Oil ETF investors, not just OPEC, hold sway over crude market
Tumult in Libya, U.S. rig counts, production plans of the oil exporting cartel and a pact on nuclear relations with Iran can all affect crude supply and demand, but oil traders have kept an equally close watch on retail investors in recent weeks.
Those investors and hedge funds, betting on a reversal of oil’s long rout, poured billions of dollars into exchange traded products at the tail end of the slide last year, providing unexpected support that helped prices stabilize.
Even as concerns about U.S. storage capacity triggered renewed slide over the past week investors have stuck with the view that a bottom might be in sight, pouring more money into financial products backed by oil futures.
There is a risk, however, that their bets could unravel and send oil prices tumbling again because of a market constellation where spot prices may head lower, but storage bottlenecks make futures contracts months ahead more expensive.
Some market participants warn that if that happens, the U.S. benchmark could slide towards $20 from around $47 now.
Holdings in exchange traded financial products have soared since the beginning of the year, especially highly-leveraged ones such as VelocityShares 3x Long Crude Oil ETN. according to data from Morningstar investment research firm.
Reuters analysis of weekly flows data shows investors have been boosting positions in several long funds, while unwinding short positions over the past four weeks.
Right now, the U.S. Oil Fund, one of the best-known of these products, holds about 60,000 crude oil futures contracts, more than 10 percent of open interest on the New York Mercantile Exchange contract for U.S. crude.
Yet with the market in contango – where futures contracts become more expensive as they get rolled over from one month to the next even if the spot price declines – investors face extra costs while they wait for the market rebound.
For example, earlier this month when the USO fund rolled its shares, the new contract cost about $ 1.70, effectively reducing the size of investors’ holdings. The next roll-over for the fund is due to start on April 7.
If investors lack the wherewithal to maintain their positions through price swings, they may pull out en masse, putting pressure on the price, said David Meaney, a portfolio manager at Boone Pickens’ billion-dollar fund, BP Capital.
“I think to at least some extent, we’ll see people who are under water on their trade throw in the towel.”
John Hyland, who manages USO, the best known oil exchange traded fund, is skeptical that funds like his can really be the driving force behind the entire oil market.
“How come it’s my buying long contracts and not someone else buying shorts that is supposed to drive markets?”
While funds, such as USO, may prove costly for retail investors, hedge funds and others may use the exchange traded products as a convenient way to manage their short-term exposure to the oil market.
Hyland says about three-quarters of investors in the fund are hedge funds and other investment vehicles, who are well aware of costs and risks and which use USO to access the futures market without having to deal with a derivatives broker. About a fifth of them trade in and out of the fund on any given day.
Yet traders say exchange traded products’ roll-overs of futures contracts are bound to cause market swings, creating risks for retail investors and potential opportunities for them.
“Beware of volatility around these contract rolls,” said a New York-based fund manager, who declined to be named because he was not authorized to speak to the media. “You’re just going to have some exacerbated moves in your front months.”