How To Trade The Oil Rally With ETFs & Stocks

After being hurt by Hurricane Harvey, positive sentiments have started building up in the oil space with a wave of positive news. Notably, U.S. crude is trading below $50.00 per barrel while Brent oil is hovering around $55.00 per barrel (read: Harvey Sinks Oil Prices, Stocks, & ETFs, Sends Gas Prices Higher).

Improving Trends

The historic output cut deal wherein OPEC, which accounts for one-third of the global output, Russia and other producers agreed to curb production by 1.8 million barrels per day until next March, is now paying off. This is especially true as OPEC oil output declined in August for the first time since March. The 14-member cartel pumped in 32.76 million barrels per day last month, representing a 79,100-barrel-per-day drop from July. Hopes of further extension to the pact by at least three months are adding to the optimism in the oil market.

As the deal aims to check the oil supply glut that has weighed on crude prices for more than three years, OPEC sees signs of a tighter global market and thus raised its global demand outlook for next year. The cartel expects global consumption to rise by 1.42 million barrels per day this year and 1.35 million barrels per day next year, up 50,000 barrels per day and 70,000 barrels per day, respectively, from the previous projection. On the other hand, supply from non-OPEC countries would remain unchanged at 780,000 barrels per day for this year but would decline by 100,000 barrel per day from the previous forecast to 1 million barrels per day for next year.

The International Energy Agency (IEA) projects global demand this year to climb the most in two years as global glut has started to shrink due to stronger-than-expected consumption in Europe and the United States as well as production declines in OPEC and non-OPEC countries.
It raised global oil demand outlook by 1.7% to 1.6 million barrels per day for this year and by 1.4% to 1.4 million barrels per day for the next (read: What Lies Ahead for Oil ETFs?).

Though inventories in developed economies are still 195 million barrels above the five-year average, it declined by 18.7 million barrels per day in July and will soon fall to this level given robust demand outlook and falling supplies. Unrest in Iraq and Venezuela will also keep output at check.

If these weren’t enough, the U.S. Energy Information Administration lowered its oil production forecast for this year and the next by 1% and 0.7%, respectively. The agency expects crude production at an average 9.25 million barrels per day for this year and 9.84 million barrels a day for the next.

State of Backwardation: A Big Bull for Oil

Further, the oil market has entered into a state of backwardation, where later-dated contracts are cheaper than near-term contracts, after three long years when oil price was above $100 per barrel. This signals that the oil market is tightening and demand is robust, paving the way for oil rally. Futures contracts for Nov 2017 Brent crude is $55.16, higher than the $54.86 futures contracts for Dec 2017, per cmegroup.com. This trend will likely prevail until May 2018, which is the biggest bullish catalyst for the commodity.

ETFs to Tap

While there are several ETFs to play the rally in oil prices, we have highlighted three funds each from different zones that are the biggest beneficiaries from this trend.

Oil Futures ETFs - United States Oil Fund (NYSE:USO) USO: This is the most popular and liquid ETF in the oil space with AUM of $2.5 billion and average daily volume of around 28 million shares. The fund seeks to match the performance of the spot price of West Texas Intermediate (WTI or U.S. crude). The ETF has 0.72% in expense ratio and gained 6.3% in 10 days.

Energy ETFs – SPDR S&P Oil & Gas Equipment & Services (NYSE:XES) ETF XES: This fund tracks the S&P Oil & Gas Equipment & Services Select Industry Index, which measures the performance of the companies engaged in the oil and gas equipment and services industry. Holding 38 stocks in its basket, the fund is well spread out across various components with each holding less than 4.2% share. The fund has amassed $280.9 million in its asset base and trades in a good volume of more than 607,000 shares a day on average. It charges 35 bps in annual fees and has risen 12.3% in the last 10 days. The product has a Zacks ETF Rank #4 (Sell) with a High risk outlook (read: Top and Flop ETFs of August: Metals Gain, Crops Crash).

Leveraged Oil ETFs - VelocityShares 3x Long Crude Oil ETN UWT: This is a popular leveraged fund targeting the energy segment of the commodity market through WTI crude oil futures contracts. It seeks to deliver thrice the returns of the S&P GSCI Crude Oil Index Excess Return and has amassed $406 million in its asset base. It trades in heavy volumes of 7.2 million shares a day, though it charges a higher fee of 1.50% per year. UWT surged 18.6% in the last 10 days.

Stocks to Tap

We have chosen three stocks using the Zacks stock screener that have a Zacks Rank #1 (Strong Buy) or 2 (Buy) with a VGM Style Score of A or B. The combination of these two offers the best upside potential. Additionally, these stocks returned handsomely in the last 10 days.

Willbros Group Inc. (NYSE:WG) : This Zacks Rank #2 company is an independent contractor serving the oil, gas and power industries, providing construction, engineering and specialty services to industry and government entities worldwide. The stock saw positive earnings estimate revision of six cents for this year over the past 30 days and has an expected growth rate of 78.43%. The stock has a VGM Style Score of A and was up 19.1% in the same time frame.

Calumet Specialty Products Partners, L.P. (NASDAQ:CLMT) : This Zacks Rank #2 company with a VGM Style Score of B is a leading independent producer of high-quality, specialty hydrocarbon products in North America. It saw positive earnings estimate revision of a couple of cents over the past month and has an expected growth rate of 83.69% for this year. Shares of CLMT gained 16.1% in the last 10 days (see: all the Energy ETFs here).

Seacor Holdings Inc. (NYSE:CKH) : This Zacks Rank #2 company with a VGM Style Score of B is engaged in the operation of a diversified fleet of offshore support vessels that service oil and gas exploration and development activities in the U.S. Gulf of Mexico, the North Sea, West Africa, Asia, Latin America and other international regions. Though the stock saw no earnings estimate revision activity over the past 30 days, its expected earnings growth rate of 103.40% is highly appreciating. It gained 8.7% in the same time frame.

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US-OIL FUND LP (USO): ETF Research Reports

SPDR-SP O&G EQP (XES): ETF Research Reports

Calumet Specialty Products Partners, L.P. (CLMT): Free Stock Analysis Report

Willbros Group, Inc. (WG): Free Stock Analysis Report

SEACOR Holdings, Inc. (CKH): Free Stock Analysis Report

VS-3X LG CR OIL (UWT): ETF Research Reports

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