Crude oil has seen a whirlwind of activity since the start of the U.S.-Israel war with Iran at the end of February, but through it all, the United States Oil Fund LP, the largest U.S. oil commodity exchange-traded fund, has outpaced gains in crude prices.
The flows into and out of the fund have been volatile during the tensions and market sentiment tied to the Middle East as traders reacted to “erratic” developments on the ground and the rhetoric from U.S. and Iranian officials, said Frank Walbaum, market analyst at trading platform Naga.com. USO invests in the U.S. benchmark West Texas Intermediate crude futures and offers a way for investors to gain exposure to prices for light, sweet U.S. crude.
USO saw large inflows when oil prices started to rise at the beginning of March, following the start of the Iran conflict, and flows increased as prices approached their peak. U.S. benchmark West Texas Intermediate crude settled as high as $112.95 a barrel this year — on April 7, according to FactSet data.
Since the start of the war, WTI has surged around 26% higher as of Wednesday’s close, according to FactSet data. USO, however, has performed even better. It’s up about 58% since Feb. 27, the last trading day before the Iran war began, according to Dow Jones Market Data.
The United States Oil Fund closed at $129.31, up 7.3% on Wednesday. It notched its biggest percentage rise in over two weeks.
The ETF follows crude prices and enables retail investors to get exposure to the market without having to use futures contracts directly, said Walbaum. That helps to “shield investors from the complexities of margin requirements, contract rollovers and delivery mechanisms,” he said.
Photo: Dow Jones Market Data, FactSet
The crude futures market is currently in a state of backwardation, which means that oil for delivery near term is trading at prices higher than contracts for oil for future delivery. WTI’s September contract settled Wednesday at $84.46 a barrel — higher than the December WTI contract, which finished at $77.74.
Typically, crude futures trade in “contango,” meaning prices for oil for future delivery are higher than current prices to reflect costs, such as those for storage and delivery.
Backwardation can be favorable for USO investors because the fund holds WTI oil futures and as those futures contracts expire, the fund has to move those holdings into that next contract. With backwardation, it would be selling the higher-priced contracts to buy the lower-priced contracts. So there’s a roll yield — a return in the price the fund gets, which is the difference between the expiring contract and the new one.
USO can be an effective tool for traders seeking exposure to oil during periods of geopolitical uncertainty, said Walbaum.
However, due to the “volatility and dynamics” of the oil market, investors need be “aware of and reactive to the rapid changes in conditions and events that affect supply in the current context, which include “diplomatic efforts, military actions, sanctions and disruptions to maritime transport,” he said.
Since the start of the Iran war, the near-term WTI contract has traded at highs above $119, but also dropped below $70 a barrel.
Investors should also consider other instruments that can help investors get exposure to the energy market, he said. Those include CFDs, and sector ETFs like State Street Energy Select Sector SPDR, the world’s largest energy-stock focused ETF, and investments in individual integrated oil company stocks, said Walbaum. CFDs, or contracts for difference, allow investors to speculate on price movements but are restricted in the U.S. because of regulation and risk issues.
A “strong risk-management strategy” would help investors avoid excessive losses in case of adverse price movements, as prices can change suddenly. Walbaum said.
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