With oil futures trading near the highest levels since July, it is easy to understand why some investors are tempted to again embrace energy stocks and the relevant exchange funds. As one example, the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEArca: XOP) is up more than 20% in just the past week, further validating the temptation to revisit energy ETFs.
Fueling the rally in the energy space, a monthly U.S. energy report argues that global oil demand could jump by the most in six years in 2016 while non-OPEC supply stalls, which suggests that the oil supply glut could be easing more quickly than expected, Reuters reports.
However, there are reasons for investors to be cautious with volatile energy ETFs. Moreover, if oil prices falls to new lows and the shale industry is unable to turn a profit, the highly leveraged industry may find it harder to repay debt obligations.
With the U.S. dollar strengthening and the Federal Reserve looking at tightening its monetary policy, the various U.S. market sectors and related exchange traded funds could behave differently in a strong USD environment.
The Trade Weighted U.S. Dollar Index has increased 15% over the past year and is at its highest level in over 10 years, writes Karen Wallace for Morningstar. Energy ETFs can prove particularly vulnerable in the face of a stronger greenback.
Additionally, oil’s recent rally does not mean the industry is bracing for a return to $80 to $100 per barrel pricing. Far from it. Many large and small exploration and production firms scaling back to cope with lower prices.
“In the past five months, U.S. production sank by 590,000 barrels a day, or more than 6 percent. The bad news: Drillers are cutting costs with a speed and brutality not seen in decades, enabling many oil producers to maintain output even as prices remain low. Goldman Sachs Group Inc. sees crude falling a further $10 a barrel as storage tanks fill up in the coming months,” according to Bloomberg.
“Last week, the number of US Oil rigs fell by 26 to 614, which is a decline of 977 rigs from last year. Oil companies have been lobbying hard to get the 40-year export ban on Crude Oil repealed, and it looks as though the idea is picking up some momentum in both houses of Congress. Regardless, it looks as though the slump in commodity prices could last years, according to Goldman Sachs and Citigroup, which may act as headwinds for a possible comeback in Oil prices,” according to Options Express.
SPDR S&P Oil & Gas Exploration & Production ETF
