The vicious trading of oil and the energy sector is likely to persist for more months especially after the Fed finally pulled its trigger on the first rate hike in almost a decade.
Higher interest rates will drive the U.S. dollar upward, making dollar-denominated assets more expensive for foreign investors and thus dampening the appeal for the commodity. In addition, it will make the borrowings, in particular for high-yield firms, costlier and result in less money flows into capital-intensive shale oil and gas drilling projects. This in turn will lead to higher bankruptcies, hitting the already battered energy sector.
Following the rate hike announcement, U.S. crude dropped nearly 5% to $35.52 per barrel, just a few dollars away from $32.40 that it hit during the financial crisis in 2008. Meanwhile, Brent oil tumbled to the nearly 11-year low of $37.11, which is not very far from the December 2008 low of $36.20. Analysts expect breaking the 2008 levels could take oil prices to levels not seen since 2004 given fears of growing global glut and weak demand that have been weighing on the oil prices (read: Will $20 Crude Soon Be Reality? Short These ETFs ).
The latest inventory storage report from EIA for the last week showed that U.S. crude stockpiles unexpectedly rose by 4.8 million barrels against the expected 1.4 million-barrel drawdown, underscoring further weakness in the energy sector. This is because production has been on the rise across the globe with the Organization of the Petroleum Exporting Countries (OPEC) continuing to pump near-record levels of oil to maintain market share against non-OPEC members like Russia and the U.S. Additionally, Iran is looking to boost its production once the Tehran sanctions are lifted.
On the other hand, demand for oil across the globe looks tepid given slower growth in most developed and developing economies. In particular, persistent weakness in the world's biggest consumer of energy - China - will continue to weigh on the demand outlook. Further, a warm winter in the U.S. will depress demand for energy and energy-related products (read: No Winter Cheer for Natural Gas ETFs? ).
Adding to the grim outlook is the International Energy Agency's (IEA) expectation that the global oil supply glut will persist through 2016 as worldwide demand will soften next year to 1.2 million barrels a day after climbing to five-year high of 1.8 million barrels this year.
The Fed move and the bearish inventory data have battered the oil and energy ETFs and are expected to continue doing so in the coming months with bleak oil fundamentals. In particular, iPath S&P GSCI Crude Oil Index ETN ( OIL ) , United States Oil Fund ( USO ) , PowerShares DB Oil Fund ( DBO ) and United States Brent Oil Fund ( BNO ) lost over 3% in Wednesday's trading session. All these products focus on the oil futures market and are directly linked to the U.S. crude or Brent oil prices.
In the equity energy ETF space, First Trust ISE-Revere Natural Gas Index Fund ( FCG ) and SPDR S&P Oil & Gas Exploration & Production ETF ( XOP ) were the worst hit, shedding 2.7% and 2.2%, respectively. These were followed by declines of 2% for Market Vectors Unconventional Oil & Gas ETF ( FRAK ) and PowerShares S&P SmallCap Energy Fund ( PSCE ) .
This fund offers exposure to the 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 30 stocks in its basket that are well spread out across each component with none holding more than 6.95% of the assets. The fund has amassed $161.1 million in its asset base while charging 60 bps in annual fees. Volume is solid with more than 1.8 million shares exchanged per day on average.
This fund provides equal weight exposure to 66 firms by tracking the S&P Oil & Gas Exploration & Production Select Industry Index. Each holding makes up for less than 2.3% of the total assets. XOP is one of the largest and popular funds in the energy space with AUM of $1.5 billion and expense ratio of 0.35%. It trades in heavy volume of around 12 million shares a day on average (see: all the energy ETFs here ).
This ETF provides exposure to the unconventional oil and gas segment, which includes coalbed methane, coal seam gas, shale oil & gas, and sands market. This fund follows the Market Vectors Global Unconventional Oil & Gas Index, holding 57 stocks in the basket. Average daily volume at 39,000 shares and AUM of $41 million are quite low for the fund while expense ratio is at 0.54%.
This fund provides exposure to the energy sector of the U.S. small cap segment by tracking the S&P Small Cap 600 Capped Energy Index. Holding 32 securities in its basket, it is heavily concentrated on the top two firms that collectively make up for one-fourth of the portfolio. Other firms hold less than 5.8% of total assets. The fund is less popular and less liquid with AUM of $33 million and average daily volume of about 19,000 shares. Expense ratio came in at 0.29%.
Investors should stay away from the above-mentioned funds as more pain is in store for oil and the energy sector. FRAK and FCG have a Zacks ETF Rank of 5 or 'Strong Sell' rating while XOP and PSCE have a Zacks ETF Rank of 4 or 'Sell' rating, suggesting their continued underperformance going into the New Year.
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