Oil Futures, Exchange-Traded Commodities And The Oil Futures Curve

April 12, 2010

Oil Futures Contracts And The Forward Curve
An oil futures contract is a standardized contract with a specific maturity, meaning that when the contract expires, the investor of that oil futures contract will either receive 1,000 barrels of oil on a specific date in a specific location (e.g., Cushing, Okla., in the case of WTI oil futures) or the investor may receive the cash value (in the case of ICE Brent oil futures). Oil futures contracts have the widest range of delivery dates, going out more than five years. The best way to think of the oil futures curve is to compare it to the term structure of interest rates—as the maturity increases, the interest rate will vary. Similarly for oil futures, as the maturity increases, the price of that contract will vary (Figure 2). There are many theories that try to explain the shape or structure of the oil futures curve—we don’t intend to debate the theories here other than to say that no one theory is able to explain the shape of the curve at all times.

Oil Futures, Exchange-Traded Commodities And The Oil Futures Curve

Development Of ETCs And Oil ETCs
ETCs were developed a few years ago due to investor demand. Initially this investor demand was for simple access to commodities, and as a result, ETCs offering long, short, forward and leveraged exposure to more than 23 individual commodities and 11 indexes were listed on European exchanges. Since then, investor knowledge of commodities and commodities investing has come a long way; meanwhile, the liquidity of oil futures with longer maturities has grown by 500 percent to 1,000 percent over the past three to five years. Since ETCs are directly or indirectly priced off commodities futures, this provides the ability to offer ETCs with exposure to different sections of the futures curve.

ETF Securities (ETFS) created the world’s first oil ETC with Shell Trading in July 2005. Four years later, ETFS offers 14 different types of exposure to the oil market, primarily in Europe, with firms like Source, UBS and Deutsche Bank also offering similar products for European investors. In the U.S., there are several futures-based oil products to choose from, such as those offered by United States Commodity Funds. Currently, oil ETCs enable investors to take long, short, forward and leveraged positions in oil, and to choose which part of the oil futures curve they would like exposure to (from front-month out to three years), as well as choose between geographic types of oil contracts.

Comparing Oil Investment Of Different Maturities
Investing in oil ETCs or oil futures of different maturities will lead to different investment returns and properties. The differences in return are caused by the sensitivity to the spot prices and the roll yield; however, they also share some things in common, including (1) low correlation to equities and bonds, which leads to the construction of more optimal portfolios, and (2) high correlation to movements in the oil price. Figure 3 shows the optimal portfolio for equities and bonds (shown by the black line) and also a portfolio that includes an investment in different oil ETCs (shown by the colored lines). The higher curves show that an investment in oil could have improved a portfolio’s performance over the past five to 10 years.

Oil Futures, Exchange-Traded Commodities And The Oil Futures Curve


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