Oil ETFs are back on the front burner, as investors look to
capture some of crude oil's recent gains amid hopes that central
banks will step up and stimulate economies, alleviating concerns
over global energy demand.
Investing in oil so far this year has been no easy task for the
average investor, who was caught between an oil price plunge that
cost oil futures 30 percent in a three-month period this spring,
and some 15 exchange-traded products to choose from.
Now, as the market rebounds on hopes for better demand and
easing concerns over global supplies-Saudi Arabia did come in and
make up the production difference following an embargo imposed
against Iran effective July 1-investors are again faced with tough
choices among so many mousetraps.
The takeaway is that when it comes to oil funds and the return
streams they generate, there's no such thing as a one-size-fits-all
As United States Commodity Funds' Chief Investment Officer John
Hyland-the man behind the market's largest oil ETF by assets, the
United States Oil Fund (NYSEArca:USO)-puts it, when it comes to
oil, there's no right way or wrong way to go about picking an
ETF-there's only being certain about what your objective is.
Narrowing Your Focus
The choices are these:To own front-month West Texas Intermediate
) oil exposure; own several months along the WTI futures curve; or
own WTI's European counterpart, Brent.
The differences between these choices so far this year would
have either cost investors as much as a 8.5 percent loss
year-to-date on a portfolio like USO, or netted them a gain of more
than 6.5 percent through the United States Brent Oil Fund
(NYSEArca:BNO). That's hardly immaterial.
In a way, many look at USO as the catch-all proxy for the oil
market because of the fund's massive size-it boasts more than $1.4
billion in assets in a space dominated by much smaller funds-and
its impressive liquidity:USO trades millions of shares on a daily
But USO, like others in the space, such as the iPath S&P
GSCI Crude Oil TR Index ETN (NYSEArca:OIL), is designed to reflect
the spot price of WTI light, sweet crude oil, and as such, it owns
primarily the front month on the WTI futures curve.
USO has lost 8.5 percent year-to-date because WTI has been in
contango for several months, thanks in part to its abundant
When a market is in contango, its front month in the futures
curve is also its cheapest, meaning investors have to pay up to
roll into another contract upon expiration, something that eats up
returns over time.
In WTI's case, that currently means investors are paying about
27c a month to have exposure to a $93-94 barrel of WTI oil.
"WTI is in contango, but there's still a good argument to owning
a fund like USO if you are looking at holding it for a short period
of time, as in days or weeks, assuming you are bullish oil," Hyland
"In the short term, paying 20-25 cents in contango is not a big
deal, but if you want to express a long-term view, that cost starts
to add up," he added.
It goes back to idea that a clear objective in an oil investment
Long-term oil exposure in the current market environment might
be better served with a strategy that dilutes the effect of
contango by diversifying allocation across various months in the
WTI futures curve.
Funds like the $591 million PowerShares DB Oil ETF
(NYSEArca:DBO) and the $109 million United States 12 Month Oil Fund
(NYSEArca:USL) do just that. They each own several contracts along
the curve to mitigate the impact of contango.
Their year-to-date performance shows the nuanced difference:DBO
and USL have seen more modest year-to-date losses, about 6 to 7
The third alternative path to oil exposure is through Brent.
Brent oil futures are currently in backwardation, which is the
opposite of contango. In backwardation, investors get paid when
they roll positions upon expiration to the next contract because
the nearby month is the most expensive on the curve. That enhances
returns over time.
Brent futures, which are trading at about $113 a barrel, are
serving up a roll yield of some $1.63, a far cry from the $3 seen
in recent months, but still a sizable difference from WTI's roll
Add to that the fact that Brent futures are up roughly 5 percent
on the year, significantly outperforming WTI, which is currently
down by that much, and you have a solid case for a Brent ETF.
Investors have only one Brent-focused fund to choose from, the
United States Brent Oil Fund (NYSEArca:BNO) designed to reflect the
spot price of Brent crude oil traded on the ICE Futures
But the fund is small-only $45 million in assets-and it doesn't
provide the liquidity some of the bigger players do. Still, on a
return basis alone, BNO has shelled out a positive 6.6 percent
year-to-date, while its WTI-focused counterparts have tallied
The WTI-Brent Spread
That disparity in performance could be coming to a close.
Tightening supplies in the U.S. Midwest could help push WTI toward
narrowing the spread between it and Brent that's now hovering
$18-near its recent highs.
"In the absence of having real-time inventory figures for global
crude oil supplies above ground, backwardation and contango are the
next best indicators of inventory," Hyland said, citing research
conducted by Yale Professor Geert Rouwenhorst.
WTI's contango has been dropping consistently while Brent's
backwardation has also given up ground.
HardAssetsInvestor.com analyst Sumit Roy argues in his latest
crude oil report that while WTI has underperformed Brent, tighter
Midwest inventories could help narrow that spread to $10-15 in
The fundamental reason behind the spread is more than inventory
related, Hyland added, noting that it's also a reflection of a
logistical problem with transportation to and from Cushing,
Okla.-the place NYMEX selected as its delivery point for WTI
"Had NYMEX picked some junction in a pipeline by the Mississippi
River, we wouldn't have that problem with the spread," Hyland said.
"Cushing is landlocked, so we have a discount."
While he doesn't dispute that WTI's disadvantage will be
"chipped away" over time as many have suggested before, Hyland was
also quick to point out that betting on a narrowing spread on the
assumption that WTI would outperform Brent hasn't necessarily paid
"That was a very popular bet among oil traders in late 2010 and
into 2011, but they were wrong, and wrong for a long time," he
said. "It's a workable trade, no doubt, but how long will it take
for you to be right?"
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