Energy ETFs Rally: Will The Gains Last?

The dual benefits of geopolitical tensions in the Middle East and reports of a surprise reduction in glut boosted oil prices in recent trades. US Commodity Funds United States Oil Fund USO was up more than 2% while US Commodity Funds United States Brent Oil Fund BNO gained about 1.8% on Mar 20. Chances of further declines in Venezuelan crude output also eased the oversupply tension somewhat and favored oil prices.

Behind the Headlines

The American Petroleum Institute reported a draw of 2.739 million barrels of United States crude oil inventories for the week ended March 16. This beat analysts' expectations of a build of 2.556 million barrels in crude oil inventories. API also reported a draw of 1.0633 million in gasoline inventory, in line with the 2.008-million-barrel draw that analysts had forecast.

Second, news that the United States could impose sanctions on Iran again and renewed tensions between Saudi Arabia and Iran raised worries about supply disturbances. Saudi Arabia declared the 2015 nuclear deal between Iran and global powers a "flawed agreement" on Monday, at the start of a meeting between the Saudi crown prince and President Trump. Both leaders have condemned Iran. The U.K., France and Germany are also mulling over new sanctions on Iran.

Venezuela is yet another factor to boost oil prices. The country is grappling with a debt burden. "And much of the oil that Venezuela does manage to produce is sent on to creditors — most notably Russia and China," according to oilprice.com.

Venezuela's oil output slid to about 1.548 million bpd in last month, marking a 52,400 barrel per day decline from January 2018, according to OPEC secondary sources. Analysts expect this downbeat trend to continue in the near term.

Oil & Energy ETFs on Tear

Thanks to this bullish backdrop, several energy ETFs were on a tear on Tuesday. Some of the winning ETFs were Energy Alphadex First Trust FXN (up 1.3%), iShares Energy Multifactor ERGF (up 1.3%) and DJ US Oil Equipment Index iShares IEZ (up 0.9%).

Why the Energy Space Could Warm Up Now

Investors should note that the energy sector enjoys seasonality at this time of the year. As per equityclock.com, the sector offered the best monthly average return (over the last 20 years) in April and that was 3.2% followed by 2.7% in March, 1.3% in February and 1.2% in December. This definitely calls for energy investing in the near term.

Per Reuters, hedge funds are definitely cautious on the outlook for oil prices, but these are reducing bullish positions very slowly. This indicates that the group sees less downside risks or more balanced risk in the oil patch.

Coming to the all-important OPEC deal, Russia will be conforming to the OPEC oil output cut deal till the target set in the extension agreement last November and even into 2019 should there be any need.

Recently, Azerbaijan indicated that OPEC and the country continue to cooperate on supporting global oil prices. All these may keep oil steady and encourage U.S. drillers to pump up more oil and support drilling companies. In short, the near-term outlook for the space looks favorable.

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