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Oil ETFs

Oil ETFs: Texas Tea or Empty Well?
by: Lee Munson May 14, 2009 | about stocks: BP / DBO / IEO / OIL / USO    
On the front page of the Financial Times yesterday (sorry, I gave up reading the Wall Street Journal when it went mass market) the headline was “Oil at $60 for first time in six months.”

How wonderful! I was long oil using commodity ETFs/ETNs since December when the price was in the 30s. Thus I expected the price to be up 50-80%. This is where I hit the empty well.

Let’s start off with some price performance data, then explain how contango markets erode the price, and end with how we need to reexamine the usefulness of these tools.

Starting with the bottom of the market on February 19th, OIL, USO, and DBO closed at 15.55, 24.28, and 15.83. So, an 85% increase should get us around 28.75, 44.90, and 29.25. I know, for more sophisticated readers you will remind me about looking at the price in the paper. When you see the price in the WSJ or FT, they are usually quoting contracts for West Texas Intermediate (NYSE:WTI) 30 days out.

But each of these three ETFs has its own special sauce to tempt investors on the ‘best’ way to invest in WTI. OIL is continually rolling over a portion of the portfolio to the nearest contract to supposedly stay close to the spot price of oil. USO claims to be buying contracts 30 days out so they should closely mirror the price for oil quoted in the paper! DBO has its own rule-based system described as “Optimum Yield Oil Excess Return.” Wow, sounds good to me! DBO further describes the strategy as “a rules-based index composed of futures contracts on Light Sweet Crude Oil (WTI) and is intended to reflect the performance of crude oil.”

I could give you the sales pitch that OIL and USO tell investors, but it is at about the same level of “very sophisticated and you wouldn’t really understand.” I even had a wholesaler from one of the funds (they should be glad I don’t mention which one) who in replying to my questions about how the mechanics work told me nobody ever asks those questions and I would have to talk directly to the portfolio manager. However, they did say the manager was very smart.

Let’s cut to the chase. Just get your charts out and compare the three ETFs since the February bottom. I can’t make this stuff up (to my dismay since I own OIL – and looking to sell as I type), and the percent gains are 38%, 34.4%, and 40.8%. This is a far cry from the 85% in the futures market. This makes me sick. While I am happy I picked the one that is up 38% (like it matters between the three?), I didn’t get anywhere near what OIL describes as an “index [that] is derived from the West Texas Intermediate (WTI) crude oil futures contracts traded on the New York Mercantile Exchange.”

Each fund tries to blame the other one for erosion of price due to contango markets; however, how good is this excuse if the performance on a huge 85% move leaves each fund with about the same return?

I am here to say today that these three devices do not work as described. Period. This is an incredible disappointment even though the ETFs have gone up over 30% in the last few months. Where is my 85%? In the past, I have suggested to readers to stick with one strategy so as not to get caught in the contango problem but now it seems like it doesn’t matter.

Going forward, I would rather take my chances on individual stocks that pay a dividend and are in the gas and oil industries. If BP is quoted in the paper at $47, I know the account will reflect this. So long guys, your well has gone dry.

Disclosure: Just sold my OIL position, long IEO and BP.