Energy ETFs unsettled as Saudi-Russia feud continues

Apr 6th, 2020 | By | Category: Commodities

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ETFs linked to the energy sector continue to be plagued by volatility and uncertainty as efforts to resolve a feud between key oil producers Saudi Arabia and Russia have stalled.

Energy ETFs remain troubled as Saudi-Russia feud continues

An emergency OPEC+ summit has been postponed, causing more uncertainty in global energy markets.

An emergency meeting held by OPEC and its Russian-led allies, due to take place on Monday 6 April, has been postponed over souring relations between Riyadh and Moscow.

The summit would have focused on negotiating a coordinated curtailment of crude oil production, helping to end the supply glut that has driven oil prices to multi-year lows.

Recently, Saudi Arabia has been flooding the market with oil, a move which Russia believes is aimed at destabilizing its energy industry as well as the rise of US oil-shale companies. Saudi Arabia denies the accusation.

The Kingdom’s policies have also angered fellow OPEC members. Iran and Venezuela, straining under the weight of US sanctions, rely more than ever on oil income to fill their government coffers.

Adding to these countries’ woes, the coronavirus pandemic has seen economic activity grind to a standstill and global demand for oil fall off a cliff.

According to analysts at Fitch ratings, demand for oil is expected to be several million barrels per day lower in 2020 compared with 2019, driven primarily by a loss of appetite for jet fuel and gasoline which represent 35% of global oil consumption.

The combination of Saudi Arabia’s full-throttle production with dwindling global demand has caused the price of oil to plummet.

Front-month futures on West Texas Intermediate and Brent Crude oil crashed approximately 62% between 20 February and 31 March to reach just $22.74 and $20.48 per barrel, respectively.

ETFs tracking WTI, such as the United States Oil Fund (USO US) and the Europe-listed WisdomTree WTI Crude Oil, CRUD_LN, as well as those linked to Brent Crude such as the WisdomTree Brent Crude Oil 1mth (OILB LN) have consequently suffered massive losses.

Investors who believe the low oil price presents a compelling buying opportunity should take heed as the oil futures curve has steepened dramatically. ETFs that track front-month futures contracts are subject to rolling costs as the expiring contract is rolled into the following month. At the moment, WTI futures for May are selling at an 11.5% premium to April.

Oil pundits were hoping the OPEC+ meeting would restore some normality into floundering oil markets – following an encouraging tweet from US President Donald Trump about the chances of an oil deal being struck, crude prices soared a record-breaking 25% on 2 April 2020 (albeit from a very low base). However, with communications between Riyadh and Moscow suspended, and the US failing to outline any limit on its own production, a near-term resolution seems unlikely.

The challenges facing the oil market served to amplify the sell-off of energy companies during the recent global equity market meltdown that was precipitated by coronavirus-induced fears. Investors are fearful that bankruptcies will rise significantly in the energy sector due to the combination of ultra-low oil prices, massive corporate debt burdens, and dismal global oil demand.

Between 20 February and 23 March (the recent equity market bottom), the iShares Global Energy ETF (IXC US) sunk 53.1%. Looking at the US and European markets individually, the Energy Select Sector SPDR Fund (XLE US) lost 56.0% in US dollar and the Lyxor STOXX Europe 600 Oil & Gas UCITS ETF (OIL FP) lost 44.6% in euro terms. Over the same period, the MSCI World, S&P 500, and Stoxx Europe 600 each lost between around 35%.

ETFs providing exposure to master limited partnerships (MLPs) have fared even worse with the Alerian MLP ETF (AMLP US) dropping 60.0% between 20 February and 23 March. MLPs are tax-efficiently structured companies that typically own energy infrastructure in the United States including pipelines, natural gas, gasoline, oil, storage, terminals, and processing plants.

Global equity markets have recovered somewhat since their low two weeks ago, buoyed by strong responses from governments and central banks. The market has also been lifted on the hope of an early end to the pandemic as China restarts its factories and Italy and Spain show signs of being able to control the spread of coronavirus within their borders. Oil and gas companies have gained along with the broad market, although these firms are still way off their February highs.

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