Markets

Energy ETFs Jump on Oil Surge Since June: Will The Rally Last?

Oil logged in the biggest weekly gain since June driven by the Organization of the Petroleum Exporting Countries’ (OPEC) urge to comply with the output cuts, disruption in U.S. production due to hurricane Sally, and supply deficit prediction by a couple of banks. Notably, crude oil price jumped 10.1% while Brent climbed 8.3%.

The OPEC and its allies are currently cutting 7.7 million barrels per day of output and the group warned that it would take action against members not complying with the deal (read: Cyclical ETFs to Gain on Vaccine Progress & Market Optimism).

Hurricane Sally halted more than a fourth of offshore output in the Gulf of Mexico on Sep 15. The Interior Department’s Bureau of Safety and Environmental Enforcement estimates that about 27.48% of current oil production in the Gulf of Mexico was shut down because of the storm. Per some sources, a tropical depression in the western part of the Gulf of Mexico could become a hurricane in the next few days, potentially threatening more oil facilities. The U.S. National Hurricane Centre warned of a “life-threatening storm surge” along the coast of Texas and Louisiana.

Meanwhile, Goldman Sachs (GS) expects supply deficit of 3 million barrels per day by the fourth quarter and reiterated its target for Brent to reach $49 by the year end and $65 by the third quarter of 2021. Swiss bank UBS also pointed at the possibility of undersupply, forecasting that Brent would rise to $45 a barrel in the fourth quarter and to $55 by mid-2021.

Further, the decline in inventories added to the oil price surge. According to the Energy Information Administration (EIA), U.S. crude stocks fell 4.4 million barrels for the week ended Sep 11 to 496 million barrels, their lowest since April. It also reported that crude stocks at the storage at Cushing — America’s key storage hub — edged down by about 100,000 barrels for the week.

This resulted in a spike in energy ETFs last week. In particular, Invesco S&P SmallCap Energy ETF PSCE and First Trust ISE-Revere Natural Gas Index Fund FCG has been the biggest winner, gaining more than 7% each. Invesco Dynamic Energy Exploration & Production ETF PXE and SPDR S&P Oil & Gas Exploration & Production ETF XOP gained at least 6.5%. However, most of these funds have a Zacks ETF Rank #4 (Sell) or 5 (Strong Sell). Please note that our ranking system takes into account the asset class outlook, which was negative for energy and hence most of the ETFs in this space have a 4 or 5 Zacks Rank.

Below we profile these ETFs in detail:

PSCE

This fund provides exposure to the U.S. small-cap segment of the energy sector by tracking the S&P Small Cap 600 Capped Energy Index. It holds 41 stocks in its basket with AUM of 14.4 million. The fund trades in average daily volume of 44,000 shares and charges 29 bps in fees per year (read: 4 Sector ETFs That Are Up Double-Digits to Start August).

FCG

This fund offers exposure to U.S. stocks that derive a substantial portion of their revenues from the exploration and production of natural gas. It follows the ISE-REVERE Natural Gas Index and holds 44 stocks in its basket. The fund has amassed $74.5 million in its asset base while charging 60 bps in annual fees. Volume is good with 824,000 shares exchanged per day on average.

PXE

This product follows the Dynamic Energy Exploration & Production Intellidex Index, which thoroughly evaluates companies based on a variety of investment merit criteria, including price momentum, earnings momentum, quality, management action and value. Holdings 32 stocks in its basket, the fund has amassed $15.8 million in its asset base while trading in average daily volume of 27,000 shares. It charges 63 bps in annual fees and expenses.

XOP

This fund provides exposure to oil and gas exploration companies by tracking the S&P Oil & Gas Exploration & Production Select Industry Index. It has amassed $2 billion in its asset base and holds 41 securities in its basket. The product charges 35 bps in annual fees and trades in average volume of 6.6 million shares per day.

What Lies Ahead?

Despite the rally, the outlook for the sector looks bleak. This is especially true as the S&P 500 Energy Index is still down about 45% year to date. The weak trend is likely to continue given worries over the outlook for oil demand.

This is especially true as International Energy Agency (IEA) slashed this year’s global oil demand outlook for the second time in two months, citing that resurging COVID-19 cases in many countries, resulting in local lockdowns and continued work-from-home, would continue to weigh on demand this quarter and the next. It expects global oil demand to fall 8.4 million barrels per day this year to 91.7 million compared with the contraction of 8.1 million barrels per day in the previous forecast. OPEC also cut the global oil demand outlook by 9.5 million barrels a day to 90.2 million versus its previous projection for a 9.1 million barrel a day drop, citing weaker-than-expected recovery in India and other Asian countries.

However, China, which emerged from a lockdown sooner than other major economies continued to recover strongly, thereby giving a boost to oil demand. Additionally, reducing supply, rise in industrial production and a weak dollar as Fed remained super dovish will act as catalysts for the commodity (read: ETF Winners as US-China Stay Committed to Phase 1 Trade Deal).

Barclays Commodities Research raised its oil price forecasts for 2020 with Brent and crude price expected to rise by $2 each to $43 per barrel and $39, respectively, citing limited potential downside to its demand outlook.

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First Trust Natural Gas ETF (FCG): ETF Research Reports

Invesco Dynamic Energy Exploration Production ETF (PXE): ETF Research Reports

Invesco SP SmallCap Energy ETF (PSCE): ETF Research Reports

SPDR SP Oil Gas Exploration Production ETF (XOP): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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