'OIL': An Oil Fund Doomed To Fail

January 21, 2016

Observant investors may have noticed that West Texas Crude Oil is trading for less than it costs to buy the metal barrel to store it. That inevitably has some folks looking to call the bottom and go long oil, and that’s just fine: There are ETFs that can do that for you.

But there’s one particular ETF—an exchange-traded note really—that looks too good to be true, the iPath S&P GSCI Crude Oil Total Return ETN (OIL | B-92).

In the “Star Wars” words of Admiral Ackbar: It’s a trap. First, here’s the chart:

As you can see, in 2015, OIL pretty much tracked its fair value perfectly—that fair value being the S&P GSCI Oil index, which is a rolling front-month futures contract in West Texas Crude. This was a terrible investment, sure, but the security seemed to be working as it should.

Then, in the fall, just as things got really interesting in oil (Texas tea, black gold), the OIL ETN seemed to start diverging from fair value. In fact, it looked like it was miraculously avoiding the steep sell-off.



Related Article: Oil: Buying Opportunity Of A Generation?


Built-In Disaster

OIL is a terrible, terrible exchange-traded note for two reasons, both built in by design.

The first is that over the long term, your fees are going to vary wildly based on how the ETN performs. OIL is in a class of old-school ETNs with path-dependent fees.

Instead of just taking today’s assets under management and multiplying that by a prorated amount of the 0.75% annual fee, it actually creates a shadow-NAV (net asset value) to apply the fee as well, based on the average index performance since inception, without giving you credit for fees already paid.

This is a terrible idea, and bad for investors (and hat tip to Sam Lee from Morningstar for writing about it extensively some years ago), and is one of the reasons OIL’s NAV is down 53%, when the index it tracks is down 45%—an unpleasant 8% surprise for anyone holding it.

How Barclays ‘Re-broke’ OIL

But that’s not related to the trading weirdness we’re seeing. What’s really going on is that Barclays re-broke the product.

You see, most banks are trying to get out of the exchange-traded-note business, because it puts a big liability on their books (the promise of the ETN), which they then have to hedge. Even with big fees, it creates complications on the balance sheet, and in the wake of the last eight years or so of bank re-regulation, complicated balance sheets are out of favor.

That’s why we’ve seen dozens of ETNs close. But in the case of OIL, Barclays basically just decided it didn’t want to issue any more of it, so on Sept. 15, 2015, it slapped a 50 cent per-share fee on any new creations.

You read that right—50 cents per share. When the NAV of OIL was $8, that meant that to make new shares, an authorized participant (APs) had to pay Barclays a 7% fee. So of course, the fund traded to at least that much.

Good Luck On Disclosure

After all, APs aren’t philanthropists, and they won’t make new shares until they’re well compensated. With the NAV of OIL now at $4, that 50 cent fee is now a guaranteed premium of at least 14%.

Of course, the only way you could possibly know that this 50 cent fee to APs exists is if you call them and ask (which we do anytime we see anything crazy), or listen religiously to our ETF morning call. Despite a lot of searching, we’ve never found documentation on it.

The last reason for the recent spike is less Barclays’ fault. Once you get a giant premium in an ETF or an ETN, there are algorithms and other irrational traders out there who (erroneously) smell blood in the water.

Whether through bad programming or just not understanding how ETNs work, they assume that the positive deviation in the traded price of OIL means something; as if there were an animal spirit that could wish the ETN to defy the price of oil long term.

Barclays Even Says Back Away

There isn’t, of course. Barclays could wipe the premium away by issuing more shares—just like Credit Suisse did when TVIX had this exact same spike in 2012. The situation has gotten so bad that Barclays is even warning investors off in a note this morning, telling them to stay the heck away from its own product.

Of course, it hasn’t gone so far as to just shutter the product—75 basis points times $500 million in assets is real money.

There are few things in the investment world that are actually easy. Avoiding products that are literally broken by design is one of them.



At the time of this writing, there’s not a chance in you-know-where that the author held the security mentioned. You can reach Dave Nadig at [email protected], or on [email protected].

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