Oil ETFs Notch Gains as Crude Price Slips

It's been a tale of two assets—crude oil dropping while exchange-traded funds tracking the commodity rise. 

Over the past 30 days, the price of the closely watched West Texas Intermediate crude oil futures has declined by 8.5% with the price falling below its 100-day moving average. Over that same period, the largest pure-play oil ETF, the $1.4 billion United States Oil Fund LP (USO) has gained about 1%.

Source: etf.com

Still, caution may be creeping in: USO experienced $20.8 million worth of net outflows last month, including $370 million moving out on April 23. 

Oil ETFs' Resiliency May Be Short-Lived

A little more than a month ago surging demand for oil was driving the price of the commodity higher. ETFs offering direct and indirect exposure to the category have been among the strongest performers of the year.

USO is up 19% from the start of the year and the Energy Select SPDR ETF (XLE), which tracks an index of energy companies, is up 16%. That tops the SPDR S&P 500 Trust ETF (SPY), which tracks the broad S&P 500 index and has gained 7.7% this year.

Still, the rest of the year looks dimmer for oil and oil-related investments, according to Tom Graff, chief investment officer at Facet in Phoenix, Maryland.

“As we look at the possible scenarios over the next six-to-12 months, we see a lot more where oil is lower than higher,” he said. “A lot of people are focusing on supply issues, particularly surrounding wars in Ukraine and the Middle East, but with Chinese and European growth outlooks murky, demand may be the more important factor.”

Another headwind for oil prices is the increasing strength of the U.S. dollar, which is expected to keep surging until the Federal Reserves starts cutting interest rates.

“As it relates to oil ETFs, differentiating the commodity prices from the underlying holdings in various ETFs is key,” said Stephen Kolano, chief investment officer at Integrated Partners in Waltham, Mass.

“Many of the oil ETFs are holding oil producers” from across the business spectrum, he added. “Key there is that the price of oil is still up almost 10% from the beginning of the year.”

Nick Codola, senior portfolio manager at Orion Advisor Solutions in Omaha, Neb., also emphasized the current disparity between the cost of production and the price of oil as a reason oil-sector ETFs are holding up under the cloud of falling oil prices.

“Their cost of production is somewhere around $40 a barrel, so anything above that they are making money, and moves in the spot price don’t affect them as much because they often hedge their exposure and lock-in longer term contracts with periodic resets,” he said.

What Codola is describing as a “week or two where oil is down” is less a threat to oil-sector ETFs than would be a sustained downtrend over several months.

“That would hurt them, and you’d start seeing significant falling revenues and margins as those old contracts expire or reprice themselves,” he added.