Oil prices have declined recently owing to the ongoing Greek debt crisis and market instability in China. At the time of writing, Brent Crude one-month futures were trading at $58 a barrel, down from $63 on the 1st July; West Texas Intermediate one-month futures were down from $59 a barrel on 30th June to under $52 on Wednesday. Investors who correctly predicted the downturn could have earned a handsome return over the last week: the Boost WTI Oil 3x Short Daily ETP (3OIS), an ETP that returns three times the inverse of the Nasdaq Commodity Crude Oil ER Index, gained 43.7%.
Oil ETPs have seen inflows.
The new lower price, however, appears to be luring in bargain hunters.
ETF securities, a leading provider of commodity-based ETPs, saw net inflows of $49.3m last week into their long oil products as investors took advantage of lower prices to establish bargain positions in the so-called “black gold”. Investors allocated capital to a range of primary oil market ETPs, including the ETFS WTI Crude Oil ETF (CRUD), the ETFS Brent 1month ETF (OILB) and the ETFS Energy ETF (AIGE). All three ETPs offer targeted exposure to energy prices by tracking indices that are based on futures contracts of their underlying commodities, while also providing a collateral yield. The AIGE ETP presents a more diversified investment in energy prices; as of June 30th it had exposure to WTI (25.4%), Brent crude oil (24.1%), natural gas (23.6%), unleaded gasoline (14.3%) and heating oil (12.6%). The TER of each ETP is 0.49%.
Investors should be wary that, despite the recorded net inflows indicating that these commodities are considered by some as attractive, there are significant macro events unfolding that may affect both the supply and demand sides of the industry, serving to keep oil prices depressed over the medium term.
On the demand side the main shocks may come from China and the Eurozone. China has recently experienced a dramatic fall in the value of its equity markets. This may be part of a greater financial crisis developing in China that could reduce China’s rate of economic growth far below analysts’ expectations. The Eurozone is also facing a potentially disruptive future as the ongoing discussions over the Greek debt crisis continue to yield no clear solution. A slowdown in both economies would likely have a dampening effect on oil demand, further decreasing prices.
At the same time, on-going negotiations over a nuclear agreement between Iran and the US, Germany, France, China, Russia and the United Kingdom, could lead to loosening of economic sanctions against the middle-eastern state. If this occurs Iran, the fourth largest holder of oil reserves in the world, would flood the markets in 2016 with potentially a million extra barrels per day, deepening the oversupply of oil and further reducing prices.
The recent fall in oil prices should once again shake up the supply side of the industry as producers attempt to consolidate during this period of historically low prices. Nitesh Shah, Associate Director of Research at ETF Securities, commented, “As we have long argued, the rally in oil prices since March has been premature and has the potential to delay the supply cuts the industry needs…The necessary price decline should see that production is indeed pared back over the coming months.”
Nitesh Shah argues that the continued price decline should begin to alter the current market share distribution and potentially shift the dynamics of the industry as a whole. “We expect high cost conventional oil producers to suffer the greatest loss in market share when prices fall, setting the scene for a nimble US shale oil industry to rebuild in due course.”
Investors could potentially play this theme via the Market Vectors Unconventional Oil and Gas ETF (FRAK) which trades in US dollars on the NYSE Arca and tracks the Market Vectors Global Unconventional Oil & Gas Index. There is an 81.3% exposure to the US and an 18.9% exposure to Canada. As of June 30th, the top five holdings of the fund included Occidental Petroleum (8.4%), Eog Resources (8.3%), Anadarko Petroleum (6.9%), Devon Energy (6.2%) and Apache (4.8%).
FRAK is billed as having exposure to firms who have ‘the potential to transform the global energy landscape’ through improved, lower cost extraction technology which dramatically increases supply capacity and decreases dependence on foreign oil sources. It has a TER of 0.54%.
The Source Morningstar US Energy Infrastructure MLP UCITS ETF (MLPD) offers another route into the energy market without relying solely on the actual price of oil. The main holdings of the ETF are firms that provide infrastructure to the oil industry in the US, such as pipelines and storage facilities, including Energy Transfer Partners (13.9%), Enterprise Products Partners (9.9%), Plains All-American Pipeline (7%), Williams Partners (7%) and Energy Transfer Equity (5.8%). The fund is listed on the London Stock Exchange and trades in US dollars.
These companies usually exhibit relatively stable cash-flows by charging a ‘poll tax’ based on the amount of oil passing through their pipelines or stored at their facilities, making their bottom line more reliant on quantity of oil supplied rather than price, tending to decrease volatility. With the US shale oil industry expected to thrive over the medium term and dramatically increase production, this fund could prove a decent investment. The TER of the fund is 0.5%.