Exchange-traded funds (ETFs) and similar products set up to offer investors an easy way of speculating on oil prices face growing scrutiny from regulators and brokers, after the Nymex WTI futures contract traded in negative territory in late April.
ETFs, which track movements in oil prices by investing in futures and swaps and which can be bought and sold like stocks, have seen a surge in interest this year from retail investors keen to bet on a recovery in oil prices as the world emerges from the Covid-19 pandemic. One of the largest ETFs, the US Oil Fund, which has historically attempted to track the Nymex WTI price by investing most of its assets in the prompt-month contract, has seen its assets under management quadruple this year to a high of more than $5bn in early April.
But regulators and brokerages are now applying closer scrutiny to these passive oil investment funds after the May WTI contract traded down to minus $37.63/bl on 20 April, a day ahead of its expiry. There are concerns that ETFs themselves could be exacerbating the price volatility seen in the wake of Covid-19 travel restrictions, particularly as they roll their contracts over each month to avoid taking physical delivery, and that some ETFs might struggle to cover their losses should crude futures turn negative again for a sustained period.
The response among some brokerages has been to start limiting ETFs' ability to acquire new oil futures positions. Since WTI went negative, the US Oil Fund, now valued at $4.5bn, has diversified its positions out of the prompt-month contract. But it also disclosed last month that its brokerage, RBC Capital Markets, said it would not buy any oil futures contracts on its behalf until further notice. RBC said it took this decision in light of its own internal risk management requirements and instructions from regulators in the US, Canada and the UK.
Another fund, the Samsung S&P GSCI Crude Oil ER Futures ETF, now valued at $630mn, in May said its broker has halted acquiring oil futures on its behalf, while another fund manager, WisdomTree, last month said it is closing eight exchange-traded products that track WTI and Brent after Shell decided to end a swaps agreement underpinning the funds. Other oil investors have not enjoyed such an orderly wind-down of their positions — Swiss bank Credit Suisse disclosed on 21 April that the value of its VelocitySharesTM 3x Long Crude Oil ETF had collapsed to zero and that investors would lose their investments.
‘Unique' risks
ETFs were designed to provide a lower-risk and more accessible oil investment option than futures contracts themselves. But there are "unique" risks associated with investments that rely on futures and swaps to track commodity prices, US commodity market regulator CFTC warns.
Investors buying into ETFs to bet on a recovery in commodity prices might not genuinely be able to "buy the dip" because oil-traded ETFs do not function like ETFs that acquire stocks and bonds, the CFTC said in a 22 May customer advisory that was meant to help "Main Street investors" understand how futures markets work, the agency's commodity pool regulator, Joshua Sterling, says. ETFs and mutual funds that invest in futures and swaps might be limited in the types of financial instruments they can hold, the CFTC says, and can lose investor capital every month when they roll over their futures positions if markets are in contango.
It remains unclear whether retail investors will heed the CFTC's warning, which came after the recent surge in investments. The US Oil Fund issued a net $2.3bn in new shares in March and $3.6bn in new shares in April, even as it recorded trading losses of $3.8bn for those months. Another fund, ProShares, in March sold net shares in its Ultra Bloomberg Crude Oil ETF worth $620mn as it lost $609mn.
