While the idea makes sense, the execution of that idea did not. Oil ETFs tend to invest at the front and right now the cheapest part of the oil curve. The ETF provider holds a long position in that future and as long as the market remains oversupplied, they will incur a loss every month when they sell the expiring contract to buy the next at a higher price. This phenomenon is called ‘contango’ and it creates a major headwind for investors. At the time of writing the spread between the June contract and September (3 months out) is 60%, that’s how much oil needs to rally in just three months in order for the ETF to break even.
The United States Oil fund (USO:arcx) suddenly became a giant bull in a china store as the fund held a disproportionately high percentage of the whole market. As the market tanked the risk of default rose. That’s why the June futures contract, which doesn’t expire until May 19, suddenly slumped below $10/b on Tuesday while Brent crude oil was pulled down with it and reached a low of $16/b.
Since then, however, the market has managed to recover some ground. Of the four reasons, only one could have a longer-term positive impact on the price. They were:
- The CME Exchange, which operates the WTI futures contract, hiked margin on holding a contract (1000 barrels) to $10,000.
- Several banks and brokers introduced trading restrictions on the June contract meaning that existing positions could be closed but no new positions could be opened.
- The USO ETF faced with a potential risk of collapsing reduced their exposure to June from 80% to just 20% after rolling futures contracts to July, August and even September.
- President Trump threatening to destroy Iranian gunboats should they continue to harass US navy ships in the Persian Gulf.
While the latter carries the risk to the potential safe passage of supply through the Strait of Hormuz, the others are mostly of a technical character. On that basis we’ll continue to see limited upside for crude oil until lockdowns are eased leading to a pickup in global demand or unfortunately, more likely that many high-cost producers are forced to cut production, either voluntary or involuntary.