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Oil, as a commodity known for its cyclical nature and its significant impact on the global economy, always garners the attention of investors. Thanks to tightening supply conditions and the prospect of higher demand, oil price has been surging in recent months with the expectation of reaching the triple-digit mark once again.
The global oil market is expected to face the biggest deficit in over a decade. According to the latest data published by Organization of Petroleum Exporting Countries (OPEC), the industry will likely face a supply shortfall of more than 3 million barrels a day next quarter. The shortage comes as the two major oil-producing nations, Saudi Arabia and Russia, extended their voluntary cuts to the end of the year.
Saudi Arabia has extended its voluntary oil output cut of 1 million barrels per day (bpd) until the end of December 2023 while Russia extended its oil export cuts by 300,000 bpd. Meanwhile, world oil inventories are also set for an even steeper drop of roughly 3.3 million barrels a day in the next three months, per OPEC. Further, escalating geopolitical tensions in the Middle East, especially the Israel-Hamas conflict, has raised worries that the fighting could affect regional oil production. Notably, the Middle East is home to almost a third of global supply (read: Oil Jumps on Middle East Conflict, Leveraged ETFs to Profit).
Coming to the demand side, “world oil demand is scaling record highs” said the International Energy Agency in a recent note. Global oil demand is set to expand by 2.2 million bpd to 101.8 million bpd in 2023, with China accounting for more than 70% growth. Resurgent Chinese consumption, jet fuel and petrochemical feedstocks will drive demand higher.
Given demand/supply imbalances, many analysts expect oil prices to soon rise above $100 per barrel for the first time in more than a year.
Fortunately, with the advent of ETFs, investors could easily venture into the energy sector without the need to engage in futures trading or take physical delivery of oil. We have highlighted the oil ETFs that could be interesting plays to directly deal with in the futures market.
United States Oil Fund is the most popular ETF in the oil space, with an AUM of $1.5 billion and an average daily volume of 3.5 million shares. It seeks an average daily percentage change in USO’s net asset value, for any period of 30 successive valuation days, within plus/minus 10% of the average daily percentage change in the price of the Benchmark Oil Futures Contract over the same period. United States Oil Fund has an expense ratio of 0.60%.
Invesco DB Oil Fund provides exposure to crude oil through WTI futures contracts and follows the DBIQ Optimum Yield Crude Oil Index Excess Return. The Index is a rules-based index composed of futures contracts on WTI. Invesco DB Oil Fund has an AUM of $268 million and charges 77 bps of annual fees. DBO trades in an average daily volume of 938,000 shares (read: Top ETF Stories of the Nine Months of 2023).
United States Brent Oil Fund is designed to track the daily price movements of Brent crude oil. It provides exposure to the near month futures contract traded on the ICE Futures Exchange. If the near-month futures contract is within two weeks of expiration, the benchmark will be the next month contract to expire. BNO invests primarily in listed crude oil futures contracts and other oil-related futures contracts, and may invest in forwards and swap contracts. United States Brent Oil Fund amassed $145 million in its asset base and charges 1.00% as annual fees and expenses. Volume is good as it exchanges 540,000 shares a day on average.
ProShares K-1 Free Crude Oil Strategy ETF tracks the Bloomberg Commodity Balanced WTI Crude Oil Index, which is tied to the crude oil futures contracts. The index is not intended to track the performance of the spot price of WTI crude oil. ProShares K-1 Free Crude Oil Strategy ETF has amassed $128.3 million in its asset base and charges 71 bps in annual fees. It trades in volume of 44,000 shares a day on average.
United States 12 Month Oil Fund provides investors with exposure to the daily price movements of West Texas Intermediate’s light, sweet crude oil. 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 the following 11 months.
United States 12 Month Oil Fund is unpopular and less liquid with an AUM of $73.1 million and an expense ratio of 0.85%. USL trades in an average daily volume of 15,000 shares.
Contango: Enemy of Oil Futures Market
While the above products provide the easiest way of gaining direct exposure to the oil commodity, these have serious consequences on the profit (or loss) incurred by the investors. This is especially true as these ETFs and ETNs need to roll from one futures contract to another in order to avoid physical delivery and are thus susceptible to roll yield.
Roll yield is positive when the futures market is in backwardation (the front-month contract is higher than the next-month contract) and negative when the futures market is in contango (the front-month contract is lower than the next-month contract). Investors should note that the state of contango could eat away returns over the longer time periods (read: Is Oil Set to Dive in 2024? ETF Areas to Gain).
However, the oil futures market is currently in a state of backwardation, which is bullish for the commodity and the oil ETFs. This signals that the oil market is tightening and demand is robust, paving the way for an oil rally. The trend is likely to continue, at least in the near term, acting as the biggest catalyst for the commodity.
If the front-month contracts were expensive than the next month, investors would enjoy profits on every roll, thereby maximizing their total returns. A market in backwardation also signifies that demand exceeds supply boosting oil prices higher. As a result, contango does not look like an obstacle for investors over the next few months.
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A Complete Guide to Oil Commodity ETFs
Oil, as a commodity known for its cyclical nature and its significant impact on the global economy, always garners the attention of investors. Thanks to tightening supply conditions and the prospect of higher demand, oil price has been surging in recent months with the expectation of reaching the triple-digit mark once again.
