Crude oil prices and commodity-related exchange traded funds advanced the most in two months on a strengthening global outlook and weakening U.S. dollar. However, the widening contango in oil futures points to risks in lingering surplus.
On Tuesday, the United States Oil Fund (NYSEArca: USO), which tracks West Texas Intermediate crude oil futures, gained 5.2% and the United States Brent Oil Fund (NYSEArca: BNO), which tracks Brent crude oil futures, rose 5.5%.
Meanwhile, WTI crude oil futures were 4.7% higher to $46.9 per barrel and Brent crude was up 4.8% to $48.5 per barrel on Tuesday.
Supporting the oil market, Royal Dutch Shell Plc said the Trans Niger pipeline in Nigeria, which can ship 180,000 barrels a day, was halted due to a leak, and the markets projected U.S. crude stockpiles dipped 3.25 million barrels last week, reports Mark Shenk for Bloomberg.
Additionally, the U.S. Dollar Index dipped 0.1% to 96.4, which has made dollar-denominated crude oil less expensive for foreign buyers.
“Equities are at new highs and the dollar’s lower; these are the primary drivers,” Kyle Cooper, director of research at IAF Advisors and Ion Energy, told Bloomberg. “Crude and the dollar usually move in opposite directions, and the relationship is stronger than normal now.”
[related_stories]However, market observers are now looking past short-term fundamentals that helped bolster the oil market.
“The market tightened dramatically because of the disruptions in Canada and Nigeria, and the decline in output here,” Chris Kettenmann, chief energy strategist at Macro Risk Advisors, told Bloomberg. “I think the supply is coming back.”
Looking at the futures market, the one-year price contango – where neat-term contracts are cheaper those a year ahead, on crude oil has almost doubled, signaling that demand from buyers like refiners could be weakening, reports Grant Smith for Bloomberg.
Related: A Factor that Could Hinder Oil ETF Investing
“Contango means you have an oversupplied market,” Bob Yawger, director of the futures division at Mizuho Securities USA, told Bloomberg. “The global numbers, outside of U.S. production, point to an oversupplied situation worldwide.”
When the one-year contango distended last year, an oil rebound turned into a rout.
“The market is in the process of rebalancing, but the overhang has not been wiped out yet,” Amrita Sen, chief oil analyst at consultants Energy Aspects Ltd., told Bloomberg. “This will undoubtedly be messy, with the market moving too far in one direction before correcting.”
Related: Supply Concerns Linger for Oil ETFs
Investors who are wary of additional weakness in the oil market have a number of bearish options to choose from, like the simple inverse United States Short Oil (NYSEArca: DNO) and DB Crude Oil Short ETN (NYSEArca: SZO).
For the more aggressive trader, there are number of leveraged options, including the ProShares UltraShort Bloomberg Crude Oil (NYSEArca: SCO), which tries to reflect the two times inverse or -200% daily performance of WTI crude oil, and DB Crude Oil Double Short ETN (NYSEArca: DTO), which also follows a -200% performance of oil. Lastly, the VelocityShares 3x Inverse Crude (NYSEArca: DWTI) takes the three times inverse or -300% performance of crude oil.
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United States Oil Fund