Avoid Oil Futures ETFs, Buy Equities Like XLE

September 02, 2015

The Department of Energy reported this morning that in the week ending Aug. 31, U.S. crude oil inventories increased by 4.7 million barrels, gasoline inventories decreased by 0.3 million barrels, distillate inventories increased by 0.1 million barrels and total petroleum inventories increased by 5.7 million barrels.

Crude oil was trading higher after the release of the latest inventory figures. In turn, oil-linked exchange-traded funds such as the United States Oil Fund (USO | B-100) and the VelocityShares 3X Long Crude Oil ETN (UWTI) were also higher on the session after surging during the past week.

YTD Returns For USO, UWTI

If September turns out to be anything like August, this month promises to be an extremely volatile one for crude oil. Last month, prices fell as much as 19 percent before surging sharply to end the period up by more than 4 percent.


WTI was last trading around $44, while Brent was last trading near $48. Each hit six-year lows of $37.75 and $42.23, respectively, last month.

BRENT

WTI

US Output Declining, Inventories Rising

Crude's rebound off the lows comes on the back of data from the EIA that show that U.S. production may be rolling over. Output in the country dipped to 9.22 million barrels per day last week, down 120,000 barrels per day from the week before and 392,000 below the 40-year high set in June.

At least based on this data, it seems that the long-awaited decline in U.S. output has arrived. That's a first step and necessary ingredient to rebalancing the severely oversupplied market.

Still, as other data from the EIA indicate, inventories continue to pile up with supply still ahead of demand. U.S. petroleum stockpiles are 175.1 million barrels, or 15.7 percent, above the five-year average. That surplus will only widen during the upcoming low-demand shoulder season.

Worldwide Oversupply
On a global basis, the International Energy Agency sees similar trends to those in the U.S. Worldwide supply ran a whopping 3 million barrels per day ahead of demand (the most since 1998) in the second quarter, sending OECD inventories to an all-time high of 2,916 million barrels in June.

Robust production from both OPEC and non-OPEC producers contributed to the supply growth.

That said, low prices are doing their job, and the rebalancing process has begun, according to the IEA.

The agency sees demand rising a swift 1.6 million barrels per day this year, the most in five years, and 1.4 million barrels per day next year.

On the other side of the equation, non-OPEC supply growth may slow from a record 2.4 million barrels per day in 2014 to 1.1 million barrels per day this year, and then contract by 200,000 barrels per day in 2016.

While the oversupply should begin to narrow going forward, in the short term, inventories may test capacity limits, pressuring prices significantly.

"Assuming OPEC production continues at around 31.7 mmbbl/d (its recent three-month average) through 2016, 2H15 [second half of the year] sees supply exceeding demand by 1.4 mb/d, testing storage limits worldwide," said the IEA. "The surplus drains down to about 850 kb/d in 2016, with 4Q16 [fourth quarter 2016] marking the first quarter of a potential stock draw."

If the IEA is right, that means crude oil is likely to stay low or even fall further in the short term, before rebounding sometime in 2016.


Takeaway For Investors
For exchange-traded fund investors and traders, that means it's probably a good idea to avoid ETFs like USO and UWTI, which could plummet if oil inventories test capacity limits.


Instead, consider focusing on energy equity ETFs like the iShares U.S. Oil & Gas Exploration & Production ETF (IEO | A-95) or the Energy Select SPDR (XLE | A-93), which may look through the short-term downturn toward a rosier longer-term outlook for oil prices.

Turning to this week’s EIA inventory figures, total petroleum inventories in the U.S. increased by 5.7 mmbbl, against the five-year average of a 2.1 mmbbl decrease. In turn, the inventory surplus decreased to 175.1 mmbbl, or 15.7 percent, against the five-year average.

Crude oil inventories rose by 4.7 mmbbl, against the five-year average of a 3.2 mmbbl decrease. In turn, the surplus in the crude category jumped to 97.5 mmbbl, or 27.2 percent.

Regionally, inventories inside and outside the Midwest rose.

Gasoline inventories fell by 0.3 mmbbl against the five-year average of a 1.3 mmbbl decrease. Gasoline inventories now have a surplus of 2.4 mmbbl, or 1.1 percent. Distillate inventories rose by 0.1 mmbbl against the five-year average of a 0.5 mmbbl increase. In turn, the distillate surplus now stands at 7.6 mmbbl, or 5.4 percent.

Demand

Total petroleum demand in the U.S. climbed to 20.3 mmbbl/d, while gasoline demand rose to 9.4 mmbbl/d and distillate demand advanced to 3.8 mmbbl/d. On a four-week rolling basis, total demand was up by 2.9 percent from last year. On that same basis, gasoline demand was up 4.8 percent and distillate demand was down by 5.3 percent.

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