One Group of Oil Investors Didn’t Cash In on the 2016 Rally

Updated on
  • U.S. Oil Fund ETF gained 6.6% this year vs 45% for WTI prices
  • Forward price curve in ‘contango’ structure erodes profits

Will 2017 Usher in the Return of OPEC?

The world’s most popular oil-tracking exchange traded fund missed out on 2016’s big crude rally.

Front-month West Texas Intermediate crude futures have gained 45 percent so far this year as OPEC engineered the first global output cut in 15 years. The U.S. Oil Fund LP, an ETF designed to track oil prices that has seen investors pour in nearly $3 billion in the past two years, only grew 6.6 percent over the same period.

The culprit? A pricing structure known as contango, when current futures are priced lower than the next month. Because the fund, known as USO, holds front-month WTI contracts, it loses money in a contango market every time it sells the futures as they near expiry and buys the next month. Returns generated off front-month WTI prices aren’t accurate because they don’t take into account the contract roll, U.S. Commodity Funds LLC President John Love said in an e-mail. USCF is the manger of the U.S. Oil Fund.

“USO’s been hit with the contango ugly stick,” said Matt Hougan, chief executive officer of Inside ETFs in San Francisco. “Despite the solid price appreciation in spot crude, investors have not been rewarded much because the roll has been costly.”

WTI price curve 1 year ago in orange; one month ago in blue; last week in green.

ETFs that track oil prices give people the opportunity to bet on price moves without requiring the large amount of capital needed to invest directly in commodities. They also give hedge funds that normally trade equities a chance to wager on raw materials without setting up new back office systems.

“Even an investor in physical WTI would encounter costs for storage, insurance, etc. that would effect that investor in a similar way,” said Love. Contango “has weighed on returns to oil investors, so even though the nominal price of a futures contract has gone up, the cost of holding an oil position has been high.”

The Standard and Poor’s 500 Energy Index, which tracks companies including explorer Exxon Mobil Corp. and oil services company Schlumberger Ltd., has gained 26 percent this year.

The ETF funds have grown in popularity as oil prices fell and investors looked for ways to bet on a rebound. Assets invested in the U.S. Oil Fund grew from as little as $437 million in May 2014 to almost $4.3 billion in March. Assets totaled $3.2 billion as of Dec. 22, according to its website.

Some relief might be on the way. The futures curves should flatten in 2017 as supply becomes tighter, improving the so-called roll yields, Citigroup researchers including Ed Morse said in a Dec. 5 note. The difference between WTI futures delivered in one month versus 12 months has fallen to $2.95 a barrel from $5.32 in early November.

That may not be much of a concern to ETF buyers, said John Hyland, former chief investment officer of USCF. Investors typically care more about buying low and selling high than about the rolls, despite the impact they have on long-term returns, he said.

“In 11 years we have observed that what flows react to most is the current price level,” said Hyland, who is now building another ETF issuer. “The users of USO seem to be too short-term focused on their trading to worry about where oil will be in 3 months, and only focused on where it will be in 3 days.”

(Updates oil price spread in ninth paragraph.)
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