Crude Oil ETFs Could See Triple Digit Oil Sooner Than You Think (USO, DBO, BNO, OIL, XLE, OIH, UHN, UCO, VDE, USL, UGA, IYE)

Sentiment in the crude oil market has been quite pessimistic lately after some disappointing economic data fueling fear over the strength of the U.S. recovery, and signs of a possible China slowdown. This is on top of the market distress already exerted by the Europe sovereign debt and banking crisis. 

Oil price was down 8% for the week, with the front-month August delivery settled at $72.14 a barrel on the New York Mercantile Exchange. 

Crude oil prices have been mostly held back by the temporary oversupply mostly due to the stagnant and declining demand among the developed nations. However, over the coming months, oil price should push higher reflecting the changing global demand/supply pattern resulted from some new development in the sector.  Some ETF’s to watch that track crude oil are: The United States Oil Fund (NYSE:USO), PowerShares DB Oil (NYSE:DBO), United States Brent Oil (NYSE:BNO), United States 12 month Oil (NYSE:USL), United States Gasoline Fund Gasoline (NYSE:UGA), iPath S&P GSCI Crude Oil Ttl Ret Idx ETN (NYSE:OIL), United States Heating Oil Fund Heating Oil (NYSE:UHN), ProShares Ultra Crude Oil (NYSE:UCO), SPDR Energy Select Sector Fund (NYSE:XLE), Vanguard Energy ETF (NYSE:VDE), iShares Dow Jones U.S. Energy Index Fund (NYSE:IYE),  and the Oil Services HOLDRs (NYSE:OIH). 

Moratorium Push – Production Loss and Delay  

Despite a federal ruling to lift offshore drilling ban, the Obama administration filed an immediate appeal along with a “modified moratorium” in the planning. Many analysts still expect the ban could last well beyond the intended 6-month period. 

The moratorium has put 33 deepwater rigs out of work and jeopardized shallow water drilling as well. More project delays and production loss would result from the exodus of these rigs, which undoubtedly will get snapped up by the state run oil companies of China, Brazil and India, just to name a few. 

Due to the long time span of offshore oil projects, after resources are redeployed elsewhere due to the Gulf moratorium, it could be more than a year — some analysts say as many as three — before they are available to return to the Gulf’s deepwater projects. 

Halliburton (HAL), one of the top three oil serivice providers, estimated a period of 12 to 24 months before returning to 50% of pre-moratorium activity levels. 

Analysts’ projections of production loss and delay arising from the moratorium range from Wood Mackenzie’s 155,000 barrels a day, or 2.2% of U.S. liquids supply in 2011 to 100,000-300,000 barrels a day in the U.S., and 800,000-900,000 barrels a day globally by 2015, from the International Energy Agency (IEA) 

Meanwhile, Sanford C. Bernstein believes as much as 500,000 barrels a day from 2013 supply may be cut with a one-year worldwide delay in deepwater drilling. 

While the moratorium is seen with very little effect near term, and its eventual impact is still unclear, various energy agencies’ forecasts–the U.S. region in particular–may need to be revised with its potentially significant longer-term impact. 

Cost Push – Oil Spill Regulation Tightening 

The expected regulation tightening from the BP Macondo well disaster in the Gulf will add to oil project costs with global implication. 

Offshore drilling costs are already escalating since the Gulf oil spill with the rising environmental, insurance costs and legal risks. Reutersquoted African independent oil and gas company Afren that it had already “experienced a 7-8% increase in costs for a project in Ghana following the safety response of Ghanaian authorities.” 

Indian state oil company ONGC also indicated insurance premium for its onshore assets, which was decided after the BP accident, rose 88% this fiscal year. ONGC expects overall insurance premiums to rise three times higher after the BP Gulf disaster. 

While the head of French oil major–Total SA–warned of tougher rules could push up crude prices $90 a barrel by year end, several analysts also upgraded their oil price targets. 

MarketWatchquoted a recent Deutsche Bank analysis that any tightening of regulations could boost deepwater exploration and development costs by about 10%, and add $5 a barrel to future oil contracts. 

Barclays Capital told Bloomberg its latest forecasts of $106 oil in 2012, $137 in the long term, and that oil futures for 2018 at under $100 are “undervalued”as BP Plc’s spill in the GoM will raise the costs and lead to drilling restrictions. 

