The ETF is down 9.3% since the start of the second half and has delivered flat returns in the year-to-date time frame.
PowerShares DB Oil Fund (DBO)
DBO also provides exposure to crude oil through WTI futures contracts and follows the DBIQ Optimum Yield Crude Oil Index Excess Return. The fund manages an AUM of $241.4 million and sees moderate average daily volume of more than 100,000 shares. Expense ratio came in at 79 bps, while DBO has also lost 9.3% since July 1 and has delivered flat returns in the year-to-date period.
United States Brent Oil Fund (BNO)
This fund provides direct exposure to the spot price of Brent crude oil on a daily basis through future contracts. However, the fund seems to be unpopular and illiquid with an AUM of $46.8 million and average trading volume of roughly 42,000 shares a day. The ETF charges 75 bps in annual fees. BNO lost about 12.9% since the start of the second half and is down 11.5% in the year-to-date frame.
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