Oil and Natural Gas ETFs have taken a beating this past week, despite improved US Economic growth and positive economic indicators. Energy prices typically rise with growth and economic activity because growth leads to higher energy consumption and demand for oil and gas products.
Regardless of how the US economy is fairing, however, several factors, including the Keystone XL Pipeline dilemma, a warm winter, the Europe crisis, and US-Iranian tensions, all have the capacity to send oil and gas ETFs through the roof or to the floor. The key to success in these volatile markets is to gauge what will likely happen and if oil and natural gas ETFs will continue their current crunch or soar to profits.
First, let us take a look at oil and natural gas prices. To begin, oil prices closed out at $98.20 per barrel last Friday, a drop of nearly 2.5%. This drop came after a few weeks of volatile price fluctuations mostly due to Iranian tensions and the European debt crisis. The United States Oil Fund (NYSEARCA:USO), has been largely on an uptrend since October as indicated in the chart below, however, many factors can still swing Oil and NYSEARCA:USO prices in either direction at a violent pace:
Natural Gas prices tell a different story, as natural gas prices have dropped from roughly $4.00 per million British Thermal Units (BTUs) to roughly $2.30 per million BTUs. This near 50% decline in past months is largely due to warm weather and oversupply in the United States, and the United States Natural Gas Fund (NYSEARCA:UNG) reflects the downtrend in recent months in the chart below:
Considering that oil and oil ETFs have continued to produce mixed results in past weeks and that Natural Gas and Natural Gas ETFs have just about reached rock bottom, what can ETF investors expect for the future of oil and natural gas ETFs?
Several factors will likely influence oil and natural gas prices in the next few months. The first factor is the TransCanada Keystone XL Oil Pipeline Project, which the Obama Administration recently rejected based on environmental concerns in Nebraska. The pipeline would open up oil supplies into the United States from the newly exploited Canadian tar sands. If the pipeline is built, one may expect a slight drop in oil prices, however the pipeline will not be complete for an additional two years, so any major price fluctuation initially generated by Keystone Xl will likely correct after the hype dies down.
Another factor which could sharply effect oil prices is the tension between the United States and Iran over control in the Persian Gulf and Strait of Hormuz. Iran and the United States have sparred about nuclear sanctions and a threat to close the Strait. If indeed Obama sanctions Iran and Iran does indeed close the Strait of Hormuz, expect extremely high oil prices until the US Navy 5th Fleet confronts the Iranian Navy. In the meantime, oil prices will likely be volatile especially if Iran starts to rattle its saber again.
As far as natural gas prices and the natural gas ETF prices, the biggest threat to NYSEARCA:UNG is the continued warm winter temperatures across America. The Northwest just got pummeled by multiple inches of rain, ice, and snow; however significant changes in climate temperatures would have to occur to drive natural gas prices up in the short term. Currently there is also a huge influx of natural gas supply in the country, so it will also take a while for inventory to dwindle even if the US goes cold for the winter.
And lastly, Europe again holds the key to the future for all ETFs, but specifically Oil and Natural Gas ETFs. As mentioned earlier, recessions typically mean lower energy prices, and Europe has the capacity to spark another global recession if Team Merkozy and company let the monster out from under the bed. If indeed the monster does come out from under the bed, expect rock bottom prices for just about every equity, but especially oil and natural gas ETFs, as a dead economy equals no energy consumption. If, however, the European financial crisis is resolved, oil and natural gas prices will likely rebound into a major bull market as the economies of the world start to recover.
Bottom Line: Oil and natural gas prices and their respective ETFs such as NYSEARCA:USO and NYSEARCA:UNG have experienced high volatility and downtrends lately due to the Keystone XL pipeline dilemma, warm weather, US-Iran tensions, and the European crisis. If any one of these issues flare up again, expect more volatility and eventually negative prices in the long term for NYSEARCA:USO and NYSEARCA:UNG. However, resolution of these issues could lead to a major bull run in the energy sector.
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John Nyaradi is Publisher of Wall Street Sector Selector, an online newsletter specializing in sector rotation trading using Exchange Traded Funds. John's new book "Super Sectors," which explains how to outsmart the market using sector rotation and ETFs, is available now by clicking here.
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