Brad Zigler

The Boons and Banes of Oil ETNs

In a word, no. Every investment, including holding physicals, is a unique mix of advanatages and disadvantages. You select an investment modality in large part, on the basis of which set seems the least odious.

If you're concerned about an issuer going under and reneging on its debt obligations, then ETNs are definitely O-U-T for you. Scratch the DB notes in favor of exchange-traded funds that hold futures instead.

If the effects of contango are noisesome, then your logical alternative is the United States 12-Month Oil Fund (NYSE Arca: USL). USL rolls expiring futures into the optimal delivery over the ensuing 12 months in an effort to minimize negative roll yields and maximize positive yields.

The Boons and Banes of Oil ETNs

No rate risk per se. Bills are short-term cash equivalents, so the rate resets to market fairly often.

Keep in mind that there were historic contangos recently which really whacked long-only oil fund returns.

On Mar 05 04:40 PM jgsgilbert wrote:

> Thanks for your quick reply Brad.
>
> If the price of DXO is also based on TBills does that mean that it
> also has interest rate risk (sorry if wrong term)? With interest
> rates being so low would that risk be quite high longer term, i.e.
> interest rates increase therefore TBill value goes down and therefore
> negatively impacting DXO? Is there a correlation between DBLCI and
> interest rates?
>
> DXO seemed to trade near the 30 mark for a while when oil was at
> $147 in July 2008. Now oil is hovering in the $40's and yet DXO is
> around $2, i.e. approx a 3.5 times drop in oil but approx a 15 times
> drop in DXO. (The graphs I've found of ^DBOLIX only go back as far
> as Oct 08). I wonder if this is due to the bias downwards for similar
> percentage gains versus losses that i noted in my example on my last
> post?
>
> Thanks for the tip re the market makers spread. I shall watch for
> those.
>
> cheers
>
> James
>
>

The Boons and Banes of Oil ETNs

DXO and its stablemates are based upon the oil subindex of the Deutsche Bank Liquid Commodity Index. In addition to the oil return, the ETFs reflect the return earned from the T-Bills used to collateralize the index futures.

DXO, in particular, is based upon the Optimal Yield varient of DBLCI which shops for the best roll target at contract expiration. DXO's mandate is to provide twice the MONTHLY, not daily, performance of the oil index (plus a single slug of T-Bill return). That probably accounts for the pricing disparity you've noted.

As for counterparty risk, the first thing that usually happens when an issuer's troubled is a widening in market maker's spreads.


On Mar 05 01:45 PM jgsgilbert wrote:

> Brad
>
> Thanks for the article. Can you please aid my understanding on how
> DXO is priced?
>
> Is it priced based on supply/demand of the DXO notes themselves (i
> didn't think so) or from movements in the Deutsche Bank Liquid Commodity
> Index (seekingalpha.com/symbo...)?
>
> If it's the later how come the price of DXO can move one way and
> yet on the same day the DBLCI move the other? Is that somehow related
> to the monthly TBill index return.
>
> Also, since these are notes and do not represent a claim on hard
> commodities (versus say ETF such as USO), how is counterparty risk
> priced into the price of these notes? In the wake of financials being
> nationalised/bailed out i wouldn't discount the possibility of any
> of these finanicals going under.
>
> If the DBLCI goes up 50% then does OLO go up 50%? In which case if
> DBLCI goes down 50% does OLO go down 50%? Then you could have OLO
> go from say 100 to 150 to 75. A net of down 25, i.e. it will drift
> down over time.
>
> Sorry if the above isn't very clear but I hope you get the drift
> of my questions.
>
> Thanks again for your help and your articles.
>
> James

The Boons and Banes of Oil ETNs

If the oil market's inverted (i.e., exhibiting backwardation), it's an indication of supply shortage. Hence, long positions would be favored.

When the market slips into contango, that's a hint of adequate or, in fact, over supply. After all, for a carrying charge market to exist, there must be supply to carry. Contango markets, all else held constant, favors short positions since futures should converge to the cash price at expiry.

