Price Moves Expose Oil ETF Differences

August 09, 2012


Team Brent

The third alternative path to oil exposure is through Brent.

Brent oil futures are currently in backwardation, which is the opposite of contango. In backwardation, investors get paid when they roll positions upon expiration to the next contract because the nearby month is the most expensive on the curve. That enhances returns over time.

Brent futures, which are trading at about $113 a barrel, are serving up a roll yield of some $1.63, a far cry from the $3 seen in recent months, but still a sizable difference from WTI’s roll cost.

Add to that the fact that Brent futures are up roughly 5 percent on the year, significantly outperforming WTI, which is currently down by that much, and you have a solid case for a Brent ETF.

Investors have only one Brent-focused fund to choose from, the United States Brent Oil Fund (NYSEArca: BNO) designed to reflect the spot price of Brent crude oil traded on the ICE Futures Exchange.

But the fund is small—only $45 million in assets—and it doesn’t provide the liquidity some of the bigger players do. Still, on a return basis alone, BNO has shelled out a positive 6.6 percent year-to-date, while its WTI-focused counterparts have tallied losses.

The WTI-Brent Spread

That disparity in performance could be coming to a close. Tightening supplies in the U.S. Midwest could help push WTI toward narrowing the spread between it and Brent that’s now hovering $18—near its recent highs.

“In the absence of having real-time inventory figures for global crude oil supplies above ground, backwardation and contango are the next best indicators of inventory,” Hyland said, citing research conducted by Yale Professor Geert Rouwenhorst.

WTI’s contango has been dropping consistently while Brent’s backwardation has also given up ground. analyst Sumit Roy argues in his latest crude oil report that while WTI has underperformed Brent, tighter Midwest inventories could help narrow that spread to $10-15 in coming weeks.

The fundamental reason behind the spread is more than inventory related, Hyland added, noting that it’s also a reflection of a logistical problem with transportation to and from Cushing, Okla.—the place NYMEX selected as its delivery point for WTI contracts.

“Had NYMEX picked some junction in a pipeline by the Mississippi River, we wouldn’t have that problem with the spread,” Hyland said. “Cushing is landlocked, so we have a discount.”

While he doesn’t dispute that WTI’s disadvantage will be “chipped away” over time as many have suggested before, Hyland was also quick to point out that betting on a narrowing spread on the assumption that WTI would outperform Brent hasn’t necessarily paid out.

“That was a very popular bet among oil traders in late 2010 and into 2011, but they were wrong, and wrong for a long time,” he said. “It’s a workable trade, no doubt, but how long will it take for you to be right?”


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