Oil ETF's Are Broken

Old Oil Drum

While oil’s spot price is up 54% year to date, oil-tracking ETF’s such as U.S. Oil Fund (USO) or U.S. 12 Month Oil Fund (USL) are up only 8% and 22% respectively.

Investors in both of these ETF’s called the direction of oil prices correctly, but earned far less than they could have.

One reason for this underperformance that is particular to USO is that the fund simulates oil exposure by simply buying near-term futures contracts. Unfortunately, oil prices have been in contango this year, whereby longer term oil contracts are at higher prices than near-term ones. Thus USO’s performance might have been dragged down by the fund continually rolling forward into more expensive contracts. Sounds like a pretty bad strategy.

Yet even USL, which invests across a 12-month futures curve and thus might avoid USO’s problem, still underperformed. Thus there is more to these ETF’s failure than simply the current state of the futures curve.

Their derivatives-based strategies have simply been bad proxies for spot oil prices, or at least no better than our old-fashioned oil plays – energy stocks.

WSJ: Rather than fret about the small print on ETFs’ futures strategies, crude-hungry investors might consider betting on explorers such as Anadarko Petroleum. Despite operational risks, the company has broadly matched oil-price rises this year and, unlike ETFs, even pays a dividend.


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