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The Oil Trade Revisited

Alfred Lee

The Oil Trade Revisited

  • Earlier this year, we sent out a trade idea “Oil Making a Comeback,” which outlined the BMO Equal Weight Oil & Gas Index ETF (ticker: ZEO) as a way to gain exposure to the oil and energy sector. We outlined supply disruptions, increasing demand through both summer driving and an economic reopening as potential catalysts for gains in crude oil. Since that time, the front month contract of West Texas Intermediate (WTI) crude has increased 11.8% to nearly US$80/barrel. ZEO has gained 9.9% on a total return basis since that time, while the S&P/TSX Composite has been flat.
  • In recent weeks, oil and a number of energy-related commodities have been the focus of attention, as prices have recently surged. Much of this stems from the supply chain disruptions, particularly with natural gas shortages in Europe. A combination of lockdowns across the continent and a cold winter that persisted into spring left supplies heavily depleted heading into the summer. As weather has recently cooled, demand for natural gas is back on the rise. The front month contract for the Netherlands TTF Natural gas forward, a European benchmark for the commodity, has surged as much as 134% since the beginning of September.
  • The natural gas shortage has bled over to, not just other regions, but also other commodities such as oil and coal. With many utilities looking to make the switch from gas, oil and coal have experienced sizable gains of their own. Brent crude has broke above US$80/barrel, a level not seen since late 2018, while West Texas Intermediate (WTI) looks poised to imminently break above US$80/barrel. Coal prices have also recently hit two-year highs.
  • Additional supply may hit the market, which would create volatility. For example, natural gas prices temporarily traded lower, as Russia stated they would provide supplies to Europe. The Oil and Petroleum Exporting Countries (OPEC+) may also eventually relent on its plan to only moderately increase supply in the coming months. However, that additional supply may not be enough to offset the International Energy Agency ‘s (IEA) forecast of stronger oil demand through the end of the calendar year.
  • With temperatures cooling in North America, it’s likely that further strain will be placed on oil and natural gas, which would potentially keep prices high for energy-related commodities. While clean energy is the future, and governments have implemented aggressive initiatives to shift toward renewable energy sources, it will take years, if not decades, for much of the infrastructure to come online. However, given the future of clean-energy, expenditures on traditional fossil fuel-related capital projects will be limited moving forward. As such, as we continue to transition from traditional to alternative energy sources, fossil fuels may remain elevated due to supply and demand imbalances.


Trade Idea:

  • Canada is a heavy producer of oil and natural gas, and given that on average, it is a higher-cost producer of crude, oil prices remaining at these levels will be a positive. Below, we compare the performance of the BMO Equal Weight Oil & Gas Index ETF (ticker: ZEO) to the S&P Global 1200 Energy Sector Index, both in Canadian dollar terms. As illustrated, Canadian energy has significantly outperformed its global counterpart.
  • Many Canadian energy companies are also integrated, with exposure to both oil and gas. With interest rates potentially moving higher as we move closer to the U.S. Federal Reserve’s imminent tapering, most assets have recently faced headwinds as liquidity is expected to be extracted from the market. Canadian energy has been an area that has moved independently and has been sheltered from the recent equity market sell-off.
  • The BMO Equal Weight Oil & Gas Index ETF (ticker: ZEO) provides exposure to the sector, while better diversifying company-specific risk. With an equal weighted approach, it prevents concentration risk, whereas the top five holdings of a market cap equivalent index constitute more than 75% of the exposure.


BMO Equal Weight Oil & Gas Index ETF Outperforms Global Energy Sector


Source: Bloomberg, December 31, 2020 to October 5, 2021. The performance of an Index fund is expected to be lower than the performance of its respective index. Investors cannot invest directly in an index. Comparisons to indices have limitations because indices have volatility and other material characteristics that may differ from a particular mutual fund.


Oil Prices Rise Steadily


Source: Bloomberg, October 6, 2020 to October 6, 2021.


Natural Gas Prices Surge as Demand Increases


Source: Bloomberg, October 6, 2020 to October 6, 2021.

