Despite a strong start to the year, Brent oil prices are declining as of late as worries about global economic growth and oil demand resurfaced. An increase in oil production, the ongoing shale boom and sluggish global demand are also responsible for the decline in oil prices even with some optimism over Chinese oil demand and North Sea supply disruptions (read: Venezuela: The Next Black Swan for Oil ETFs?).
Brent oil prices fell by $8 since mid-February on these concerns and is currently hovering around $110 per bbl. This means that the Brent oil is down nearly 1% when looking at the past two-month period. The price is expected to fall further to $80 per barrel by the end of this year, according to CNBC, due to negative supply/demand imbalances.
In this backdrop, the only ETF to play directly on Brent oil - United States Brent Oil Fund (BNO) - has seen a 6% fall in its prices since mid-February. The fund provides a vehicle to hedge against the loss associated with the rising cost of crude oil.
BNO in Focus
The ETF has failed to attract investors with just $37.7 million in AUM and a lower volume of about 40,000. This suggests a wide bid-ask spread for the product and that investors have to pay extra beyond the annual fee of 75 bps in fees per year. The ETF saw an outflow of over $8 million so far in the year (read: Three Most Popular ETFs of February).
The fund tracks the daily changes in percentage terms of its units’ net asset value to reflect the daily changes in percentage terms of the spot price of Brent crude oil.
This is measured by the changes in the price of the futures contract on Brent crude oil as traded on the ICE Futures Exchange. The fund focuses on contracts that are in the next month to expire, less BNO's expenses, except when the near month is within two weeks of expiration. When that is the case, the next month’s contract will be used instead.
The portfolio consists of crude oil futures contracts and other oil-related futures and may consist of forwards and swap contracts. These investments will be collateralized by cash, cash equivalents and US government obligations with remaining maturities of two years or less (read: Crude Oil ETF Investing 101).
The fund easily outperformed many other oil-based ETFs in the segment, gaining about 1.55% year-to-date compared with 2.49% loss for WTI crude, as represented by (USO), and 1.48% gain for United States Natural Gas Fund (UNG). However, the fund has underperformed the United States Gasoline Fund (UGA) and the broad market fund (SPY) by a wide margin.
Apart from fundamentals, let us have a technical look at the chart for the Brent oil ETF and its trends:
As seen from the above chart, the ETF was on the rise in the second half of 2012 with a moderate decline in the last quarter. This positive trend was seen again in January 2013 but could not be sustained in February.
Currently, BNO is showing weakness on the price front. The ETF fell below the 50-day EMA for the first time since January, a key indicator for negative sentiment. The fund is trading near its support level, and falling further will demonstrate a clear strong downtrend. Additionally, the fund has also witnessed a bearish breakout accompanied by low volumes (see more ETFs in the Zacks ETF Center).
Oil Price Outlook
The instability in the euro zone as well as concerns on the ongoing worries over the budget and automatic spending cuts (sequestration) in the U.S. will continue to weigh on crude oil prices.
According to the Energy Information Administration (EIA), the U.S. crude oil production would jump 14% this year and 22% in the next. As a result, U.S. could leapfrog both Russia and Saudi Arabia to become the world’s biggest producer of oil in five years time (read: 3 Energy ETFs for America's Production Boom).
In addition, the rise in oil production in Saudi Arabia in the coming months and strengthening dollar due to tight monetary policies by the central bank would put downward pressure on oil prices. Apart from this, the resolution of transportation issues that will reduce U.S. oil imports by the end of the year is another major threat that can result in further reduction in oil prices in the future.
Based on fundamentals, technicals, and the demand/supply outlook, investors should avoid the direct play on oil prices for the time being. Instead, investors should focus on the funds providing exposure to various oil companies, as they could be better positioned than this technically weak ETF (read: Time to Buy the Oil Equipment ETFs?).
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US BRENT OIL FD (BNO): ETF Research Reports
SPDR-SP 500 TR (SPY): ETF Research Reports
US GAS FUND LP (UGA): ETF Research Reports
US-NATRL GAS FD (UNG): ETF Research Reports
US-OIL FUND LP (USO): ETF Research Reports
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