The energy space has been fired up by solid trading thanks to climbing crude oil and gasoline prices following the Iraqi insurgency. Average price of gasoline reached the highest level since 2008 to $3.86 per gallon (read: 3 Energy ETFs to Watch on Iraq Turmoil).
This is especially true as the Sunni Islamist militants strengthened their grip on north Iraqi and is now looking to capture the capital city of Baghdad in the south. Since Iraq is the second-largest oil producer in the Organization of the Petroleum Exporting Countries (:OPEC) group after Saudi Arabia generating about 3.3 million barrels of oil per day, investors are concerned that violence spreading in South will disrupt global oil supplies, resulting in a spike in crude oil prices.
South Iraq accounts for one-third of the total country’s production and International Energy Agency (:IEA) expects production from Baghdad to reach 8.5–9 million barrels per day by 2020. According to the Energy Information Administration, oil generally influences two-thirds of the retail price of gasoline.
The instability in the Middle East led to a surge in United States Gasoline Fund (UGA). The fund gained about 6.11% over the past 10 days and easily crushed the other oil-based ETFs – gains of 6.05% for Brent Oil (BNO) and 4.5% for WTI crude (USO). The gasoline ETF also outpaced the broad market fund (SPY), which is hitting new highs, by wide margins (read: Uprising in Iraq Puts These Oil ETFs in Focus).
UGA in Focus
The fund allows investors to directly make a play on the gasoline futures market and provides exposure to front-month gasoline futures, tracking RBOB gasoline for delivery to the New York harbor which is traded on NYMEX.
The ETF is illiquid with daily trading volume of less than 16,000, suggesting a wide bid-ask spread. As such, investors have to pay extra beyond the annual fee of 60 bps in fees per year. The fund has amassed $44.8 million in its asset base (see: all the energy ETFs here).
While generating solid returns, the fund might benefit from the positive roll yield as traders need to roll from one future contract to another in order to avoid delivery. Roll yield is positive when the futures market is in backwardation (the front-month contract is higher than the next-month contract) and negative when the futures market is in contango (the front-month contract is lower than the next-month contract).
Currently, the gasoline market is in backwardation according to CME group, which is bullish for the commodity and the gasoline ETF UGA. This is because the fund rolls over the next month futures contracts at a lower price, thereby making profits. A market in backwardation signifies that demand exceeds supply, boosting gasoline prices.
Unlike last year, most of the commodities are enjoying a strong rally this year on a combination of supply constraints and rising demand. While agricultural commodities delivered lackluster returns this month, oil and gasoline are lately the star performers on Iraq tensions, refinery maintenance, growing demand and a favorable futures curve (read: Stumbling Start to June for Agricultural Commodity ETFs).
This trend is likely to continue at least in the near term as demand is expected to continue to rise in the summer months. Further, the profit from processing of oil into gasoline is also climbing, boosting gasoline prices. This suggests that investors may want to consider UGA for their portfolios if the tension in Iraq continues to escalate. As such, this ETF could remain a top pick in the energy commodity corner of the world.
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