Many look at the United States Oil Fund (USO) as the catch-all proxy for the oil market because of the fund's massive size and its impressive liquidity. But a changing dynamic in trading volume between West Texas Intermediate (WTI) and Brent crude could be a sign that all that is changing.
Boasting more than $1 billion in assets and trading some 5 million shares a day on average, WTI-futures-focused USO is often heralded as the best access point to the oil market for many ETF investors. By comparison, the United States Brent Oil Fund (BNO)—the market's only Brent futures-based ETF—has only $50 million in assets and an average daily trading volume of 40,000 shares.
But the dynamic between WTI and Brent is changing, with the Europe-traded oil benchmark slowly overtaking its U.S.-traded rival's dominance when it comes to futures trading. In the past three years, the number of Brent futures contracts outstanding on the ICE Futures Europe exchange has more than doubled, while the number of WTI contracts, which are traded on the New York Mercantile Exchange, has risen only 30 percent in the same time frame, according to the Wall Street Journal.
More importantly, while WTI contracts still outnumber its rival's, Brent has been more heavily traded recently, and even topped WTI monthly trading volume at one point last year, the Journal reported.
"Brent has been gaining on WTI because of distortions in WTI's price due to pipeline and other infrastructure bottlenecks in the U.S. Midwest, which is where WTI trades," Hard Assets Investor's analyst Sumit Roy said.
"Brent is the better reflection of global prices and fundamentals," he added.
Over the past two years, WTI has traded at steep discounts between $10 and $30 below Brent, partly because it's so abundant and not easily transported to the East Coast.
WTI's futures curve remains, in fact, in contango amid the supply glut that has pressured the value of the front-month contract relative to other contracts in the futures curve. That means investors are currently paying an annualized roll cost of about 4.9 percent to have exposure to a $92 barrel of WTI oil.
Brent's futures curve, meanwhile, is in backwardation—the front-month contract is the most expensive in the curve, meaning investors collect an additional roll yield when they move from an expiring position into a cheaper contract. That's yet another reason why more investors are turning to Brent to express their bullish views on oil all the while collecting an annualized roll yield of 4.7 percent on a $109/barrel contract, Roy said.
USO, designed to reflect the spot price of light sweet crude oil delivered to Cushing, Okla., as measured by the changes in nearby WTI futures, has bled nearly 18.75 percent of value in the past year, while BNO—a fund comprising nearby Brent futures—has slipped only 7.3 percent in the same 12-month period.
Aside from the fundamental case for Brent, United States Commodity Funds' Chief Investment Officer John Hyland, who runs both funds, pointed out that from a liquidity standpoint, it's "hard to believe" that the explanation many investors use to own USO vs. BNO is that it is easier and cheaper to trade.
"Although USO does trade 1 cent wide, BNO only trades 2 to 4 cents wide," Hyland said. "It's hardly a compelling case for everyone to use USO all the time."
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