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Oil in Great Contango: Here's How to Play With Crude ETFs
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Oil prices have been downbeat for quite some time thanks to poor demand emanating from the coronavirus-led lockdowns and a price war between Saudi Arabia and Russia over the decision to prolong the output cut deal.
Though Saudi and Russia finally put an end to their row and agreed on the biggest OPEC+ output cut deal in mid-April, oil continued to slump on storage crisis. WTI suffered more than the Brent. On Apr 20, May WTI crude futures dropped to below zero for the first time in historyand dealt a blow to the investing world.
However, the liquid commodity tried to recover at the end of last week backed by earlier-than-scheduled output cuts by some OPEC producers and Middle East tensions, only to slump again on Apr 27 (read: OPEC Output Deal Cut: Will It Help Oil & Energy ETFs?).
U.S. crude’s June contract lost about 24% on Apr 27, at the time of writing, as global oil storage – both offshore and onshore – is fast reaching its capacity. Demand for oil in April is forecast to decline by a record 29 million b/d, per the International Energy Agency. With this, oil is now trading at about $12 per barrel (bbl), down from $60/bbl at the start of the year (read: Sector ETFs to Win or Lose on Oil Collapse).
However, the demand scenario is more bullish for later months thanks to the gradual reopening of economies. This took the oil market in contango. A contango market is defined as the futures contracts trading at a premium to the spot price.
Oil Pain Causes Restructuring in USO
The above discussion explains the acute pain in the WTI crude ETF United States Oil Fund, LP (USO - Free Report) , which was originally designed to track the daily changes in percentage terms of the spot price of WTI crude oil. WTI was off about 55% in the past month. The fund lost about 15% on Apr 27 to about just $2.00. To save the product from further slide, the fund manager continued to change the fund’s compositions lately.
It started betting in favor of longer-term contracts since last week. Now with the June contract too falling fast, USO has undergone another structural change. On Apr 27, USCF, the fund’s administrator, said that over the next three days, the USO will sell all of its West Texas Intermediate contracts for June delivery, in favor of longer-term contracts.
The fund’s breakdown will now be as follows: 30% July contract, 15% August contract, 15% September contract, 15% October contract, 15% December contract and 10% in the June 2021 contract, as quoted on CNBC.
Will Oil Recover Over the Medium Term?
Investors should note that USO eked out solid inflows of about $4.2 billion in the past one month (as of Apr 27, 2020) despite the oil crash. This means that investors are betting big on a long-term oil price recovery with this product, especially with the product shifting toward more longer-dated futures.
Which is the Best Oil ETF?
That said, we would like to note that United States 12 Month Oil Fund (USL - Free Report) is sticking to its objective and is a more apt product in fighting the latest oil crash. USL's Benchmark is the near month futures contract to expire and the contracts for the following 11 months, for a total of 12 consecutive months. If the near month futures contract is within two weeks of expiration, the Benchmark will be the next month contract to expire and the contracts for following 11 consecutive months. Each contract month is equally weighted. USL lost 4.7% on Apr 27 and was off just 21% in the past month.
Another product Invesco DB Oil ETF (DBO - Free Report) tracks the DBIQ Optimum Yield Crude Oil Excess Return Index. “Rather than select the new future based on a predefined schedule (e.g. monthly) the index rolls to that future (from the list of tradable futures which expire in the next 13 months) which generates the maximum implied roll yield. The index aims to maximize the potential roll benefits in backwardated markets and minimize the loss from rolling down the curve in contango markets.” The fund lost only 2.4% on Apr 27, while it has shed 13.9% in the past month.
iPath Pure Beta Crude Oil ETN is designed to provide exposure to the Barclays WTI Crude Oil Pure Beta TR Index. The index reflects the returns that are potentially available through an unleveraged investment in the futures contracts in the crude oil markets. OLEM was down 8% on Apr 27 and lost 20% past month.
Bottom Line
Though USO may benefit from the recent structural changes, USL, DBO and OLEM look better bets from the perspective of their original investment objectives, we believe along with some other analysts. The latest restructuring is distorting USO's original objective of tracking the near-term price of oil, per CNBC, though this is helping the fund to stay afloat amid the ongoing oil price carnage.
