Rise in Oil Price Fails to Lift Energy ETFs: What's Ahead?

After falling to the lowest level since December 2021, on Tuesday, oil recorded its first weekly gain in a month, buoyed by Hurricane Francine, which disrupted production in the Gulf of Mexico. Brent crude rose above $72 per barrel, pushing its weekly climb to about 2%, while West Texas Intermediate traded below $70 per barrel.

However, higher oil prices failed to fuel the rally in the energy space with many ETFs still in red. The popular ETFs — Energy Select Sector SPDR XLE, Vanguard Energy ETF VDE, SPDR S&P Oil & Gas Exploration & Production ETF XOP, Fidelity MSCI Energy Index ETF FENY and VanEck Vectors Oil Services ETF OIH — were down more than 2% each. All these ETFs have a Zacks Rank #1 (Strong Buy) or #2 (Buy).

The storm had prompted a production shutdown of around 730,000 barrels a day (bpd) in the Gulf of Mexico (about 42% of Gulf production), according to the US Bureau of Safety and Environmental Enforcement. The US Bureau of Safety and Environmental Enforcement stated that about 24% of crude production and 26% of natural gas output in the US Gulf of Mexico were offline due to the storm.

Energy ETFs in Focus

Energy Select Sector SPDR: It is the largest and the most popular ETF in the energy space, with an AUM of $34.1 billion. It offers exposure to the broad energy space and follows the Energy Select Sector Index. Energy Select Sector SPDR holds 22 securities in its basket and charges 9 bps in annual fees.

Vanguard Energy ETF: It provides exposure to a basket of 113 energy stocks by tracking the MSCI US Investable Market Energy 25/50 Index. Vanguard Energy ETF has amassed $7.6 billion in its asset base and charges 10 bps in annual fees.

SPDR S&P Oil & Gas Exploration & Production ETF: It provides exposure to 53 oil and gas exploration and production companies by tracking the S&P Oil & Gas Exploration & Production Select Industry Index. It has an AUM of $2.6 billion and charges 35 bps in fees per year.

Fidelity MSCI Energy Index ETF: It follows the MSCI USA IMI Energy Index, holding 112 stocks in its basket. FENY charges 8 bps in annual fees and has accumulated $1.5 billion in its asset base.

VanEck Vectors Oil Services ETF: It tracks the MVIS U.S. Listed Oil Services 25 Index, which offers exposure to companies involved in oil services to the upstream oil sector, including oil equipment, oil services or oil drilling. VanEck Vectors Oil Services ETF holds 26 stocks in its basket. With an AUM of $1.5 billion, it charges 35 bps in annual fees.

Concerns

Weak Demand/Supply Trends

Despite the positive momentum, oil prices are still trading close to three-year lows amid persistent concerns over slowing demand.

International Energy Agency (IEA) lowered the oil demand outlook by 70,000 bpd to 900,000 bpd for this year, citing weak China demand and feeble growth in other regions. The Organisation of Petroleum Exporting Countries (OPEC) also slashed the 2024 oil demand growth forecast for the second time. It expects world oil demand to rise by 2.03 million bpd in 2024, down from last month's forecast of growth of 2.11 million bpd.

Last week, OPEC and its allies extended the oil production cuts of 2.2 million bpd through November and planned to phase out those beginning in December until November 2025. However, it will increase production in 2025 for the first time since 2022. The first addition to supply, of 180,000 bpd, is now expected in December. Additionally, growing output from the United States, Guyana, Brazil and Canada will continue to take a toll on oil prices.

Geopolitical Tensions

Geopolitical risks in the Middle East will continue to provide some support to oil prices. The ongoing conflict in Gaza and the potential for a broader regional escalation, involving Iran, Hamas and Hezbollah are contributing to market uncertainty.

Analysts Go Bearish

Analysts in a Reuters poll reduced their oil price forecasts for 2024 for the fourth consecutive month. The poll shows Brent prices to average $82.86 per barrel this year, down from $83.66 a barrel expected in the July forecast. West Texas Intermediate is projected to average $78.82 per barrel in 2024, down from $79.22 a barrel expected in last month's poll.

Analysts believe the bullish drivers of the ongoing OPEC+ cuts and geopolitical flare-ups in the Middle East will be offset by the bearish demand trends and oil imports in China and Europe.

Will the Fed Provide Some Respite?

The Fed is expected to cut interest rates at its meeting scheduled to take place on Sept 17 and 18. Lower interest rates tend to lower the expenses of purchasing goods and services, potentially stimulating economic expansion and driving oil demand.

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