Oil ETF Crystal Ball: More Turmoil Ahead

According to Bloomberg, fears over oil supply disruptions have led to the price of oil likely rising higher this week than in any other week over the last two years. In fact, this week Nomura Holdings put out a research note pointing to a possible $220 a barrel scenario should supply disruption grow in Libya and move into Algeria. All this drama seemed to have peaked oil prices earlier this week but now oil is rebounding going into the weekend of February 26th.

As of Friday afternoon February 25th, Oil ETFs are predicting more turmoil and higher oil prices. A quick look at three key oil related ETFs — USO the United States Oil Fund, DBO the PowerShares DB Oil Fund and XOP the SPDR S&P Oil and Gas Exploration and Production ETF — show them all trending upward mid day. See chart below:

Market participants are likely hedging their oil exposure leading into the two day weekend as further developments occur in Libya as well as other Middle Eastern hotspots.

The three oil ETFs highlighted above have been a decent investment this year, although their performance year to date differs considerably. See the year to date chart below:

 

How could one oil ETF be up 10% this year while another is just breaking even? It’s all in the details people. XOP, the only product that invests in the companies that are involved in oil and gas exploration, has seen the biggest rise year to date in part because contango has not been an issue diminishing performance. DBO, a oil futures product that employs an optimised approach to selecting which oil futures contract to invest in, has successfully mitigated some of contango’s effects. Finally USO, which robotically purchases the next month’s oil futures contract, has likely suffered the most from contango. As you can see, the underlying approaches of all three ETFs yield substantial differences in performance and it pays to understand them before making an investment. For more information about contango, see the recent U.S. News and World Reports story Magoon Capital contributed to.

For now it appears oil’s behavior will continue to be closely tied to the latest headlines and video from the Middle East — not the global economic recovery — and that has Wall Street hedging its bets.