What a difference one month makes. That’s how much time has passed since oil’s brief but spectacular plunge into negative territory.
On April 20, front-month West Texas Intermediate crude oil futures settled at -$37.63/barrel. On May 20, front-month futures settled at $33.49—a gain of more than $71 from the bottom.
Just like the decline, the rebound in oil prices has been rapid and unexpected, catching many market participants off guard. Few could have imagined a month ago that oil prices would be back in the $30’s so quickly, especially as economies around the world continue to struggle.
Yet here we are.
A faster than expected bounce in global oil demand and a much more drastic than expected reduction in oil supplies may be what’s fueling crude’s ascent.
In its May Oil Market Report, the International Energy Agency (IEA) said that, “better than expected mobility and the gradual easing of lockdown measures” pushed it to increase its demand outlook for the second quarter by 3.2 million barrels per day and its demand outlook for the full year by 700,000 barrels per day.
Signs Of Improvement
Granted, demand is still expected to be down on a year-over-year basis by 19.9 mb/d and 8.6 mb/d in Q2 and the full year, respectively, but that’s still a significant improvement.
Meanwhile, on the supply side, production cuts instituted by OPEC, its allies and other countries, have been immense. According to the IEA, supply may fall by 12 mb/d in May to a nine-year low of 88 mb/d. That includes massive output curbs from Saudi Arabia, Russia, the U.S., Canada and other major producers.
Add that all up and you have a market that is significantly tighter in May than it was in April.
While the speed of oil’s rebound may be a surprise, many investors had anticipated that prices would eventually recover. They poured billions of dollars into oil and energy ETFs as crude prices tumbled relentlessly during March and April, hoping to profit from any snapback in the commodity.
Unfortunately, not every ETF captured the upside. The United States Oil Fund LP (USO), a popular ETF among retail investors, pulled in nearly $6 billion in fresh cash in March and April, but few of the fund’s investors are making a profit today.
Breakeven At Best
Even after rebounding 50% from its lows, USO is only back to where it was trading on April 21, when front-month oil prices closed at $10. In other words, a tripling of oil prices has only resulted in breakeven returns for investors who purchased on that day.
Anyone who purchased the fund earlier in April or March is down significantly. For example, USO is down 56% since March 10—the last time front-month futures were trading around current levels.
A steep contango in futures markets and a portfolio of contracts further out on the curve hurt USO’s ability to ride the rebound in oil prices. It’s an unfortunate outcome for investors who may not have been aware of the structural factors working against the ETF. (Read: Biggest Oil ETF Shakes Up Structure)
Oil Price (Blue) vs USO Return Since March 10 (Yellow)
Not every oil-related ETF has suffered the same fate as USO. Though not as popular as that ETF, other energy funds delivered better performance to investors who bought into them. For example, the Energy Select Sector SPDR Fund (XLE) and the Vanguard Energy ETF (VDE) are each up about 66% from their lows set on March 23.
More importantly, today the funds are trading higher than they were back on March 10, the last time oil was hovering around $34. Unlike USO, these funds haven’t had to contend with the enormous costs of rolling futures positions forward. (Read: Why You Can’t Buy Spot Oil: A Guide To Contango & Backwardation)
As ETFs that hold baskets of energy stocks, XLE and VDE bottomed out with the broader stock market in late March. When oil prices cratered below zero on April 20, the two funds hardly budged, remaining well above their lows set the month before.
Returns Since March 10
There is no question that energy equity ETFs like XLE and VDE have been the better tools for capturing oil’s recent rally than oil-futures tracking ETFs like USO.
But it’s not just a short-term phenomenon; that outperformance tends to hold longer term as well. For instance, in the 10-year period between 2009 and 2019, XLE was up 38.3%, VDE was up 23.3% and USO was down 67.4%. That compares to front-month oil futures, which were down 23.1% in the same time frame.
The evidence suggests that other than for extremely short-term holding periods, energy equity ETFs tend to outperform oil futures-tracking ETFs. The latter may be useful for strategies such as day trading, pair trading and hedging, but it is not appropriate as a buy-and-hold investment.