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Oil in Great Contango: Here's How to Play With Crude ETFs
Oil prices have been downbeat for quite some time thanks to poor demand emanating from the coronavirus-led lockdowns and a price war between Saudi Arabia and Russia over the decision to prolong the output cut deal.
Though Saudi and Russia finally put an end to their row and agreed on the biggest OPEC+ output cut deal in mid-April, oil continued to slump on storage crisis. WTI suffered more than the Brent. On Apr 20, May WTI crude futures dropped to below zero for the first time in historyand dealt a blow to the investing world.
However, the liquid commodity tried to recover at the end of last week backed by earlier-than-scheduled output cuts by some OPEC producers and Middle East tensions, only to slump again on Apr 27 (read: OPEC Output Deal Cut: Will It Help Oil & Energy ETFs?).
U.S. crude’s June contract lost about 24% on Apr 27, at the time of writing, as global oil storage – both offshore and onshore – is fast reaching its capacity. Demand for oil in April is forecast to decline by a record 29 million b/d, per the International Energy Agency. With this, oil is now trading at about $12 per barrel (bbl), down from $60/bbl at the start of the year (read: Sector ETFs to Win or Lose on Oil Collapse).
However, the demand scenario is more bullish for later months thanks to the gradual reopening of economies. This took the oil market in contango. A contango market is defined as the futures contracts trading at a premium to the spot price.
Oil Pain Causes Restructuring in USO
The above discussion explains the acute pain in the WTI crude ETF United States Oil Fund, LP (USO - Free Report) , which was originally designed to track the daily changes in percentage terms of the spot price of WTI crude oil. WTI was off about 55% in the past month. The fund lost about 15% on Apr 27 to about just $2.00. To save the product from further slide, the fund manager continued to change the fund’s compositions lately.
It started betting in favor of longer-term contracts since last week. Now with the June contract too falling fast, USO has undergone another structural change. On Apr 27, USCF, the fund’s administrator, said that over the next three days, the USO will sell all of its West Texas Intermediate contracts for June delivery, in favor of longer-term contracts.
The fund’s breakdown will now be as follows: 30% July contract, 15% August contract, 15% September contract, 15% October contract, 15% December contract and 10% in the June 2021 contract, as quoted on CNBC.
Will Oil Recover Over the Medium Term?
Investors should note that USO eked out solid inflows of about $4.2 billion in the past one month (as of Apr 27, 2020) despite the oil crash. This means that investors are betting big on a long-term oil price recovery with this product, especially with the product shifting toward more longer-dated futures.
Which is the Best Oil ETF?
That said, we would like to note that United States 12 Month Oil Fund (USL - Free Report) is sticking to its objective and is a more apt product in fighting the latest oil crash. USL's Benchmark is the near month futures contract to expire and the contracts for the following 11 months, for a total of 12 consecutive months. If the near month futures contract is within two weeks of expiration, the Benchmark will be the next month contract to expire and the contracts for following 11 consecutive months. Each contract month is equally weighted. USL lost 4.7% on Apr 27 and was off just 21% in the past month.
Another product Invesco DB Oil ETF (DBO - Free Report) tracks the DBIQ Optimum Yield Crude Oil Excess Return Index. “Rather than select the new future based on a predefined schedule (e.g. monthly) the index rolls to that future (from the list of tradable futures which expire in the next 13 months) which generates the maximum implied roll yield. The index aims to maximize the potential roll benefits in backwardated markets and minimize the loss from rolling down the curve in contango markets.” The fund lost only 2.4% on Apr 27, while it has shed 13.9% in the past month.
iPath Pure Beta Crude Oil ETN is designed to provide exposure to the Barclays WTI Crude Oil Pure Beta TR Index. The index reflects the returns that are potentially available through an unleveraged investment in the futures contracts in the crude oil markets. OLEM was down 8% on Apr 27 and lost 20% past month.
Bottom Line
Though USO may benefit from the recent structural changes, USL, DBO and OLEM look better bets from the perspective of their original investment objectives, we believe along with some other analysts. The latest restructuring is distorting USO's original objective of tracking the near-term price of oil, per CNBC, though this is helping the fund to stay afloat amid the ongoing oil price carnage.
Want key ETF info delivered straight to your inbox?
Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>