Energy ETFs A Bargain If Citi's $60 Oil Call Is Right

April 24, 2017

Oil prices fell by more than 7% last week, their worst decline in about a month. WTI crude oil futures dropped below $50/barrel, even as OPEC signaled that it may continue to restrict production during the second half of 2017.  

The cartel meets on May 25 to discuss whether to extend the temporary production curbs put in place at the start of the year. Those curbs―a six-month output reduction of 1.2 million barrels per day from OPEC countries and 558,000 barrels per day from a group of non-OPEC countries―were aimed at reducing the enormous glut of inventories that had accumulated during the oil bust of the last couple of years.

Key OPEC sources recently suggested that the cuts are likely to be extended. Kuwait's oil minister, who expects the supply agreement to be renewed for another six months, said that he is satisfied with the compliance from OPEC and non-OPEC countries.

Why Energy ETFs Are Struggling
All else equal, an extension of the supply reduction agreement is positive news for oil prices. Why then did oil prices fall, and why are oil ETFs―such as the United States Oil Fund (USO), down 12%, and the Energy Select Sector SPSDR Fund (XLE), down 9.3%―among the worst-performers this year?

Chart courtesy of StockCharts.com

The answer to that question has two parts.

The first is simply that oil prices and energy ETFs already rallied sharply last year in anticipation of reduced supply. From their lows of $26 in early-2016, crude oil prices nearly doubled. At the same time, the energy sector, as measured by the XLE, was the top-performing sector of 2016 with a 28% gain.

Thus, the improvement in oil market fundamentals (including the OPEC production cuts, which were first revealed in September), were largely baked into prices by the end of 2016. 

The second reason oil prices and energy ETFs are struggling is that the oil market rebalancing that OPEC is attempting to hasten is being delayed by rising U.S. production.

 

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