Oil ETFs Make a Comeback

At the end of a lackluster summer, the price of oil showed strong signs of recovery. European Brent crude prices approached $80 per barrel in the first days of fall, while U.S. West Texas Intermediate (WTI) prices hovered just a few dollars short of the year high of $75 per barrel. According to a report by ETF.com, and with the final quarter of the year often representing one of the strongest for oil, investors in the exchange-traded fund (ETF) space may want to watch out for oil-based ETFs as they climb alongside the price of crude. (See also: Top Oil ETFs.)

Lagging Supply Fosters Increased Price

Of late, oil supplies from Iran and Venezuela have dwindled, pushing up prices globally. According to the International Energy Agency (IEA), Iran's oil exports have already fallen sharply as investors anticipate U.S. sanctions on the Iranian industry, which are slated to take effect on Nov. 4. Iran's oil exports have dwindled by hundreds of thousands of barrels per day, although sources disagree about the exact figure.

In Venezuela, where the economic crisis continues, oil production has fallen as well. The country has exported about 350,000 barrels per day less for this year as compared with previous years. If the economic situation does not improve, this figure could fall even more. All of this helps to push up the price of oil, which in turn can bolster those ETFs holding oil-related stocks.

Big Gains for Big Oil ETFs

One of the largest oil ETFs in the nation, the United States Oil Fund LP (USO), oversees about $1.7 billion and has climbed by just under 25% this year. The much smaller United States Brent Oil Fund LP (BNO), at $101 million, has also posted big gains, returning 23% so far this year. The IEA explains that, "if Venezuelan and Iranian exports do continue to fall, markets could tighten and oil prices could rise without offsetting production increases from elsewhere," per ETF.com. Indeed, it seems that the dwindling production from these oil-rich parts of the world may have already boosted the aforementioned ETFs by a significant margin.

There is likely more behind the oil ETF gains than just supply, though. Oil futures have experienced a phenomenon known as backwardation, referring to a state in which near-month futures are more costly than longer-dated futures. ETFs able to navigate this landscape could use it to an advantage when it comes to eking out returns. (See also: ETFs Provide Easy Access to Energy Commodities.)

U.S. Producers

U.S. oil producers have already benefited from the shift in supply from Iran and Venezuela. American oil producers are now generating a record 11 million barrels of oil per day, up about 1.5 million barrels per day from this time last year. With production up in the U.S. and diminished concerns of a glut of supply thanks to the international landscape, U.S. producers are enjoying the best of both worlds: massive output and high oil prices that don't seem to show any signs of stopping.

Nonetheless, there are reasons for ETF investors to hesitate before shifting their assets toward oil-based ETFs. There are reasons to expect oil prices to continue to increase, but investors in this arena remember well previous downturns. In prior downturn events, rapid increases in U.S. oil production may have played a role in crashing prices. Demand for oil remains incredibly strong, but if fuel costs rise, demand could also dwindle.

The reality of the oil industry is that it remains boom-or-bust. For the time being, oil (and, as a result, oil ETFs), are performing terrifically. In all likelihood, though, this cannot persist forever. For some, this means an opportunity to capitalize while the possibility of great returns remains. (For additional reading, check out: OPEC vs. the US: Who Controls Oil Prices?)

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