Playing The Oil and Gas Sector With ETFs

oil gasCrude Oil: The Federal Reserve’s decision to leave its monetary stimulus program intact, together with positive momentum in the domestic manufacturing sector and bullish data from the Chinese economy have strengthened oil prices to 2-year highs of around $110 per barrel.

Partly offsetting this favorable view has been a spike in U.S. production – now at its highest levels since 1989 – and easing Syrian tensions.

The immediate outlook for oil, however, remains positive given the commodity’s constrained supply picture. And, while the Western economies exhibit sluggish growth prospects, global oil consumption is expected to get a boost from sustained strength in China, the Middle East, Central and South America that continue to expand at a healthy rate.

EIA expects global oil demand growth by another 1.1 million barrels per day in 2013 and by a further 1.2 million barrels per day in 2014. Importantly, EIA’s latest report assumes that world supply is likely to go up by 0.8 million barrels per day this year and by 1.2 million barrels per day in 2014. (Read: Play Goldman’s Views with These Commodity ETFs)

In our view, crude prices in the final few months of 2013 are likely to exhibit a sideways-to-bearish trend, trading in the $100-$105 per barrel range.

Natural Gas

Over the last few years, a quiet revolution has been reshaping the energy business in the U.S. The success of ‘shale gas’ — natural gas trapped within dense sedimentary rock formations or shale formations — has transformed domestic energy supply, with a potentially inexpensive and abundant new source of fuel for the world’s largest energy consumer.

With the advent of hydraulic fracturing (or fracking) — a method used to extract natural gas by blasting underground rock formations with a mixture of water, sand and chemicals — shale gas production is now booming in the U.S.

As a result, once faced with a looming deficit, natural gas is now available in abundance. In fact, natural gas inventories in underground storage hit an all-time high of 3.929 trillion cubic feet (Tcf) in 2012. The oversupply of natural gas pushed down prices to a 10-year low of $1.82 per million Btu (MMBtu) during late April 2012 (referring to spot prices at the Henry Hub, the benchmark supply point in Louisiana). (See All Energy ETFs Here)

However, things started to look up in 2013. This year, cold winter weather across most parts of the country boosted natural gas demand for space heating by residential/commercial consumers. This, coupled with flat production volumes, meant that the inventory overhang was gone, thereby driving commodity prices to around $4.40 per MMBtu in Apr — the highest in 21 months.

During the last few weeks, though, natural gas demand has gone through a relatively lean period, as mild weather prevailed over the country, leading to tepid electricity draws to run air conditioners. This led to a slide in the commodity’s price. In fact, healthy injections over last few weeks, plus strong production, have meant that supplies have overturned the deficit over the five-year average.

With more moderate weather expected during the next few weeks, leading to reduced power demand, natural gas prices may experience another downward curve. This, in turn, is expected to pull down natural gas producers, particularly small ones.

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