Tags: oil | etf | investors | crude

Oil ETF Investors Can't Catch a Break Amid Rising Crude: Gadfly

Oil ETF Investors Can't Catch a Break Amid Rising Crude: Gadfly
(DPC)

By    |   Monday, 13 June 2016 07:15 AM

Suppose that when West Texas Intermediate crude fell to $26 a barrel on Feb. 11 you had a stroke of genius and figured it couldn't get much lower. Since you don't have the billion-dollar backing of a commodities-trading house, you acted in the only way you could and bought into an oil exchange-traded fund.

Nice work, you'd think. Crude is up almost 90 percent since then. Not quite so good for you, though -- ETF returns are about half that.

The devil here is in the detail. Oil ETFs generally don't track the spot price of the commodity but the total return from the futures contract. And that's a whole different kettle of fossil fuels.

Imagine a simple strategy for investing in Nymex WTI futures. You enter a futures contract to sell 1,000 barrels of crude next month, and wait until close to the delivery date before buying crude on the spot market to fulfil the contract. Then you use your trading profit to do the same thing next month, and the month after that.

Crude oil: $48.25/barrel

If you think that strategy would work best when the market's betting on a rising oil price, you'd be dead wrong. In the first month you make a tidy profit from the rising price of crude, but you then have to reinvest your profits at the new, higher contract price. Quite soon, the cost of rolling into the next month's contract starts to overwhelm any positive benefits you might get from the increasing price:

As a result, traders generally find life easier when futures curves are in backwardation -- with longer-dated contracts cheaper than shorter-term ones -- than the reverse situation, known as contango.

That dynamic makes life tough for oil ETFs at present. In theory, a fund like U.S. Oil, which had $3.58 billion in net assets as of March 31, tracks the movements of WTI crude. In practice, its managers are trading in the futures market just like anyone else, and as the contango on near-term contracts has gotten steeper, it's become harder and harder to match the performance of spot oil.

There are ways of mitigating this problem. U.S. Oil's smaller sister ETF, the U.S. 12-Month Oil Fund, tries to spread its risk from contango by betting across the first 12 months of the futures curve. Following the performance of the funds back to the U.S. 12-month Oil Fund's inception in 2007 suggests that's a smarter strategy than the more straightforward one followed by U.S. Oil, but it still trails the performance of the underlying commodity.

Unfortunately, unless you have a magic cost-free oil storage facility to hand, the muted returns from rolling futures contracts are the best you're going to get. In commodities markets, there are no free lunches.

© Copyright 2021 Bloomberg L.P. All Rights Reserved.


Markets
Suppose that when West Texas Intermediate crude fell to $26 a barrel on Feb. 11 you had a stroke of genius and figured it couldn't get much lower. Since you don't have the billion-dollar backing of a commodities-trading house, you acted in the only way you could and bought...
oil, etf, investors, crude
461
2016-15-13
Monday, 13 June 2016 07:15 AM
Newsmax Media, Inc.
 
Newsmax TV Live
 

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

NEWSMAX.COM
MONEYNEWS.COM
© Newsmax Media, Inc.
All Rights Reserved