Oil Spike Lifts Energy ETFs

The stars are aligning for a bull run in the oil markets, as the world continues to shed its pandemic-induced cabin fever with road trips and flights amid uncertainty over how flexible the supply of the commodity will be in handling that demand.

Prices for the U.S. benchmark West Texas Intermediate recovered from the $40 per barrel mark at the start of the year to hit $70 per barrel earlier in June on the back of massive demand for travel in places where COVID-19 is on the retreat.

The International Energy Agency’s latest projections expect global oil demand to recover to prepandemic levels by the end of 2022, leading to domestic surplus drawdowns and a possible lag in refineries being able to keep up in turning crude into gasoline.

Consider the Invesco DB Energy Fund (DBE), which tracks energy-related futures contracts and has posted year-to-date returns of 38.93%. Let’s compare it to the other largest commodity baskets in the ETF realm.

• Invesco DB Base Metals Fund (DBB), industrial metals: 12.98%
• Invesco DB Agriculture Fund (DBA), agriculture: 9.54%
• Aberdeen Standard Physical Precious Metals Basket Shares ETF (GLTR), precious metals: -4.26%

Here’s what’s driving oil prices higher, and how ETF investors can get into the market.

Geopolitics & Demand Flip

The crude oil crash last March was driven by both ends of the supply and demand curve. Much of the world went into lockdown to avoid the spread of COVID-19, which kept people from driving and flying, sending demand down substantially.

At the same time, Saudi Arabia and Russia began an oil production war after the latter walked out of OPEC negotiations on how the cartel’s members would react to the pandemic. The spat between the world’s second- and third-largest producers depressed prices further until early April, when the two countries agreed to curtail production.

The world was awash in oil that it didn’t need late last spring, so much so that the price of West Texas Intermediate went negative on April 20 as traders with expiring oil futures were forced to pay buyers to take those contracts on instead of taking delivery of oil they couldn’t store.

Now, the scenario is flipped on its head.

Americans are itching to travel after nearly a year and a half at home, and other countries are opening up to travel as more people get vaccinated.

At the same time, geopolitics in the Middle East could complicate global oil supplies. Iranian President-elect Ebrahim Raisi told reporters on Monday that he would not meet with U.S. President Biden or negotiate on other matters, while demanding the U.S. lift its banking and shipping sanctions on the country.

A hardline approach could scuttle attempts to revive the Iran Nuclear Deal and leave the country unable to export to other countries that move money through American financial institutions.

Tying Investment To Crude Prices

The ETF most closely following the whims of the oil market is the US Oil Fund LP (USO), which holds futures contracts expiring within two months into the future at the latest. Its closest competitor is the Invesco DB Oil Fund (DBO), which is less prone to price swings because it moves its expiring contracts into whatever month is most attractive within the next 13 months on the market.

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However, the funds have respective expense ratios of 0.79% and 0.78%, both fairly pricey compared to the broader ETF market. Plus, both funds are structured as commodity pools, so long-term holders could incur greater capital gains taxes.

A less volatile option is the ProShares K-1 Free Crude Oil Strategy ETF (OILK), which splits its exposure equally between contracts that roll each month and contracts that expire semiannually. This fund is structured as an open-ended fund rather than a commodities pool, which keeps investors from having to make a separate filing come tax time, and which an expense ratio of 0.68%.

Producers & Refiners

The simplest way to get exposure to the companies in the oil space is by using the Energy Select Sector SPDR Fund (XLE). The benchmark fund following U.S. energy companies in the S&P 500 has year-to-date returns of 43.98% and an expense ratio of 0.12%.

Alternative options for a broader energy portfolio include the Vanguard Energy ETF (VDE), which has a wider share of holdings, and produced 47.48% returns so far this year. It has a 0.10% expense.

An option with narrowed focus is the VanEck Vectors Oil Refiners ETF (CRAK), the only fund right now that’s solely tracking the companies that turn crude oil into the stuff that goes into gas tanks. However, it carries a relatively pricey expense ratio of 0.60%.

Charts are courtesy of StockCharts.com

Contact Dan Mika at [email protected]