Alfred Lee

The Oil Trade Revisited

  • Earlier this year, we sent out a trade idea “Oil Making a Comeback,” which outlined the BMO Equal Weight Oil & Gas Index ETF (ticker: ZEO) as a way to gain exposure to the oil and energy sector. We outlined supply disruptions, increasing demand through both summer driving and an economic reopening as potential catalysts for gains in crude oil. Since that time, the front month contract of West Texas Intermediate (WTI) crude has increased 11.8% to nearly US$80/barrel. ZEO has gained 9.9% on a total return basis since that time, while the S&P/TSX Composite has been flat.
  • In recent weeks, oil and a number of energy-related commodities have been the focus of attention, as prices have recently surged. Much of this stems from the supply chain disruptions, particularly with natural gas shortages in Europe. A combination of lockdowns across the continent and a cold winter that persisted into spring left supplies heavily depleted heading into the summer. As weather has recently cooled, demand for natural gas is back on the rise. The front month contract for the Netherlands TTF Natural gas forward, a European benchmark for the commodity, has surged as much as 134% since the beginning of September.
  • The natural gas shortage has bled over to, not just other regions, but also other commodities such as oil and coal. With many utilities looking to make the switch from gas, oil and coal have experienced sizable gains of their own. Brent crude has broke above US$80/barrel, a level not seen since late 2018, while West Texas Intermediate (WTI) looks poised to imminently break above US$80/barrel. Coal prices have also recently hit two-year highs.
  • Additional supply may hit the market, which would create volatility. For example, natural gas prices temporarily traded lower, as Russia stated they would provide supplies to Europe. The Oil and Petroleum Exporting Countries (OPEC+) may also eventually relent on its plan to only moderately increase supply in the coming months. However, that additional supply may not be enough to offset the International Energy Agency ‘s (IEA) forecast of stronger oil demand through the end of the calendar year.
  • With temperatures cooling in North America, it’s likely that further strain will be placed on oil and natural gas, which would potentially keep prices high for energy-related commodities. While clean energy is the future, and governments have implemented aggressive initiatives to shift toward renewable energy sources, it will take years, if not decades, for much of the infrastructure to come online. However, given the future of clean-energy, expenditures on traditional fossil fuel-related capital projects will be limited moving forward. As such, as we continue to transition from traditional to alternative energy sources, fossil fuels may remain elevated due to supply and demand imbalances.


Trade Idea:

  • Canada is a heavy producer of oil and natural gas, and given that on average, it is a higher-cost producer of crude, oil prices remaining at these levels will be a positive. Below, we compare the performance of the BMO Equal Weight Oil & Gas Index ETF (ticker: ZEO) to the S&P Global 1200 Energy Sector Index, both in Canadian dollar terms. As illustrated, Canadian energy has significantly outperformed its global counterpart.
  • Many Canadian energy companies are also integrated, with exposure to both oil and gas. With interest rates potentially moving higher as we move closer to the U.S. Federal Reserve’s imminent tapering, most assets have recently faced headwinds as liquidity is expected to be extracted from the market. Canadian energy has been an area that has moved independently and has been sheltered from the recent equity market sell-off.
  • The BMO Equal Weight Oil & Gas Index ETF (ticker: ZEO) provides exposure to the sector, while better diversifying company-specific risk. With an equal weighted approach, it prevents concentration risk, whereas the top five holdings of a market cap equivalent index constitute more than 75% of the exposure.


BMO Equal Weight Oil & Gas Index ETF Outperforms Global Energy Sector


Source: Bloomberg, December 31, 2020 to October 5, 2021. The performance of an Index fund is expected to be lower than the performance of its respective index. Investors cannot invest directly in an index. Comparisons to indices have limitations because indices have volatility and other material characteristics that may differ from a particular mutual fund.


Oil Prices Rise Steadily


Source: Bloomberg, October 6, 2020 to October 6, 2021.


Natural Gas Prices Surge as Demand Increases


Source: Bloomberg, October 6, 2020 to October 6, 2021.

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