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Pump Up Gains With This Gasoline ETF

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Gasoline prices are experiencing an upward ride in recent months. Futures jumped to the highest level since August, when Hurricane Harvey knocked out a quarter of U.S. fuel refining capacity. According to AAA, the average price at the pump is about $2.83, up 21% year over year, with drivers in nine states paying $3 a gallon for regular gasoline.

The surge was mainly due to oil price, which has been surging on a rebalancing of the oil market buoyed by the historic output cut deal, Iran sanctions and robust demand. The trend is likely to continue given that Trump has decided to restore sanctions on Iran, which will disrupt oil supplies in the major Middle East oil producer Iran, resulting in further tightening of the global glut (read: ETFs & Stocks in Focus as Trump Reimposes Sanction on Iran).

Since crude oil is the primary component of gasoline, a $1 dollar increase in crude oil has led to an increase of nearly 2.5 cents a gallon in the price of gasoline.

Additionally, gasoline demand is expected to rise as America is heading into a peak summer season, pushing up the gas price further. Per Energy Information Administration (EIA), regular gasoline price is expected to reach the highest in four years this summer. “Gasoline prices have a seasonal component and typically increase following the winter into the spring and summer when gasoline demand is higher and gasoline specifications change from winter-grade gasoline to spring- and summer-grade gasoline.”

Investors could easily take advantage of surging gas prices by focusing on United States Gasoline ETF (UGA - Free Report) , which allows investors to make a direct play on the commodity of RBOB gasoline (read: Sector ETFs to Top & Flop on Higher Oil Prices).

UGA in Focus

The fund provides investors with exposure to front-month gasoline futures, tracking RBOB gasoline for delivery to the New York harbor, which is traded on NYMEX. The ETF is illiquid with daily trading volume of about 22,000, suggesting that investors have to pay extra beyond the annual fee of 75 bps per year. The fund has managed assets of $46.7 million so far and surged 12.7% over the past three months.

As traders need to roll from one future contract to another, the fund is susceptible to roll yield. Notably, roll yield is positive when the futures market is in backwardation and negative when the futures market is in contango. Basically, if the price of the near month contract is higher than the next month futures contract, then this is backwardation and the opposite holds true in contango.

State of Backwardation on UGA

UGA is poised to benefit from the prolonged period of backwardation. Currently, the gasoline market is in backwardation, which is favorable for the commodity and the gasoline ETF UGA. This bullishness is expected to continue till the end of this year. Hence, the fund continues to roll over the next month futures contracts at a lower price, thereby making profits (see: all the Energy ETFs here).

Bottom Line

Given that gasoline prices are on the rise and will continue to do so heading into the summer driving season, UGA could be an interesting pick for investors looking to make a concentrated play on the gasoline segment of the energy market.

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