Underscoring investors’ skittishness toward riskier assets, the United States Oil Fund (NYSEArca: USO), which tracks West Texas Intermediate crude oil futures, is lower by nearly 7.50% this month. Some market observers believe the U.S., now a major oil exporter, could weaponize oil in its trade spat with China, an idea that some argue could prove ill-fated.

“Chinese policy makers might look at the renewed pressure the U.S. is putting on Venezuela and Iran as a sign they may be trying to weaponize oil against China,” writes Gavekal Research’s Louis Gave, according to Barron’s.

Using oil against China is a potentially slippery slope for the U.S., particularly for President Trump. Another presidential election year is right around the corner and Texas, home to the second-most electoral votes after California, is biggest oil producer in the U.S. Other red states are also major oil producers and Trump could ill afford to lose those states and hope to win reelection.

“That could have limited impact on the U.S. economy since the country’s shale revolution has made it more of an energy exporter and higher oil prices would be good for ‘red states’ like Texas, Louisiana, Alaska and North Dakota and Oklahoma,” Gavekal’s Gave adds, reports Barron’s.

What’s Next for Oil?

Looking ahead, fundamentals are improving. The International Energy Agency projects consumption to increase each quarter of 2019 year-over-year, albeit at a slower-than-usual pace for the first quarter. Meanwhile, on the supply side, Saudi Arabia and other members of the Organization of Petroleum Exporting Countries have been cutting output. Additionally, U.S. sanctions on Iran and Venezuela have reduced further bets on international supplies.

“Higher oil prices though would be bad for China (as well as other emerging markets that import oil like India), further deteriorating its current account balance,” reports Barron’s.

Current OPEC compliance with production cut plans remains above their historical average, and it usually takes between two to three quarters for inventories to normalize after the cuts. While demand has yet to catch up to elevated supplies, rebounding economies in Europe and steady economic growth in the U.S. could prompt more upside for oil this year.

USO, the benchmark oil ETF in the U.S., is more than 25% below its 52-week high, indicating the fund is in a bear market.

For more information on the energy sector, visit our energy category.

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