ETF investors get caught on wrong side of oil market collapse
Investors who piled into exchange-traded products in an attempt to capture the rebound in prices were in for a nasty shock this week as vanishing demand sent oil prices to historic lows.
The United States Oil Fund (USO), the world’s largest oil ETF, saw $1.6bn inflows last week, the most on record, as investors called a bottom to falling oil prices, according to data from Bloomberg. USO has seen $4.9bn inflows this year alone.
However, a rebound in prices was not to be as the historic turmoil sent USO plummeting 12% to its lowest level since launch in 2006 on Monday while the WisdomTree WTI Crude Oil ETC (CRUD) was down 10.7%.
Where ETF investors benefitted is the vast majority of products rolled their futures contracts before the carnage took place. For example, the Bloomberg Commodity Oil index, which CRUD tracks, rolled over from the May contract to the July one between 8 April and 15 April and therefore did not experience the same drop.
The declining performance came as oil prices fell to below zero for the first time in history. With futures contracts for West Texas Intermediate due to expire on Tuesday, prices fell to as low as -$40 a barrel as companies looked to offload the futures contracts, which need to be physically settled.
Chris Bennett, director, index investment strategy at S&P Dow Jones Indices, said the lack of oil storage was the key driver in the collapse in prices.
Bennett added: “Those who waited until the very last day of trading in the May contract were faced with the prospect of taking ‘delivery’ at a point in time where storage was near-full.
“It is too early to say who was caught in the struggle to exit, and who profited, but part of the explanation is a perfect storm of collapsing demand for a commodity whose production cannot just be shut down without incurring major expense.”
Oil prices are down around 80% since February as a lack of demand amid the coronavirus turmoil combined with an oil war between Saudi Arabia and Russia.
Saudi Arabia and Russia’s agreement on 13 April with other states to cut production by 10 million barrels per day has done little to curb the collapse in prices.
Florence Pisani, global head of economic research at Candriam, commented: “Some producers have been able to hedge the sale of some of their production in the futures markets, but the current very low oil prices will lead to asset write-downs and bankruptcies.
“The current developments validate the Saudi strategy: the price collapse will eliminate many US producers from the market, forcing the US to contribute to the downward adjustment of world production.”
Last Friday, USO, which is down 76% year-to-date, moved 20% of its contracts to the second-traded month, according to a filing with the Securities and Exchanges Commission, citing the market and regulatory environment.
Oversupply combined with lack of demand has caused a divergence between crude futures and those for the following month. This divergence – known as contango – was a key driver for the change in investment approach.
“As a result of these changes [in the market], USO May not be able to meet its investment objective,” the filing said.
According to Bloomberg, the world’s largest oil ETF makes up 25% of all outstanding contracts in the West Texas Intermediate crude futures highlighting its importance to the market.