Threat of Iraqi chaos stokes oil prices and oil ETFs higher at a time of record demand.
Iraq, one of the world’s largest oil producers, looks to be on the brink of significant unrest and instability, providing a catalyst for a major break to the upside for the global oil market and helping push already-rallying energy-linked ETFs into record territory.
The SPDR Energy Select Sector SPDR (XLE | A-95), the largest energy ETF on the market, with more than $12 billion in total assets, has been forging new highs this year, and has rallied about 10 percent year-to-date. In fact, XLE is the second-best-performing of the nine sector SPDRs in 2014, behind only the Utilities Select Sector SPDR Fund (XLU | A-93)—a segment that’s linked to energy.
In sum, the country’s 3.3 million barrels of oil a day of crude output looks, all of a sudden, to be vulnerable, as a cross-current of ethnic groups appear to be vying for control of key cities in or near major oil provinces. The country’s oil production has doubled since just after the toppling of Saddam Hussein in 2003, and global oil markets have come to rely on those barrels.
“Iraq has been a major driver of global oil supply growth, having doubled its production over the past decade,” Sumit Roy, analyst at HardAssetsInvestor.com, said in a commentary. “Any major disruption in the country would tighten the market significantly, leading to sharply higher prices. That is a distinct upside risk for prices.”
Moreover, the potential chaos in Iraq comes at a time when U.S. oil inventories have already been dropping; global oil demand is at record levels despite concerns about China’s economic growth; and the U.S. summer driving season is in full swing—a confluence of factors helping push energy-focused ETFs rise into record territory.
XLE, which tracks the energy sector of the S&P 500, invests primarily in companies involved in oil and gas—about 77 percent of the portfolio—as well as in energy equipment and services.
A different approach to the segment, via futures-based United States Oil Fund (USO | A-100) has also delivered solid total returns, now nearing 10 percent in the same period. It’s the largest pure-oil ETF on the market today. It invests solely in the near-month WTI crude futures contract.
The Department of Energy reported this morning that in the week ending June 6, U.S. crude oil inventories decreased by 2.6 million barrels—roughly twice as many as analysts had expected, and more than four times the five-year average for the period.
Those numbers come just weeks after the American Automobile Association estimated that Memorial Day weekend would see the second-largest number of drivers since 2000, and the highest since the credit crisis of 2008. From a historical perspective, 2014’s number of summer drivers is expected to clock in at 2.6 percent higher than the 10-year historical average.
Clearly, that’s supportive for crude oil prices, but they have remained relatively steady in recent days, facing technical resistance.