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ETPs see boost as oil price continues to flounder

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Last week saw the 22nd consecutive week of inflows into long ETF Securities’ WTI ETPs, reflecting investor demand for exposure to US crude oil. Some USD 50.7m flowed into long WTI ETPs as the price dropped by 5.8 per cent on the back of a widening US supply glut.

The sharp price declines have attracted bargain hunting investors. Internationally, the spread between WTI and other global oil benchmarks like Brent widened to its highest level in 13 months.

Exchange traded commodities such as oil are structured as debt products, backed by futures, and investors have to contend with the contango or benefit from backwardation if they are to invest in oil through ETPs. 

Nitesh Shah (pictured) and Josh Tiwana, research analysts with ETF Securities, explain that  to maintain a position in oil, the futures contract underlying the ETP will need to be ‘rolled-forward’ when it expires. If the June contract is more expensive than the March contract for example, the investor incurs a loss on the roll. That would happen when the futures curve is upward sloping as in contango. Conversely if the June contract is cheaper than the March contract, the investor profits from the roll, backwardation.

WTI oil price has fallen in eight months from around USD107 a barrel to the USD50-odd range and oil is attracting a new set of investors through ETPs, looking for a value play.  

“In the past few years people who invested in oil were either tactical players looking at commodities on a day to day basis or long term investors with a depth of knowledge of commodity markets” Shah says. “But what we have seen over the last three to four months during this drastic drop in oil prices is that that the investor base has expanded. We are seeing more institutional investors and more pension funds engaging because the price has fallen and a lot of people think there is a lot of value in oil.”

And time might be running out. Shah and Tiwana believe that oil prices at such low levels aren’t sustainable in the medium term. “It’s difficult for oil producers to remain profitable. The traditional  oil producing countries will struggle to balance their government budgets with oil revenues so low so people are expecting to see oil prices go up” Shah says.

Both Brent and WTI futures are in contango at the moment, so investors are likely to incur roll costs unless there is an offsetting increase in the oil price. However, the only practical way to invest in oil is through  futures  or products based on those futures like ETPs, unless you have access to oil storage facilities. “There is no escaping that” Shah says. The market would only likely move into backwardation if prices were expected to remain low for a prolonged period.

However, Shah believes that ETPs offer an efficient way of getting access to the market. The futures market is largely reserved for sophisticated investors with established credit lines with futures exchanges. ETPs can be accessed by most investors via their stock broker just like any ordinary stocks. Oil ETPs trade with high liquidity and are available in a variety of currencies.

Looking forward, people are expecting the June OPEC meeting to produce a turning point in the oil price. Shah and Tiwana expect oil prices to make a partial recovery but that the outlook for oil will remain structurally weak. They believe that it is unlikely that prices will recover above USD100 a barrel in the foreseeable future and expect a USD65-70 level for both WTI and Brent for 2015 year end.

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