XLE: Oil May Not Remain Range Bound For Long
The WTI oil prices have been hovering around $60 a barrel since May, and the latest EIA report hasn’t helped. Strong gasoline and diesel demand, however, may have prevented oil from falling back to $40 a barrel, as warned by Goldman Sachs. OPEC hasn’t made any major change in its strategy while concerns regarding a surge in supply from Iran are largely exaggerated. Total production from major oil producing regions in the U.S. is falling. Oil prices might rise in the near future. The Energy Select Sector SPDR ETF can be a good option for passive investors. The WTI oil prices climbed to $60 a barrel in May from low-$40s in January, but since then, prices have hovered around this level, and the latest weekly report from Energy Information Administration hasn’t helped. According the report released on Wednesday, the positive impact of better-than-expected drawdown on inventories was offset by the unexpected increase in gasoline stocks. Last week, crude inventories dropped by 2.7 million barrels to 467.93 million; this was significantly greater than analysts’ expectations of a drop of 1.7 million barrels. Further drops like these could go a long way in providing respite to energy investors who have struggled due to the oversupply of crude oil which took the stockpiles to their highest level in nearly 80 years. However, oil stocks at Cushing, Oklahoma grew by 112,000 barrels, depicting the first increase in over a month. Domestic gasoline stocks climbed by 460,000 barrels, which was in stark contrast to analysts’ expectations of a drop of 310,000 barrels, as per data compiled by Thomson Reuters. The report appears mixed, which is part of the reason why crude prices are largely unchanged at $60.26 a barrel at the time of this writing. The other reason that may have prevented the prices from falling back to $40 a barrel despite warnings from analysts, including those from Goldman Sachs , is the better-than-expected strength in gasoline and diesel demand, particularly in the Northern Hemisphere. In its latest report, the International Energy Agency said that in the first three months of this year, the global oil consumption clocked in 1.7 million barrels a day higher as compared to the corresponding period last year. This strength is due to a number of factors including cheap gasoline and diesel prices, economic recovery in the U.S. and the rebound in U.S. construction activity. The OPEC’s meeting held earlier this month in which the oil cartel decided to maintain its existing level of production also did not leave any mark on oil prices, given the decision was widely anticipated. But OPEC’s decision to not to increase its ceiling of 30 million barrels a day shows that perhaps the group is comfortable with the current price environment. It also remains to be seen how the conflict in the Middle East related to the Islamic State plays out. So far, the violence hasn’t stopped the flow of crude oil from Iraq and Libya, but things might change dramatically if the conflict spreads. Meanwhile, the market is also weighing the possibility of the return of the Iranian crude in the near future as the June 30 deadline for the nuclear deal approaches. Investors are concerned that a green signal from the negotiations will pave the way for lifting of economic sanctions on Iran. This will allow the Islamic Republic to unload its 40 million barrels of crude stocks, which will exacerbate the supply glut and drag the prices lower. However, I believe this is the worst case scenario, which is highly unlikely. That’s because the P5+1 (Germany and five permanent members of the U.N. Security Council) are not going to immediately lift all the sanctions at once. Rather, the sanctions will be eased gradually as Iran takes a number of unspecified steps to decrease its nuclear activity. If the sanctions are lifted, then the world will likely witness a slow and steady growth of crude supplies from Iran. By the time Iranian exports touch the pre-sanction level, the global market will likely be in a better position to absorb this supply. Without any major shift in strategy from OPEC, the oil prices, however, might not remain range bound in the $60 a barrel zip code for long. The slowdown in production growth from the U.S. is going to play a major role in taking the prices higher. Production from some of the key regions has already started to decline. Oil production from North Dakota, for instance, the second biggest oil producing state in the U.S., has fallen from 1.23 million barrels a day in December to 1.17 million barrels a day in April, as per latest data from North Dakota’s Department of Mineral Resources. Without any meaningful rebound in drilling activity, which is evident in the 60% drop in the number of rigs since September, the total production may continue to fall. Same goes for Texas, the nation’s top oil producing state whose output has already fallen from nearly 2.7 million barrels a day in December to 2.4 million barrels a day in March, as per data from Railroad Commission of Texas. The strength in gasoline and diesel demand, no major uptake in production from OPEC members, including Iran, and dwindling output from key oil producing regions of the U.S. will likely take crude to $70 a barrel in the near future. In this case, investors who would like to have a broad exposure to the energy sector should consider investing in the Energy Select Sector SPDR ETF (NYSEARCA: XLE ). Unlike the SPDR S&P Oil and Gas E&P ETF (NYSEARCA: XOP ), which focuses just on the oil and gas producers or the Market Vectors Oil Services ETF (NYSEARCA: OIH ) which relies on the performance of oil service companies, the Energy Select Sector SPDR ETF includes nearly 40 of the largest companies in the U.S. energy space, including vertically integrated oil majors, independent producers, oilfield services companies as well as midstream stocks. The fund’s top holdings are Exxon Mobil (NYSE: XOM ) and Chevron (NYSE: CVX ), followed by the global oilfield services leader Schlumberger (NYSE: SLB ), North America’s largest mid-stream company Kinder Morgan (NYSE: KMI ), my top large-cap tight oil pick EOG Resources (NYSE: EOG ) and the world’s biggest independent E&P company ConocoPhillips (NYSE: COP ). Together, these six companies represent nearly half (48.2%) of the fund. With a weighted average market cap of more than $110 billion and daily exchange volume of more than 2.7 million shares, the Energy Select Sector SPDR ETF is one of the largest and the most liquid ETFs in the energy sector. Moreover, the ETF also charges one of the cheapest fees as compared to other energy sector funds, which is evident in its total annual operating expense ratio of just 0.15%. Therefore, I believe that the Energy Select Sector SPDR ETF could be the best option for passive investors who are willing to bet on oil’s recovery. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.