Cost Push – Project Costs Bottomed 

According to the data released last month by Cambridge Energy Research Associates(IHS CERA), oil and gas upstream project costs are poised to “begin an ascend back to pre-recession levels.” (See Chart) 

IHS CERA noted the upward volatility in the underlying sectors that comprise its Upstream Capital Costs Index (UCCI) such as steel, and yard and fabrication. A weaker U.S. dollar and a shortage of skilled labor also played into the rising costs.  The index peaked in Q3 2008 after climbing 230% since the base year 2000, and has fallen 13% since the peak. 

On the operation side, IHS CERA Upstream Operating Costs Index was up 2% in the 6-month period from Q3 2009 to Q1 2010, pointing to “the upswing in onshore service rates, increased material input prices and escalating manpower costs.” 

Since both indexes measure the data before the BP Macondo blowout, the oil spill in the Gulf only adds more uncertainty and impetus to the trend of increasing costs. 

Asian Energy Demand Push 

Energy consultancy Douglas-Westwood indicated China will be the key driver of global oil demand growth, about half of total.  As much as people are worried about a “slowdown” in China, a less than double-digit growth still translates into increasing energy demand. (By the way, Goldman Sachs just “downgraded” the 2010 growth prospect of China to 10.1%.) 

Not to make this too lengthy a discussion regarding the Asian energy demand trajectory–particularly from China—and the prospect of peaking “easy” world oil supplies, I will simply refer to the following charts and data from Douglas-Westwood: 

Market Push – Risk On Rest of the Year 

Last but not least, the following factors suggest fund managers could be looking to put on the inflation trade (risk on)–short the dollar and long commodity and equity–probably through the rest of the year. 

  • The broad market pull-back last week 
  • Start of a new quarter and earnings season  
  • Low intrest rate (near-zero in the U.S.)  
  • Current high correlation between commodity and equity 
  • A market-friendly Congress in an election year

In fact, for much of the June month, crude oil had resumed its historical inverse relationship with dollar before the big panic button got triggered. (See Chart) 

 
If we take a look around the globe, the long term higher dollar risk should become evident. European governments have taken on massive austerity measures amid concerns about their credit ratings. Meanwhile, China is also implementing various tightening measures amid concerns over inflation and possible asset bubbles.

On the other hand, the U.S. seems more inclined to keep deficit spending to fight off deflation (a misperception, read here) and to stimulate growth. 

A weak dollar will translate into higher commodity prices, including crude oil. A break of the dollar index ETF (NYSE:DXY) below 80could single-handedly send crude oil soaring to the range of $85 to $90 a barrel.  (NYSE:DXY) 52-week low now sits at 74.17. 

OPEC “Accustomed to” $100 Oil
 
Even though many have dismissed OPEC’s influence on the world energy market; nevertheless, with roughly 40% share of global oil production, what the cartel will or will not do still matters.

In January of this year, several OPEC members including Kuwait and Libya basically told reporters that OPEC will not act as long as oil prices are under $100. 

Right now, the main factor that will determine oil prices in 2010 and 2011 is the pace of global oil demand recovery following the Great Recession. 

Based on the factors discussed here, barring a world double-dip recession or depression as warned by some economists, we will likely see crude oil reach $85-$90 a barrel by the end of 2010, and $100 by 2011

Of course, the ongoing geopolitical tension in the oil producing regions of Middle East and Africa will only hasten the arrival of a triple-digit oil price. 

 
About: Economic Forecasts & Opinions The theory of quantum mechanics and Einstein’s theory of relativity (E=mc2) have taught us that matter (yin) and energy (yang) are inter-related and interdependent. This interconnectness of all things is the essense of the concept “yin-yang”, and Einstein’s fundamental equation: matter equals energy. 

The same theories may be applied to equities and commodity markets. All things within the markets and macro-economy undergo constant change and transformation, and everything is interconnected.  

That’s why here at Economic Forecasts & Opinions, we focus on identifying the fundamental theories of cause and effect in the markets to help you achieve a great continuum of portfolio yin-yang equilibrium.
 


 

There are a myriad of different ETF options available to participate in the rise in oil as some will do much better than others. We have included some in the list below. 

PowerShares DB Oil Fund West Texas Intermediate Crude Oil (NYSE:DBO)
The investment seeks to track the price and yield performance, before fees and expenses, of the Deutsche Bank Liquid Commodity Index – Optimum Yield Oil Excess Return. The index is a rules-based index composed of futures contracts on Light Sweet Crude Oil (WTI) and is intended to reflect the performance of crude oil. 

