COM - If Crude Oil Is Heading Higher ERX Could Turbocharge Returns

2023-08-29 12:45:32 ET

Summary

• Crude oil prices have stabilized above $80 per barrel, indicating a potential increase in the coming weeks and months.
• High gasoline and distillate crack spreads suggest bullish signs for crude oil prices.
• U.S. energy policy will be a key issue in the 2024 election, with Republicans supporting a drill-baby-drill policy and the Biden administration advocating for alternative and renewable fuels.

While the U.S. and Europe continue to support alternative and renewable fuels and inhibit fossil fuel production and consumption, crude oil is the energy commodity that powers the world. The number of EVs on the road is rising, but most cars are gasoline-powered.

Addressing climate change under the Biden administration handed pricing power in the oil market back to OPEC, the international oil cartel led by Saudi Arabia. Since 2016, Russia has cooperated with the cartel on production policy, making it the most influential non-member. Output quotas have become a function of negotiations between Riyadh, Saudi Arabia, and Moscow. The war in Ukraine, sanctions on Russia, and Russian retaliation impacting energy and food markets have complicated worldwide pricing. Moreover, the potential for a BRICS currency that challenges the U.S. dollar's role as the world reserve currency could further change oil market dynamics because of non-dollar pricing. China has recently purchased Saudi Arabian oil in yuan, and India has priced its requirements in rupees, signifying the potential demise of the petrodollar.

While crude oil prices have declined from the March 2022 fourteen-year high, they may have reached rock bottom above $60 per barrel and could head higher over the coming weeks and months. Higher oil prices are good news for the leading U.S. oil companies that stand to prosper. The Direxion Daily Energy Bull 2X Shares ETF ( ERX ) product turbocharges the Energy Select Sector SPDR® Fund ETF ( XLE ) that holds nearly 40% of its assets in the two leading U.S. diversified oil companies, Exxon Mobil Corporation ( XOM ) and Chevron Corporation (CVX).

Crude oil prices have stabilized above the U.S. target to replace the SPR

U.S. NYMEX WTI crude oil prices (CL1:COM) have stabilized around the $80 per barrel level over the past weeks.

The one-year chart highlights the pattern of higher lows and higher highs in the nearby NYMEX crude oil futures contract since reaching a $64.42 per barrel low on March 20, 2023. Crude oil futures rallied 30.6% to an $84.16 high on August 10. At just over the $80 level on August 29, the energy commodity remains closer to the recent high than the March low.

While crude oil prices remain significantly lower than the March 2022 fourteen-year $130.50 per barrel high, the price action has been primarily bullish since late March.

The U.S. government capped oil prices with unprecedented sales from its Strategic Petroleum Reserves, which have declined to a four-decade low, below 350 million barrels. In late 2021, the SPR stood at over 600 million barrels. The sales had an average price of around $95 per barrel. In October 2022, the Biden administration issued a Fact Sheet that told the oil market, " The administration intends to repurchase crude oil for the SPR when prices are at or below about $67-$72 per barrel, adding to global demand when prices are around that range. "

The ten-year chart shows that NYMEX crude oil prices fell below the bottom end of the administration's target buying range.

The chart shows the decline to or below the range in December 2022, March, May, June, and July 2023. However, the SPR has remained near the low in August 2023, and declined during the months when crude oil prices were under pressure and in the administration's SPR target zone for purchases.

As the markets head into September, nearby crude oil prices at the $80 per barrel level preclude SPR buying based on the 2022 Fact Sheet . Meanwhile, if prices head high, the administration has fewer SPR barrels to push prices lower, which could mean the period of low prices was a missed opportunity.

Product prices remain elevated - Crack spreads are high

While crude oil prices rose to the highest since 2008 at over $130 per barrel in March 2022, gasoline and distillate fuel prices reached record highs last year.

The chart illustrates gasoline's rally to a record $4.3260 high in June 2022, eclipsing the 2008 $3.6310 per gallon wholesale previous record high.

Heating oil futures are a proxy for other distillates, including jet and diesel fuels. In April 2022, heating oil futures rose to a record $5.2217 per gallon wholesale high, surpassing the 2008 $4.1586 previous peak.

Crack spreads are real-time oil product demand indicators and provide clues about the path of least resistance of the most significant input in product refining, crude oil prices.

