Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 357

Lessons in oil ETFs, futures and negative prices

The past few weeks have been a turbulent time for the global oil market, with oil futures prices falling below zero for the first time ever. In this article we discuss the alternatives for investors who are looking for exposure to oil.

Unless you own a storage tanker to physically hold oil, it is virtually impossible to invest in oil at the spot price. The most common way of gaining exposure is through oil futures contracts, but investing in futures directly can be complex and tedious. Most investors prefer to gain access to the oil market via exchange traded funds (ETFs), leaving the fund to manage the futures exposure for them.

Oil futures and contango

A key component of the performance of oil futures and any ETF that aims to track oil futures prices is ‘roll return’, which in turn depends on the shape of the oil futures curve.

Futures expire according to a predetermined schedule. On the futures settlement date, anyone holding a contract must take physical delivery of the oil. In order to avoid this, investors (including in oil ETFs), must ‘roll’ from one contract to the next prior to the settlement date. Rolling involves either a cost, or a credit, depending on the shape of the futures curve.

When the futures price of a commodity is higher than the spot price, this is known as ‘contango’. A market is in ‘backwardation’ when the futures price is below the spot price.

It is crucial that anyone considering investing in an oil ETF understand the impact this can have.

I’ll use the time around the roll period in early April 2020 of the BetaShares OOO fund (Crude Oil Index ETF - Currency Hedged (synthetic)) in the example below, but the concept of contango and its impact on performance applies to any futures-based oil ETF, or to anyone rolling futures themselves.

OOO aims to track an index that normally provides exposure to front-month West Texas Intermediate (WTI) Crude oil futures. WTI futures contracts settle on the third business day prior to the 25th of the month and therefore need to be rolled to maintain exposure. OOO’s Index gradually rolls the current contract over a five-day period commencing on the fifth business day of each month.

We have been witnessing extreme conditions with both demand and supply-side shocks. As you can see in the chart and table below, the futures curve has been very steep at the front end (steep contango). The curve has shifted dramatically over the last few months—it was still in backwardation in January. Following the S&P GSCI Crude Oil Index rebalance ending 13 April, however, the roll cost was as high as 27% per month.

Source: Bloomberg. Data as at 14th April 2020.

Source: CME. Data as at 15 April 2020.

The premium of the subsequent month’s futures contract will decay towards the oil spot price as the expiry date approaches. This is an unavoidable component of commodity futures.

At the time of the screenshot above, the June contract was trading at US$28.01, while spot WTI oil was US$20.78. If the spot price had stayed stable at that price, the June futures contract would have to erode 26% from then until expiry on 19 May 2020. This erosion would be reflected in a fall in Net Asset Value (NAV) of any oil ETFs, which aim to track these contracts.

Negative oil futures prices

On 21 April 2020, US oil futures prices were negative for the first time in history, following the largest one-day sell-off ever. This was based off the May WTI Crude futures contract, which settled on 21 April in the US.

Due to the supply glut and lack of demand for oil resulting from the global pandemic shutdown, the cost of storing oil has risen astronomically. Traders were desperately trying to offload contracts before settlement to avoid taking physical delivery. Given the cost of shutting a well, many producers were willing to pay someone to dispose of their oil.

What does this mean for funds that aim to track an index which provides exposure to oil futures?

The index the BetaShares OOO fund aims to track finished rolling into the June contract on 13 April, so was not holding May contracts when they traded negatively. On 21 April, when the May contract fell below zero, the June contract was trading at ~US$20. Of course, the performance of the ETF over that time was affected by the prevailing price of the June contract (it had been trading at highs closer to ~US$24 the day before).

Whilse oil futures prices are now back in positive territory, the risk of turning negative again remains. In the current environment, as the settlement date of the June contract approaches that risk may increase.

In view of these unprecedented market developments, and to reduce the risk of exposure to negative prices (which potentially could reduce an ETF’s value to zero), many oil ETFs have considered it prudent and in investors’ interests to temporarily replace exposure with longer-dated contracts. In our case, exposure has been temporarily replaced with the less volatile three-month forward contract until further notice. This was done with the aim of reducing the risk of permanent loss of capital, and should also reduce the cost of rolling futures.

These types of de-risking changes have not been limited to ETF providers. Index providers have also made changes to benchmarks linked to short-term oil futures prices.

What lies ahead for oil?

Oil is a physical spot asset, the price of which is determined by supply and demand, unlike equities whose prices are based primarily on expectations of future earnings. In order to behave functionally, markets must square off all supply and demand. Until the global lockdown ends or unless there are monumental supply cuts, the dynamics look likely to remain extremely out of balance.

The US WTI Crude has been hardest hit, primarily due to geographic location. The landlocked city of Cushing, Oklahoma, is the major trading hub and delivery point for WTI crude contracts. While the shortage of off-land oil tankers is less severe, the global shutdown has caused US storage facilities, pipelines and refineries to approach physical constraints.

Oil markets are currently hitting transportation bottlenecks, without having filled storage capacity. If we do test global storage capacity in the coming weeks (beyond US onshore), there will likely be significant volatility, and oil futures prices could decline further until supply meets demand.

