Tranquility in Crude Repels Chaos-Loving ETP InvestorsMoming Zhou
The U.S. crude market is the steadiest it’s been in at least eight years, driving investors away from exchange-traded products that profit from changes in oil prices.
“Low volatility is a disincentive for investors,” John Hyland, chief investment officer of United States Commodity Futures Funds, an Alameda, California-based ETP manager, said in a phone interview on May 14. Big price swings, with oil more expensive now than in the future, make a perfect scenario for ETP investors, he said.
Only part of Hyland’s dream picture has become a reality. In January, as the southern leg of the Keystone XL pipeline began moving oil to Gulf Coast refineries from the hub in Cushing, Oklahoma, the market for West Texas Intermediate crude, the North American benchmark, slid into backwardation. That’s when shorter-term prices for upcoming delivery are higher than those in the more distant future.
As Hyland points out, investors also need prices that fluctuate, and that hasn’t happened. Implied volatility for WTI crude options expiring in three months, a measure of expected future price movement, fell yesterday to the lowest level since Bloomberg started tracking the data in November 2005. As a result, total shares outstanding in the six largest U.S.-traded oil ETPs have declined 29 percent in the past year.
Such domestic stability is due in part to a rise of 15 percent from a year earlier in U.S. crude production as a combination of horizontal drilling and hydraulic fracturing, or fracking, unlock supplies in shale formations. Growing domestic inventories, now close to 400 million barrels, the highest level in government weekly data going back to 1982, have shielded the U.S. market from political tensions in Ukraine and supply curtailments in Libya.
Front-month WTI futures, or contracts for crude delivery that expire in the near-term, rose 1.7 percent to $104.07 a barrel on the New York Mercantile Exchange, bringing this year’s advance to 5.7 percent. The United States Oil Fund, managed by Hyland’s company and the biggest crude ETP, rose 0.4 percent to $37.52 yesterday for a gain this year of 6.2 percent.
“USO is used by a lot of folks whose holding period is measured in days or, at the longest, weeks,” Michael Johnston, a managing director at Chicago-based ETF Database, which analyzes exchange-traded funds, said by phone May 16. “They are taking their toys and playing elsewhere right now where they expect more volatility.”
Backwardation allows USO to buy more barrels of crude each month as it sells the expiring futures and rolls over to the less expensive second-month contract. The asset value of the fund increases if the price of the second-month futures rises.
WTI was mostly in contango in the past 10 years, a pattern in which prices for later deliveries are higher than nearby contracts.
Total assets of the six biggest oil ETPs declined 24 percent to $1.63 billion on May 19 from $2.14 billion in mid-January.
Shares outstanding of the eight-year-old USO dropped to 13.4 million on Feb. 14, the lowest level since October 2008. The total was 13.8 million yesterday. Assets declined to $517.2 million from more than $1 billion in January.
The total asset value of the PowerShares DB Oil Fund was $310.6 million on May 19, down from this year’s high of $318.6 million on April 21. The value of the iPath S&P GSCI Crude Oil Total Return Index ETN was $251.3 million, from this year’s peak of $269.4 million on Jan. 23.
ProShares Ultra DJ-UBS Crude Oil, which seeks results corresponding to twice the performance of the underlying index, advanced 13 percent this year. Total assets declined to $96.1 million yesterday from as high as $237.8 million on Jan. 16.
ProShares UltraShort DJ-UBS Crude Oil and PowerShares DB Crude Oil Double Short ETN, the two so-called inverse funds that seek a drop in crude prices, also had declines in the value of their assets.
Trading volumes in Nymex WTI futures also slid, with a daily average of 527,000 contracts this month, the lowest level since February.
U.S. crude production climbed to 8.43 million barrels a day in the week ended May 9, the highest since 1986, according to the government’s Energy Information Administration. Stockpiles reached as high as 399.4 million on April 25.
“We have a glut of oil sitting here,” Stephen Schork, president of the Schork Group Inc. in Villanova, Pennsylvania, said by phone on May 16. “Ukraine hasn’t impacted WTI much. Why would anyone worry about WTI when you have record high inventories here?”