The way you play the short/long game (i.e., buying one fund verse shorting its opposite) depends upon your ability or inclination to use margin and your expectations about the shape of the futures term structure.

It wasn't just a contango that propelled the DTO double-short note to such outsized gains; it was a WIDENING contango. The carry market was a headwind for a short position in the double-long DXO note.

The situation should, indeed, be reversed when the market returns to backwardation. A deepening inversion should boost returns for the double-long note.

Knowing where you are--or THINK you are--in the cycle helps you determine the ideal approach.






On Feb 21 05:44 AM GOEBOC wrote:

> Then, what is the conclusion in a backwardation situation, is it
> that you must buy the double long etn instead of shorting the double
> short? That is it?

The Boons and Banes of Oil ETNs

Breakeven for whom? The OPEC producer? They're all over the board with breakeven prices, based upon their balance sheets.

For oil refiners, this quarter's downstream pricing has been providing a nice, fat margin (if they're not locked into hedge contracts). They're MORE than breaking even.


On Feb 17 03:02 AM PeteK wrote:

> Most oil company CEO agree that oil has to be around $50 to break
> even.
> With labor and other costs going up, that's a reasonable figure.
>
> "Dark Night" is right, agree 100%. DXO is a good pick.
>

The Boons and Banes of Oil ETNs

If you read the article, you'll note that I DON'T think oil prices are stuck, to wit: "... eventually, oil prices will rise." The wild card for a DXO investor is the shape of the futures delivery curve. A virulent contango can negate price gains.

On Feb 16 07:16 PM Dark Night wrote:

> Yes, oil prices has fallen dramatically but if u think that these
> oil prices will stay low for the long term then that will be a fanasty.
> Oil companies & OPEC has cut back capacity and exploriation and
> sooner or later the oil oversupply will correct. Henry Groppe , a
> noted oil analyst predicted that oil will fall below the $40 mark
> by 2009 because of oil speculation and now he and his investment
> group is predictating that oil will swing back to the $60-80 level
> by the end of next year. His track record has been very good. <br/>
>
> So I decided to buy some shares of DXO at $2.40 and wait it out ..when
> oil start to raise then I should make some nice profits on DXO. I
> think DXO can easily hit $10-$15 level by next year (if oil hits
> $60-$80 level) and then I will probably sell ..I just need to be
> patient. All I can lose is my original investment in DXO. Perhaps
> I will be right or perhaps I will be wrong only time will answer
> that question.

Which Is Headed Higher: Gold or Oil?

Much of the WTI-Brent arbitrage is related to the time value of money. WTI is a true spot market where oil is immediately deliverable; Dated Brent is actually a short-term forward contract in which oil is subject to a load-in schedule.Because of this, the current US glut and widening contango market exacerbates the Brent time differential.

There's also shipping rates to be taken into account. Delivery of WTI is by pipeline. Brent's FOB shipboard,

Oil ETN Liquidity - Long and Short

Read my comment on OIL and DUG above. USO wasn't included because it's not an ETN either. It's technically a commodity pool that holds actual futures.

The ETNs are (or should be anyway) devoid of tracking error because they're not actual portfolios of phayical assets. Getting rid of tracking error means you take on credit risk, however, as the ETNs represent debt obligations of the issuer.


On Dec 19 12:14 PM Jack Walker wrote:

> Brad,
>
> Thanks of this informative and well-prepared article. The addition
> of OIL and DUG along with perhaps USO would be welcome additions.
>
>
> Jack

Oil ETN Liquidity - Long and Short

No ulterior motives here. OIL was, in fact, included. It's the ETN that tops the table.

DUG wasn't included for two reasons: 1) It's not an ETN. It's, instead, an ETF. 2) It tracks an oil and gas EQUITY index, not spot oil or oil futures. We'd be comparing apples to kumquats if DUG was included.




On Dec 19 09:09 AM Hmm?! wrote:

> Why did you leave out OIL and DUG which have 8-10 times the volume
> of your examples?
>
> It makes me question your motives for this article.