Explainer: Oil ETPs – the perils of trading crude like a stock

NEW YORK (Reuters) – A historic plunge in oil prices in the wake of the COVID-19 pandemic has highlighted the risks of oil-focused exchange-traded products (ETPs).

Market participants, especially individual investors, have piled into oil ETPs in recent weeks to bet that U.S. crude prices CLc1 will rebound from its nearly 60% tumble since March 6.

But many of these products – including the United States Oil Fund LP (USO.P), the largest U.S. oil ETP – have the potential for steep losses as oil markets are roiled.

Oil ETPs hold crude futures but can be bought and sold like stocks. The products are a popular way for individual investors to bet on moves in crude prices, as trading commodity futures can be difficult for retail market participants.

Unlike stocks, oil futures contracts expire every month, so the funds must roll their holdings into the following month’s contract to avoid physical delivery of the oil.

With oil markets currently in contango, a condition in which later-dated futures trade at higher prices than nearer-dated ones, the ETPs are forced to buy next month’s contracts at a steep premium, exposing their shareholders to additional losses on top of falling oil prices.

USO has seen heavy inflows since early March from investors seeking to position for a possible rebound in oil, tripling its assets under management year-to-date to $3.61 billion even as its price has fallen by around 80%.

The fund avoided potentially catastrophic losses when May oil futures traded below $0 per barrel for the first time ever on Monday because it had already rolled its holdings into later-dated contracts. Still, it has fallen nearly 40% in the past week to $2.59.

USO has tried to further mitigate potential losses by spreading its holdings throughout contracts expiring in July, August, and September, in addition to front-month contracts expiring in June.

While the portfolio changes have eased some worries over the fund’s exposure to the front-month contract CLc1, which is most heavily traded, they also limit USO’s upside should those futures rally significantly, as they did on Thursday.

Still, some market watchers worry that persistent scarcity of oil storage could send June or later-dated futures to or below zero.

U.S. oil ETPs manage roughly $5 billion in assets, according to Sumit Roy, analyst at ETF.com.

Among other such products, the ProShares Ultra Bloomberg Crude Oil (UCO.P) fund had $780.2 million, while the Invesco DB Oil Fund (DBO.P) had $356.9 million.

USO was estimated to have controlled roughly 25% to 30% of June U.S. crude futures CLM0 before recent changes to its portfolio. According to Roy at ETF.com, the ETP now holds about 11% of those contracts.

While some analysts believe the fund’s monthly roll of its futures contracts does not have much effect on the oil markets, some traders have attempted to time their buying and selling to coincide with the fund’s monthly moves.

Certain ETPs, such as UCO, are levered, meaning that they use derivatives to amplify the moves in the futures they track, typically by a factor of two or three. A sharp one-day decline in futures prices could force these products to liquidate, since they cannot trade below zero.

Several levered ETPs, such as the VelocityShares 3x Long Crude Oil ETNs, which traded under the ticker UWT, have already shuttered since mid-March.

The oil plunge has claimed at least one unlevered ETP as well. Barclays PLC (BARC.L) announced on Monday that it would liquidate its iPath Series B S&P GSCI Crude Oil Total Return Index ETNs (OIL.P) on April 30.