Looking beyond and to the eventual recovery, there is the chance that if we see sweeping refinery shutdowns and pipelines get clogged, we could see a supply-led inflationary shock when demand returns to pre-crisis levels. However, for those looking to capitalise, the strength of this rebound will depend on both a sharp increase in demand and how much excess inventory is built.

Energy companies

The current oil rout could see the energy industry finally undertake the critical restructuring it needs. Shale producers were already seeing sharply higher costs of capital, and the COVID-19 crisis could see that capital dry up entirely. The potential for widespread bankruptcies could see global energy markets once again be the domain of energy’s ‘supermajors’.

Energy remains a sector that’s crucial to any eventual recovery in global growth. One option for investors looking at a cyclical recovery by major energy companies is an ETF such as the BetaShares Global Energy Companies ETF – Currency Hedged (ASX:FUEL), which provides exposure to the 50 largest energy companies globally ex-Australia. These companies historically have shown a high correlation to the price of oil futures as can be seen in the chart below.

Source: Bloomberg, BetaShares. Data as at 29 April 2020. Past performance is not indicative of future returns

Note: As discussed above, the price of oil futures contracts is not the same as the ‘spot price’ of oil. As such, the performance of oil futures, or an ETF that is linked to oil futures, may be materially different to the performance of the spot price of oil itself.


Alistair Mills is Associate Director, Portfolio Analytics & Adviser Business at BetaShares, a sponsor of Firstlinks.This article is for general information purposes only and does not address the needs of any individual.

For more articles and papers from BetaShares, please click here.



The how and why of investing in commodities

Global ETFs: insights into a multi-trillion-dollar industry

Australian ETFs: end of year reviews 2018


Most viewed in recent weeks

Buffett's meeting takeaway: extreme caution

Warren Buffett's annual meeting of Berkshire Hathaway showed he has not been 'investing while others are fearful' during the crisis. lt's a reminder to take caution and preserve cash.

Welcome to Firstlinks Edition 356

Few investors are as influential as Warren Buffett, although for the moment, the market is ignoring his caution. The annual meeting of Berkshire Hathaway revealed Buffett did not use the heavy market falls in February to buy shares. Rather than 'buy when others are fearful', he was a net seller of US$6 billion for the quarter, disposing of all airline shares. Berkshire is sitting on US$137 billion in cash, suggesting he expects better buying opportunities to come.

  • 7 May 2020

The vibe of future returns: tell ‘em they’re dreamin’

It's the vibe, but not much else. Super balance calculations default to earnings rates of 7.5%, but that's in the past. Global experts suggest financial plans are now dreaming at this level.

Baseline outlook for economic recovery is too optimistic

We cannot throw our hands up in the air and say 'this time around, it's simply too hard'. Having no macro view is unhelpful, but many of the baseline scenarios are overly optimistic, says the former CEO of Westpac and now Chairman of Chi-X Australia.

Retiree spending patterns differ from most expectations

A study of actual spending habits shows retirees have a faster-than-expected drop-off in spending in later years, casting doubts on financial plans that assume increasing expenditure over time.

Welcome to Firstlinks Edition 357

There is a remarkable concentration similarity between the Australian and US stock markets that has delivered poor results for Australians and great results for Americans (and global investors). As the share prices of five Australian banks have tanked, the prices of five US technology companies have surged. Each group now represents 20% of their respective indexes, but the journey has been a disaster for many Australians.

  • 13 May 2020

Latest Updates


Baseline outlook for economic recovery is too optimistic

We cannot throw our hands up in the air and say 'this time around, it's simply too hard'. Having no macro view is unhelpful, but many of the baseline scenarios are overly optimistic, says the former CEO of Westpac and now Chairman of Chi-X Australia.


Will our government embrace these three reforms?

COVID-19 is an opportunity for a crucial policy reset, but what does that really mean? Business is hoping for three big reforms, but there are massive barriers to be overcome.


8 reasons business has little to learn from 'The Last Dance'

Everyone seems to be watching The Last Dance, a fascinating sports documentary about the pursuit of excellence by one of the greatest athletes of all time. Let's not stretch the business analogy too far.


Do long-term investors need to care about the ‘next big thing’?

When we look back five years from now, which companies will we regret not having bought at today’s prices? The next opportunities come from focusing on the long term, not the next few months.


Not all non-residential real estate performs the same

Retail assets, particularly those focused on discretionary shopping, will continue to underperform and industrial and logistics assets will be the winners for the foreseeable future.


The uncertainties of using debt in a time of crisis

The ability of countries to support their economies today turns on fiscal practices set well before this crisis. Increasing levels of debt escalate overall risk, and tie our hands in the future.


Do you qualify for this help in the crisis?

It will surprise many that benefits worth over $8,700 could be available for a couple with a super balance over $4 million. Check if you are eligible for the Commonwealth Seniors Health Card.


What SMSF trustees need to know about benefit payments now

The government has announced initiatives to help people use their superannuation in response to the crisis, but for early access and drawdown changes, there are important rules to follow.



© 2020 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use.
Any general advice or class service prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, has been prepared by without reference to your objectives, financial situation or needs. Refer to our Financial Services Guide (FSG) for more information. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.