What's Boosting Oil ETFs

The United States Oil Fund (NYSEArca: USO), which tracks West Texas Intermediate crude oil futures, is up 9.4% over the past month in what can be described as a stunning reversal of fortune for the previously downtrodden oil exchange traded fund.

While that type of rally would appear to lure new investors, those considering fresh positions in USO and rival oil ETFs should consider one of the catalysts that is driving oil prices higher: Short covering. Oil’s rally, like gold’s, has drawn plenty of skeptics.

There might be something to that skepticism as many of the world’s major ex-U.S. producers of oil have not displayed a willingness to pare production. Even the output reductions in the U.S. have been modest. The good news is U.S. shale output is slightly declining, but challenges remain on the output front from OPEC producers.

OPEC has hinted at its desire to limit production in face of the prolonged low oil environment. However, Iran, which has just recently re-entered the global oil market, is only just starting to ramp up production, potentially putting a damper on plans for a OPEC cut.

“As crude has soared 50 percent since Feb. 11, the number of bets on increased prices has barely budged. Instead, the upward pressure on prices appears to have come from traders cashing out of bearish wagers at an unprecedented pace. The liquidation of short positions during the last seven weeks covered by data from the U.S. Commodity Futures Trading Commission was the largest on record,” according to Bloomberg.

Traders could be acknowledging the fact that although oil prices have surged, there has been little in the way of dramatic production cuts to fuel a more sustained rally for crude futures.