Two ETFs contributed to the carnage in oil markets on Tuesday, selling vast quantities of benchmark U.S. oil futures as they shifted their exposure to later-dated contracts amid fears of negative prices.
The United States Oil Fund (USO) and the Samsung S&P GSCI Crude Oil ER Futures ETF sold about 110,000 contracts in the most-liquid June WTI futures on Tuesday, according to Bloomberg calculations based on the funds’ filings — equivalent to 19% of the total open interest in the contract at the end of the previous day.
The data points to one reason for Tuesday’s collapse in June WTI prices, which tumbled by as much as 68% to touch a low of $6.50 a barrel. At the same time, its discount to later-dated contracts — known as contango — also widened dramatically, with the spread between June and July almost doubling to a contango of as much as $10.99 a barrel.
The sales are an indication of just how important the ETFs have become to the oil futures markets in recent weeks, as they have attracted record inflows from investors hoping to pick the bottom of the price rout. As of Tuesday, USO, the largest oil-focused ETF, accounted for about 30% of the open interest in the June WTI contract, while the Samsung ETF accounted for about 10% of it in the September WTI contract.
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The $3 billion USO, which historically has invested only in the front-month contract, said late on Tuesday it had shifted some of its holdings out of the June contract into the July and August ones. This was “because of extraordinary market conditions in the crude oil markets, including super contango,” it said. According to its website, it had sold 90,670 June WTI contracts at prices of $11.57 and $12.19 in trades that were still pending on Tuesday.
The smaller $400 million Hong Kong-listed Samsung ETF also switched its holdings out of June WTI futures on Tuesday. In a filing at around midnight Hong Kong time, Samsung Asset Management (Hong Kong) Ltd, which manages the fund, said it would shift its entire position from June to September WTI contracts “shortly after” the filing was published. That amounted to a sale of roughly 20,000 June WTI contracts, according to Bloomberg calculations.
Oil futures turned negative on Monday for the first time in history as investors struggled to exit positions in the expiring May WTI contract. That didn’t affect ETFs like USO or the Samsung fund, which had already rolled their exposure to the June contract by then.
However, investors in the ETFs are being hit by the combination of a drop in oil prices and the cost of rolling their positions from cheaper near-dated contracts to more expensive later-dated contracts. In a move designed to boost its nominal share price, the United States Oil Fund announced Wednesday that it will execute a one-for-eight reverse share split, that will be effective after close of market on April 28. It follows a similar move by Barclays, which announced that it will implement a one-for-40 reverse split of its iPath S&P GSCI Crude Oil Total Return Index ETN effective the open of trading on May 1, according to a statement.
“These funds got an assist from the Fed when they were told they would backstop the higher end of the high-yield credit industry,” an expert says.
The possibility of negative prices has sent a shockwave through the ETF industry. Should the price of the futures they hold fall below zero, ETFs could go “lights out”, Charlie McElligott, a cross-asset macro strategist at Nomura Securities, warned on Tuesday.
“It is possible that the price of June 2020 contracts will drop to zero or a negative value,” Samsung Asset Management said in its filing. “In the worst-case scenario, the Net Asset Value of the Sub-Fund may drop to zero and investors may suffer a total loss of their investments in the Sub-Fund.
Pierre Andurand, a hedge fund manager who has successfully bet on lower oil prices in recent months, warned that oil ETF investors faced the possibility of being “completely wiped out.”
“Anything that invests in the front two months WTI is a recipe for disaster,” he said.
