Supply Concerns To Boost Crude Oil ETFs

Supply concerns pushed crude futures contacts north of $90 per barrel on Tuesday, providing positive price support to the US Oil Fund (USO), PowerShares DB Oil Fund (DBO) and the iShares Dow Jones US Oil & Gas Ex Index (IEO).

As for crude supply in the US, there are two forces that could result in a supply shock.  First, is the recent closure of the Trans Alaska Pipeline, which is an artery for oil transport to refineries on the US West Coast.  The flow through this 800-mile pipeline, which links Prudhoe Bay on the Arctic Ocean with the terminal at Valdez accounts for nearly 20 percent of US oil production annually.  In fact, according to the Wall Street Journal, upon news of the leak, BP (BP), ConocoPhillips (COP) and Exxon Mobil (XOM) all cut their oil production from Alaska’s Prudhoe Bay field by 95 percent.  With this in mind, if the leak is not controlled and fixed within the next few days, there could be a negative impact on US crude reserves.   In regards to when the fix is supposed to be complete, there is some ambiguity as that more problems could arise due to ice or wax buildups in the actual pipeline.  

Further supply constraints in US crude production could stem from a report from President Obama’s panel investigating the Gulf Oil spill which stated that the oil industry needs to do more to reduce the probability of another large-scale disaster.  To be more specific, the Associated Press indicates that the panel recommends increasing the liability cap for damages when companies drill offshore, increasing budgets and training for the federal agency that regulates offshore drilling and lending more weight to federal scientific opinions in decisions about drilling.  In a nutshell, the report raised speculation that Big Brother might slow down production in the Gulf of Mexico, which could boost crude prices. 

These supply constraints come at a time when global crude demand is expected to rise.  In the short-term, colder than normal weather in the US is leading to increased heating oil consumption, leading to increased crude oil demand.  As for long-term growth, the Energy Information Agency (EIA) states that global consumption of crude oil is expected to increase due to resurgent demand driven by improving economies in both the developed and developing worlds. 

In the developed world, the US is witnessing increased consumer confidence and an improving economy and Germany is witnessing growth illustrated by a recent report that factory orders in the country rose five times more than economists forecasted as demand in nations outside of Europe soared.  As for the developing world, China’s appetite for black gold is expected to grow by nearly 4 percent this year, while non-OECD Asia, the Middle East and Latin America is expected to witness increased consumption as well. 

At the end of the day, supply constraints are pushing up crude oil and increased demand is expected to enable the commodity to sustain elevated price levels.  As mentioned above, some ways to play curde include:

  • ·         US Oil Fund (USO), which seeks to reflect the changes in percentage terms of the spot price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes in the price of the futures contract on light, sweet crude oil traded on the New York Mercantile Exchange
  • ·          PowerShares DB Oil Fund (DBO), which tracks a rules-based Index composed of futures contracts on Light Sweet Crude Oil (WTI) and is intended to reflect the performance of crude oil.
  • ·         iShares Dow Jones US Oil & Gas Ex Index (IEO), which seeks to replicate an index which measures the performance of the oil exploration and production sub-sector of the United States equity market, and includes companies that are engaged in the exploration for and extraction, production, refining, and supply of oil and gas products.  This equity play on crude oil includes holdings such as Occidental Petroluem (OXY) and Apache Corporation (APA). 

Disclosure: No Positions

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