An IC reader asks: "The price of oil has nearly halved and, while it's possible it could halve again, I believe the price will recover on a timeframe of anything between six months and five years. How might I capture those gains?"
Oil prices have plummeted over the past year to dramatic lows. This week the US oil price fell below $50 a barrel for the first time in five years and ICE February Brent - the international oil marker - fell a further $1.42 to $51.64 on Tuesday 6 January 2015 in early trading. The price of Brent Crude and West Texas Intermediate Crude (WTI) have now more than halved since mid 2014.
That could spell opportunity if the market lifts over the coming years and there are several options for those willing to take a risk on the price of crude oil. Our reader is keen to invest in a product that will directly reflect the share price of the commodity and is not enthusiastic about investing directly in oil giants such as Shell or BP, which would give him an income but not necessarily reflect the price of oil.
Access to the oil spot price is almost impossible for a private investor due to the difficulty of buying and storing large quantities of the asset. This means that our reader should choose between an actively managed fund with a portfolio of oil companies, an exchange traded fund (ETF), which could include small oil producer equities, or an exchange traded commodity dealing in oil futures (ETC).
ETCs are likely to be the most effective way of gaining exposure to the price of oil due to their ability to concentrate on single commodities. Db WTI Crude Oil Booster ETC (XCT9) is a synthetic product that tracks futures contracts based on oil commodities, rather than granting exposure to the spot price. The fund has effectively tracked the db WTI Crude Oil Booster USD Index over one and three years, falling 40.99 per cent over a one-year period compared with 40.46 for the index and 47.73 per cent over three years compared with the index's 46.52 per cent.
An ETC like this, made up of 100 per cent crude oil, offers close exposure to oil prices via futures trading. However, it also risks bringing lower returns if the oil futures price is repeatedly lower than the spot price when the contracts reach maturity, a situation known as contango. In order to avoid this phenomenon, called negative roll yield, Deutsche Bank has come up with a method of selecting the most efficient futures to purchase within the ETC. This is the 'Booster' element in the Db WTI Crude Oil Booster, meaning returns should ideally be higher.
There is another risk concerning the complex nature of the swap agreements underpinning the futures contracts. The majority of ETCs are debt securities and based on swaps with counterparties. Db's ETC is vulnerable to credit exposure to swap counterparty Deutsche Bank AG, but collateralised with gold bars to protect investors in the event of a default. Swaps are also a consideration in the fees imposed by ETCs. Db WTI Crude Oil Booster includes a 0.45 per cent management fee and collateral fee of 0.7048 per cent as well as swap fees, which all hit returns.
A lower-risk alternative is a more diversified product such as the iShares Oil & Gas Exploration & Production UCITS ETF (SPOG). This fund is made up of a wider group of energy producers, which could dilute the investment portfolio with non-oil commodities. However, the fund still offers exposure to more speculative investment, with its top holdings made up of explorers such as ConocoPhilips making up the largest chunk of the portfolio, at 12.14 per cent. The fund has effectively tracked the S&P Commodity Producers Oil and Gas Exploration & Production Index, with total returns over a three-year period down 14.39 per cent compared with 13.30 for the index.
It could also offer a more transparent structure for a less experienced investor as it is a physical ETF, which physically holds assets as opposed to using more complex swap agreements. It also has lower management fees than other funds.
"You can get a less pure reflection of the oil price with a fund of shares, but you do have a more easily understandable instrument," says Edward Allen of Thurleigh Investment Managers.
The final option is a managed fund such as Guinness Global Energy Fund (IE00B6XV0016), set up by Tim Guinness at Guinness Asset Management. The fund is one of a limited number of actively managed funds dealing in oil. However, over three years it has generated a cumulative total return of 9.35 per cent compared with the MSCI World Energy Index total of 19.53 per cent. The Junior Oils Trust (GB00BH57C751) is another actively managed fund offering exposure to smaller companies but has also not performed well in recent years, falling short of the benchmark by over 40 per cent on a 10 year cumulative return.
| 1 year total return (%) | 3 year cumulative total return (%) | 5 year cumulative total return (%) | 10 year cumulative total return (%) | |
| Junior Oils P Acc | -26.723 | -33.074 | -43.697 | 29.907 |
| FTSE 350 Oil&Gas Producers TR GBP | -9.448 | -8.388 | 4.499 | 76.258 |
Source: Morningstar as at 3 January 2015
The main considerations for investors should be whether they are willing to take a punt on an oil commodity through an ETC or whether they prefer to diversify the risk through an ETF or actively managed fund, which could be less correlated to the oil price but better protect them in the event of further crashes.