 United States Oil Fund West Texas Intermediate Crude Oil (NYSE:USO)
The investment seeks to reflect the performance, less expenses, of the spot price of West Texas Intermediate (WTI) light, sweet crude oil. The fund will invest in futures contracts for WTI light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas and other petroleum based-fuels that are traded on exchanges. It may also invest in other oil interests such as cash-settled options on oil futures contracts, forward contracts for oil, and OTC transactions that are based on the price of oil. 

United States Gasoline Fund Gasoline (NYSE:UGA)
The investment seeks to track, net of expenses, the changes in percentage terms of the price of gasoline. The trust will invest in the futures contract on unleaded gasoline delivered to the New York harbor traded on the New York Mercantile Exchange that is the near month contract to expire. 

iPath S&P GSCI Crude Oil Ttl Ret Idx ETN (NYSE:OIL)
The investment is linked to the performance of the Goldman Sachs Crude Oil Return Index and reflects the returns that are potentially available through an unleveraged investment in the futures contacts comprising the index plus the Treasury Bill rate of interest that could be earned on funds committed to the trading of the underlying contracts. The index is derived from the West Texas Intermediate (WTI) crude oil futures contract traded on the New York Mercantile Exchange. 

United States Heating Oil Fund Heating Oil (NYSE:UHN)
The investment seeks to track, in percentage terms the movements of heating oil prices. The fund consists of listed heating oil futures contracts and other heating oil related futures, forwards, and swap contracts. These investments will be collateralized by cash, cash equivalents and US government obligations with remaining maturities of two years or less. 

ProShares Ultra Crude Oil (NYSE:UCO)
The investment will seek to replicate, net of expenses, twice the daily performance of the Dow Jones UBS Crude Oil Sub-Index. The fund normally invests assets in financial instruments with economic characteristics twice the return of the index. It may employ leveraged investment techniques in seeking its investment objective. 

SPDR Energy Select Sector Fund (NYSE:XLE)
The investment seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of publicly traded equity securities of companies in the Energy Select Sector Index. The fund will normally invest at least 95% of its total assets in common stocks that comprise the relevant Select Sector Index. The Funds have adopted a policy that requires each fund to provide shareholders with at least 60 days notice prior to any significant material change in a fund’s policy or its underlying index. 

Vanguard Energy ETF (NYSE:VDE)
The investment seeks to track the performance of a benchmark index that measures the investment return of energy stocks. The fund employs a passive management investment approach to track the performance of the MSCI US Investable Market Energy Index, an index made up of stocks of large, medium-size, and small U.S. companies within the energy sector. The sector includes the construction or provision of oil rigs, drilling equipment, and other energy-related equipment and services; or companies engaged in the exploration, production, marketing, refining, and/or transportation of oil and gas products. 

iShares Dow Jones U.S. Energy Index Fund (NYSE:IYE)
The investment seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Dow Jones U.S. Oil & Gas index. The fund uses a representative sampling strategy to try to track the index. The index measures the performance of the oil and gas sector of the U.S. equity market. The index includes companies in the following sectors: oil and gas producers and oil equipment, services and distribution. 

United States Brent Oil (NYSE:BNO)
The United States Brent Oil Fund, LP (“BNO”) is a domestic exchange traded security designed to track the movements of Brent crude oil. BNO issues units that may be purchased and sold on the NYSE Arca. The investment objective of BNO is for the daily changes in percentage terms of its units’ net asset value (“NAV”) to reflect the daily changes in percentage terms of the spot price of Brent crude oil as measured by the changes in the price of the futures contract on Brent crude oil as traded on the ICE Futures Exchange, less BNO’s expenses. 

United States 12 month Oil (NYSE:USL)
The investment seeks to replicate the changes in percentage terms of the price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes in the average of the prices of 12 futures contracts on crude oil traded on the NYMEX. The fund will consist of the near month contract to expire and the contracts for the following eleven months, for a total of 12 consecutive months’ contracts. When calculating the daily movement of the average price of the 12 contracts each contract month will be equally weighted. 

Oil Services HOLDRs (NYSE:OIH)
The investment seeks to diversify your investments in the oil service industry through a single, exchange-listed instrument representing your undivided beneficial ownership of the underlying securities. The investment holds shares of common stock issued by specified companies that, when initially selected, were involved in the oil service industry. Except when a reconstitution event, distribution of securities by an underlying issuer or other event occurs, the group of companies will not change. There are currently 18 companies included in the investment. 

 

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