New Record For US Oil Production 

February 14, 2018

Backwardation Effect

Dwindling global inventories are why oil prices pushed to three-year highs earlier this month, but the recent prices correction suggests accelerating U.S. production growth may be starting to dampen some of the market’s bullish enthusiasm.

For 2018 as a whole, the IEA sees a balanced market, with 1.3 million barrels per day of demand growth largely offset by U.S.-led growth in production.

That could mean there’s limited upside for oil prices from here. Still, oil-tracking exchange-traded funds may benefit from a futures curve in backwardation, delivering positive returns even if prices don’t rise.

“Even if we don't see outsized price increases … from a total return perspective, commodity returns will benefit from a change to positive roll yields based on the reshaping and structuring of the fundamental market,” Maxwell Gold, director of investment strategy and research at ETF Securities, said.

Case in point: Over the past six months, the United States Brent Oil Fund LP (BNO) jumped by 27.9%, outpacing the 23.3% gain for underlying Brent futures contracts. As long as the futures curve remains in backwardation, that outperformance should persist.


6-Month Returns For BNO & Brent Oil Futures


Undervalued Energy Stocks

Meanwhile, energy equity ETFs could also perform well, even if oil prices don’t climb much from here. The Energy Select Sector SPDR Fund (XLE) is down 6.7% year-to-date, lagging the less than 1% loss for the S&P 500.


YTD Returns For XLE & SPY


According to Credit Suisse analysts, energy stocks are discounting oil prices in the $40’s, considerably less than current levels.

“We believe the sector has transitioned from ‘sell the rally’ to ‘buy the dip’ given the combination of reasonable E&P valuations, institutions being underweight energy, and our expectations of oil inventory draws continuing to support oil prices in 2018 even assuming robust U.S. oil production growth,” the analysts said in a recent research report.

Follow Sumit Roy on Twitter @sumitroy2

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