The gasoline crack spread chart shows the bullish path of the refining spread since the March 2020 pandemic-inspired low. The gasoline crack reached a record $61.95 per barrel high in June 2022; at $27 per barrel in August 2023, the gasoline crack is at a high historical August level as the end of the summer tends to be a period where gasoline demand recedes heading into fall and winter and refining spreads decline.

At over $51 per barrel, the distillate refining spreads is at the highest pre-2022 price in history.

The bottom line is high gasoline and distillate crack spread levels is a bullish sign for crude oil that is sitting around the $80 per barrel level on August 29, reducing the odds of the administration's ability to purchase for the SPR at the $67-$72 per barrel range.

U.S. energy policy will be at the center of the stage in the 2024 election

The 2024 Presidential election season will kick into high gear over the coming months. The Republicans have already held the first of many debates to cull the herd of candidates facing off with incumbent President Joe Biden in November 2024.

One of the top issues will be energy independence as the Biden administration remains committed to supporting alternative and renewable fuels and inhibiting fossil fuel production and consumption to address climate change.

At the first debate, Republican candidate Nikki Haley said " Climate change is real " while pointing out that U.S. policy without Chinese and Indian cooperation is pointless, and subsidies for electric vehicles are benefiting China.

U.S. energy policy will be at the center of the stage in the 2024 election, with some Republicans supporting a drill-baby-drill and frack-baby-frack policy, with the administration supporting staying the current course. Moderate Republicans like former Governor Haley will continue acknowledging climate change while advocating for Chinese and Indian cooperation on initiatives.

The bottom line is the election will be a referendum on the future of U.S. energy policy. Today, oil prices have become a function of negotiations between Riyadh, Saudi Arabia and Russia, OPEC's most influential non-member since 2016 when Moscow began cooperating with the cartel's production quotas. Saudi Arabia recently extended its production cuts into September 2023, citing Chinese economic weakness. However, the Saudis require an $80 per barrel oil price to balance the domestic budget. Russia has used oil, natural gas, and grains as economic weapons against countries supporting Ukraine. OPEC+ will do the U.S. no favors and will not likely increase production at prices over $80 per barrel. Meanwhile, with less petroleum in the SPR, the Biden administration could face higher oil prices with fewer barrels to sell as the 2024 election nears. The higher oil prices climb, the more pressure on the incumbent President.

Oil company profits have soared - The XLE is steady in 2023 after a significant rally since the March 2020 low

NYMEX crude prices exploded higher in 2022 after reaching a pandemic-inspired record low below zero in 2020. U.S. oil companies cut costs and consolidated operations during the pandemic, allowing them to benefit and profit during the dramatic rally that took oil prices to a fourteen-year high in 2022. At $80 per barrel, the U.S. leading oil companies continue to post significant earnings.

The S&P 500 Energy Sector SPDR ((XLE)) owns shares of the leading U.S. crude oil and oil-related companies. The top ten holdings on August 24 included:

At $87.96 on August 29, XLE had $37.3 billion in assets under management. XLE trades an average of over 18 million shares daily and charges a 0.10% management fee.

XLE rose 314% from $22.88 in March 2020 to $94.71 in November 2022. At near the $88 level on August 29, 2023, XLE remains near the high.

ERX turbocharges the XLE's returns - ERX is a short-term trading product

The fund summary for the Direxion Energy Bull 2X ETF product that turbocharges the S&P 500 Energy Sector SPDR states:

At $63.41 on August 29, ERX had over $408 million in assets under management. ERX trades an average of more than 650,000 shares daily and charges a 0.94% management fee.

The five-year chart shows ERX rose over 1500% from $5 in March 2020 to an $80.27 high in mid-2022. Since the high, ERX declined 21% to the $63.41 per share level, while the XLE is only 7.1% lower than its peak.

ERX is a short-term trading instrument offering leverage. The gearing comes at a price: time decay. If the XLE declines or remains stable, ERX will lose value. Therefore, ERX is only appropriate for short-term risk positions on the bullish side of oil-related companies' shares. Please read about and fully understand the risks of leveraged ETFs here .

If crude oil's current consolidation is a prelude to higher prices and a rise to or above the $100 per barrel level, oil company earnings will soar, and shares will move higher. A new high in the XLE would likely launch the ERX ETF significantly higher, mainly if the rally occurs quickly. ERX is only appropriate for short-term, long risk positions as a leveraged product. Time and price stops are necessary risk dynamics for the trading product.

ERX could turbocharge rewards if crude oil prices and oil-related company shares' current consolidation prelude another significant rally.

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