“We tend to cheat.”
That frank admission, made by former Saudi Oil Minister Ali Al-Naimi a month ago, reflects the longstanding view that OPEC lacks the discipline to limit oil production output in order to boost prices.
But maybe Mr. Al-Naimi needs to update his view. The oil producing cartel has been honoring (and extending) its November 2016 move to cut output, and as global oil production cuts managed to slowly shrink bloated stockpiles, oil prices have moved north of $60 per barrel, a three-year high.
In an early January note to clients, Michael Tran, director of energy strategy at RBC Capital Markets, noted that stronger fundamentals have placed the oil market on the firmest footing seen in several years.
Still, stock prices for many oil-related companies have not yet risen in tandem with the oil price rebound. “We’ve never seen such a disconnect between the higher beta (energy) equities and oil prices,” says Brandan Rakszawski, product manager of hard assets at Van Eck Global.
For example, since bottoming out in June 2017, prices for West Texas Intermediate Crude (WTI) have risen around 50 percent. Yet the VanEck Vectors Unconventional Oil & Gas ETF (FRAK), which focuses on oil drillers, has risen less than 25 percent. This ETF, which carries a 0.54 percent expense ratio, could be poised for strong gains in 2018. Rakszawski says drillers have been forced to cut spending, and should see a strong boost in cash flow this year now that oil prices have rebounded.
Wall Street forecasts are all over the map regarding whether oil prices will rally further in 2018, stay range bound or pull back. It may be best to assume that oil prices will remain stable. After all, OPEC’s output cuts have largely been matched by U.S. shale oil production increases. This trade-off has led to a stalemate that should help oil prices hang on to recent gains.
Analysts at Merrill Lynch posit that the recovery leg of this oil cycle is sustainable. The firm’s commodity analysts expect oil prices to trade in a wide range around $60.
Even if you have a strong conviction on the direction of oil prices, the commodity-focused ETFs aren’t necessarily a profitable approach. The largest such fund, the United States Oil Fund LP (USO), for example, which carries a 0.77 percent expense ratio, rose 2.47 percent in 2017. That’s just a fraction of the 16.2 percent rally in West Texas Intermediate Crude prices last year. That’s because such funds must rollover futures contracts, and often lose a small bit of value during each month’s transaction.
Justin Demko, senior vice president-wealth management at UBS, notes that his team of advisors steers clear of such funds. “They’re really best for short-term price speculation and we prefer to focus on more traditional investment opportunities in energy geared for longer-term returns,” he says.