Until recently, oil exchange-traded products (ETPs) were viewed by investors and the ecosystem as relatively steady vehicles however two months of unprecedented market volatility has changed this outlook entirely.
On 21 April, the concept of negative oil prices became a reality when West Texas Intermediate (WTI) plummeted to as low as $-37 a barrel as traders looked to offload the expiring May futures contracts in a market where storage was quickly vanishing.
Although oil ETPs had already rolled their futures contracts to June, it quickly sunk in that there was a very real possibility prices could once again trade below zero before the next scheduled roll dates, effectively wiping out investor returns, who continued to pile into these products.
ETF issuers and index providers reacted quickly by changing their investment strategies so oil ETPs were not fully exposed to the currently riskier front-month contracts in a move to protect bullish investors from seeing their investments crash to zero.
Europe’s largest oil ETP, for example, the $2.6bn WisdomTree WTI Crude Oil ETC (CRUD), saw its strategy adjusted after Bloomberg announced plans on 24 April to advance the roll of the WTI July contract to September across its Bloomberg Commodity Index (BCOM) suite, the index CRUD tracks.
The sweeping changes to investment strategies on oil ETPs at first appeared to be the big news however they turned out to be just the tip of the iceberg.
With regulators becoming increasingly concerned about the behaviour of these products, the Securities and Exchange Commission (SEC) is yet to allow the world’s largest oil ETP, the $4.5bn United States Oil Fund (USO), to create an additional four million shares to meet the ongoing demand, therefore effectively blocking it from seeing new flows.
Similar action was also taken by WisdomTree after it announced a temporary halt to creations on CRUD on 30 April due to “unprecedented levels of volatility” in WTI crude oil contracts.
It is not just regulators, however, that are worried about the way oil ETPs have traded during the historic volatility. Brokers have started putting their foot down by refusing to facilitate purchases of the futures contracts.
The $497m Samsung S&P GSCI Crude Oil ER Futures ETP (3175) was forced to halt creations last month after its broker withdrew from the market while last Thursday RBC Capital Markets took similar action on USO, according to an SEC filing, throwing into question the product’s future.
WisdomTree felt the brunt of broker action this side of the pond as it was forced to close eight oil ETCs and one carbon ETC with $550m AUM last week after its swap provider, Shell Trading Switzerland, terminated the purchase agreements.
The moves made by brokers highlight just how concerned they are about how oil ETPs have traded during the coronavirus turmoil.
Now, the question is where do ETF issuers and index providers go from here? According to Athanasios Psarofagis, ETF analyst at Bloomberg, the days of front-month oil exposure are “done”.
For the more plain vanilla oil ETPs, this means a complete re-appraisal of how to offer investors exposure to oil prices.
Psarofagis suggested issuers will spread out more evenly across the futures curve however added this would lead to the ETPs moving further away from the spot price meaning investors need to be aware the performance will look different.
How different issuers approach this remains to be seen but it is crucial they employ a robust rules-based approach which minimises the need for active decisions like the ones we have seen over the past two months.
Meanwhile, some index providers have been consulting with the market as to whether changes are needed to their indices following the short-term action taken to roll away from front-month contracts.
A spokesperson from S&P Dow Jones Indices told ETF Stream in a statement: “SPDJI issued a consultation to market participants on proposals related to negatively priced commodities futures contracts more generally.
“Should the respective index committees decide that any methodology changes to the SPDJI commodity indices be adopted as a result of this consultation, such decision and the timing of implementation will be announced to the public.”
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