Commodity ETFs have seen a tremendous surge in popularity in recent years, as the marriage of futures contracts the exchange-traded structure has democratized an asset class that was once accessible only to large, sophisticated investors. Oil ETFs have become particularly popular, as investors have embraced the opportunity to bet on one of the world’s most sought after resources.
Because oil is a major cost component for both companies and consumers, many investors have embraced the opportunity to hedge against an increase in costs by establishing exposure to the commodity. And because it is subject to wild price swings–crude has touched both $140 and $35 in recent years–speculators have embraced this resource as an opportunity to generate big profits in a relatively short period of time.
Investing in oil through ETFs is not the simple binary process that it once was; there are a number of options offering exposure to a variety of commodities. Each of these resources maintain similar physical properties, and their prices will often be impacted by the same economic forces. But they certainly aren’t identical, as each maintains a unique risk/return profile. Below, we profile the different types of oil accessible through ETFs:
West Texas Intermediate
Also known as Texas light sweet crude oil, West Texas Intermediate (WTI) is a type of crude oil used as a benchmark in oil pricing and serves as the underlying commodity on NYMEX oil futures contracts. WTI is primarily refined in the Midwest and Gulf Coast regions of the U.S., and maintains its price settlement point in Cushing, Oklahoma.
WTI is lighter and sweeter then Brent crude, and generally is $1 more expensive than Brent (and $2 more expensive than the OPEC Reference Basket, a weighted average of oil blends from OPEC countries).
ETFs offering exposure to WTI include:
- United States Oil Fund (NYSEARCA:USO): This ETF has nearly $2 billion in assets, and invests primarily in near-month NYMEX contracts.
- iPath S&P GSCI Crude Oil Total Return Index ETN (NYSEARCA:OIL): This cleverly-named product is structured as an ETN, meaning that it is a senior unsubordinated debt security. The index to which this note is linked reflects the returns that are potentially available through an unleveraged investment in the West Texas Intermediate (WTI) crude oil futures contract plus the Treasury Bill rate of interest.
- PowerShares DB Oil Fund (NYSEARCA:DBO): This fund is linked to a rules-based index comprised of futures contracts on WTI. Unlike USO, this fund tracks an “Optimum Yield” version of an index that seeks to replace expiring futures contracts with new contracts expiring in the month that will generate the highest “implied roll yield” (either minimizing the drag of contango or maximizing the yield from backwardation).
- United States 12 Month Oil (NYSEARCA:USL): This ETF also invests in WTI futures, but spreads exposure across various maturities instead of investing exclusively in front month contracts. That potentially reduces the impact of contango, but also makes the fund less sensitive to changes in the spot price.
Brent crude doesn’t maintain nearly the recognition of WTI, but is a more important global resource than most realize. The Brent crude oil contract trades in U.S. dollars in London, and is the second most liquid commodity futures contract in the world (it comes in behind only WTI and ahead of gold and natural gas). Brent crude oil often serves as a benchmark for pricing of oil produced in Europe, Africa, and the Middle East that is headed west. Brent is priced at the port of Sullom Voe in the Shetland Islands off the North Sea and moved via tanker to its end destination.
Brent crude is accessible through the United States Brent Oil Fund (NYSEARCA:BNO), a relatively new product launched by United States Commodity Funds in June 2009.
Another option for oil exposure is the United States Gasoline Fund (NYSEARCA:UGA), which invests primarily in RBOB gasoline futures traded on the NYMEX. RBOB stands for “Reformulated Blendstock for Oxygenate Blending,” and is the raw ingredient used to make different blends of gas. In 2006, the NYMEX phased out trading in unleaded gasoline futures because the product contained a chemical banned in many states for polluting groundwater. RBOB gasoline doesn’t contain the chemical MTBE, and was phased in in place of unleaded gasoline. Prices of RBOB futures roughly line up with what drivers see at their local gas station.
Heating oil accounts for about 25% of the yield of a barrel of crude, the second largest allocation after gasoline. As the name suggests, this form of oil is used as a fuel for furnaces or boilers in buildings. Heating oil is used most heavily in areas of the U.S. and Canada where natural gas is not readily available, and is the primary source of fuel in certain countries.
Heating oil futures are traded on the ICE and NYMEX exchanges, and contracts have delivery dates in all 12 months of the year; the United States Heating Oil Fund (NYSEARCA:UHN) invests primarily in near month NYMEX contracts.
In addition to the more targeted funds profiled above, there are a number of broad-based energy products that include exposure to a number of different forms of oil:
- PowerShares DB Energy Fund (NYSEARCA:DBE): This product tracks the performance of a rules-based index that consists of futures contracts on WTI, heating oil, Brent crude oil, RBOB gasoline, and natural gas.
- ELEMENTS Rogers International Commodity Energy ETN (NYSEARCA:RJN): This exchange-traded note also offers exposure to a diversified basket of energy commodities, with WTI and Brent oil accounting for almost 80% of the related index.
- iPath Dow Jones-UBS Energy Total Return ETN (NYSEARCA:JJE): The index underlying this ETN is composed of futures contracts on four energy-related commodity contracts: crude oil, heating oil, natural gas, and unleaded gasoline.
- E-TRACS UBS Bloomberg CMCI Energy ETN (NYSEARCA:UBN): In addition to WTI, Brent, heating oil, gasoline, and natural gas, the index underlying this ETN includes exposure to gasoil (about 10% of total exposure).
Disclosure: No positions at time of writing.
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