The global oil market is expected to face the biggest deficit in over a decade. According to the latest data published by Organization of Petroleum Exporting Countries (OPEC), the industry will likely face a supply shortfall of more than 3 million barrels a day next quarter. The shortage comes as the two major oil-producing nations, Saudi Arabia and Russia, extended their voluntary cuts to the end of the year.
Saudi Arabia has extended its voluntary oil output cut of 1 million barrels per day (bpd) until the end of December 2023 while Russia extended its oil export cuts by 300,000 bpd. Meanwhile, world oil inventories are also set for an even steeper drop of roughly 3.3 million barrels a day in the next three months, per OPEC. Further, escalating geopolitical tensions in the Middle East, especially the Israel-Hamas conflict, has raised worries that the fighting could affect regional oil production. Notably, the Middle East is home to almost a third of global supply (read: Oil Jumps on Middle East Conflict, Leveraged ETFs to Profit).
Coming to the demand side, “world oil demand is scaling record highs” said the International Energy Agency in a recent note. Global oil demand is set to expand by 2.2 million bpd to 101.8 million bpd in 2023, with China accounting for more than 70% growth. Resurgent Chinese consumption, jet fuel and petrochemical feedstocks will drive demand higher.
Given demand/supply imbalances, many analysts expect oil prices to soon rise above $100 per barrel for the first time in more than a year.
Fortunately, with the advent of ETFs, investors could easily venture into the energy sector without the need to engage in futures trading or take physical delivery of oil. We have highlighted the oil ETFs that could be interesting plays to directly deal with in the futures market.
United States Oil Fund (USO - Free Report)
United States Oil Fund is the most popular ETF in the oil space, with an AUM of $1.5 billion and an average daily volume of 3.5 million shares. It seeks an average daily percentage change in USO’s net asset value, for any period of 30 successive valuation days, within plus/minus 10% of the average daily percentage change in the price of the Benchmark Oil Futures Contract over the same period. United States Oil Fund has an expense ratio of 0.60%.
Invesco DB Oil Fund (DBO - Free Report)
Invesco DB Oil Fund provides exposure to crude oil through WTI futures contracts and follows the DBIQ Optimum Yield Crude Oil Index Excess Return. The Index is a rules-based index composed of futures contracts on WTI. Invesco DB Oil Fund has an AUM of $268 million and charges 77 bps of annual fees. DBO trades in an average daily volume of 938,000 shares (read: Top ETF Stories of the Nine Months of 2023).
United States Brent Oil Fund (BNO - Free Report)
United States Brent Oil Fund is designed to track the daily price movements of Brent crude oil. It provides exposure to the near month futures contract traded on the ICE Futures Exchange. If the near-month futures contract is within two weeks of expiration, the benchmark will be the next month contract to expire. BNO invests primarily in listed crude oil futures contracts and other oil-related futures contracts, and may invest in forwards and swap contracts. United States Brent Oil Fund amassed $145 million in its asset base and charges 1.00% as annual fees and expenses. Volume is good as it exchanges 540,000 shares a day on average.
ProShares K-1 Free Crude Oil Strategy ETF (OILK - Free Report)
ProShares K-1 Free Crude Oil Strategy ETF tracks the Bloomberg Commodity Balanced WTI Crude Oil Index, which is tied to the crude oil futures contracts. The index is not intended to track the performance of the spot price of WTI crude oil. ProShares K-1 Free Crude Oil Strategy ETF has amassed $128.3 million in its asset base and charges 71 bps in annual fees. It trades in volume of 44,000 shares a day on average.
United States 12 Month Oil Fund (USL - Free Report)
United States 12 Month Oil Fund provides investors with exposure to the daily price movements of West Texas Intermediate’s light, sweet crude oil. 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 the following 11 months.
United States 12 Month Oil Fund is unpopular and less liquid with an AUM of $73.1 million and an expense ratio of 0.85%. USL trades in an average daily volume of 15,000 shares.
Contango: Enemy of Oil Futures Market
While the above products provide the easiest way of gaining direct exposure to the oil commodity, these have serious consequences on the profit (or loss) incurred by the investors. This is especially true as these ETFs and ETNs need to roll from one futures contract to another in order to avoid physical delivery and are thus susceptible to roll yield.
Roll yield is positive when the futures market is in backwardation (the front-month contract is higher than the next-month contract) and negative when the futures market is in contango (the front-month contract is lower than the next-month contract). Investors should note that the state of contango could eat away returns over the longer time periods (read: Is Oil Set to Dive in 2024? ETF Areas to Gain).
However, the oil futures market is currently in a state of backwardation, which is bullish for the commodity and the oil ETFs. This signals that the oil market is tightening and demand is robust, paving the way for an oil rally. The trend is likely to continue, at least in the near term, acting as the biggest catalyst for the commodity.
If the front-month contracts were expensive than the next month, investors would enjoy profits on every roll, thereby maximizing their total returns. A market in backwardation also signifies that demand exceeds supply boosting oil prices higher. As a result, contango does not look like an obstacle for investors over the next few months.