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Oil ETFs Head to Head: USO vs DBO

Sweta Killa

No doubt, oil has been the hottest and most volatile commodity so far this year. It is again showing large swings in its prices. This is especially true as oil broke its near-term trading range and regained momentum, indicating that the worst might be over for the commodity.


Notably, WTI crude surged near $50 per barrel mark on Tuesday trading while Brent jumped to more than $53 per barrel. However, prices retreated over 1% in Wednesday’s trading session. With this, both WTI and Brent are up more than 6% since the start of October.


Oil Rebound in the Cards?


The latest boost came amid signs of dwindling supply, improving demand and an increased willingness by major oil producers to support the prolonged slump in the market. The weakness seen in dollar, a declining rig count and better demand/supply balance added to the strength (read: Q4 Outlook for Oil & Gas ETFs).


In particular, U.S. production dropped by 120,000 barrels per day to a one-year low of 9 million barrels in September from the earlier month. The Energy Information Administration (EIA) expects a dramatic drop in U.S. production through the middle of next year before the momentum is resumed in late 2016. Oil output is expected to decline from 9.25 million barrels per day (bpd) 2015 to 8.86 million bpd in 2016.


On the other hand, the agency expects global oil demand for 2016 to increase at the fastest pace in six years, suggesting that oversupply is easing faster than expected. It also raised the Chinese demand outlook from 11.41 million bpd to 11.48 million bpd for the next year.


However, the latest inventory storage report from EIA showed that U.S. crude stockpiles rose 3.1 million barrels in the week (ending October 2), much higher than the market expectation of a 2.2 million barrel build. Total inventory was 461 million barrels, still near the highest level in at least 80 years. Despite the bearish inventory data, the oil price rally seems to have legs – it is likely to continue for the coming weeks as the oil market begins to tighten (read: Summer Madness to Nut Case? A Fall Preview of ETFs).


Given the renewed optimism and improving demand/supply fundamentals, many oil ETFs and ETNs have seen smooth trading over the past week. While the ETNs are leading, investors should look at the ETF options, which are more liquid, transparent and tax efficient. That being said, the two popular oil ETFs – United States Oil Fund (USO) and PowerShares DB Oil Fund (DBO) – that provide exposure to the WTI oil gained more than 6% in the past five trading days.


Though the duo might appear similar at a glance, there are a number of key differences between the two that are detailed below:


USO


This is the largest and actively traded ETF in the oil space with AUM of $2.6 billion and average daily volume of around 24.9 million shares. The fund provides investors with exposure to front-month oil futures contract traded on the NYMEX. Expense ratio came in at 0.45% (read: 6 ETFs to Watch in September).


As traders need to roll from one futures contract to another in order to avoid delivery, the fund is susceptible to roll yield. Notably, roll yield is positive when the futures market is in backwardation, and negative when the futures market is in contango. Basically, if the price of the near month contract is higher than the next month futures contract, this is backwardation and the opposite holds true for contango.


DBO


Unlike USO, this ETF follows the DBIQ Optimum Yield Crude Oil Index Excess Return plus the interest income from the fund's holdings of primarily US Treasury securities. The Index employs the rules based approach when rolling from one futures contract to another in order to minimize the effect of contango.


Instead of automatically rolling into the near-month oil futures contract, the benchmark selects the futures contract with a delivery month within the next 13 months, when the best possible “implied roll yield” is generated.  As a result, DBO potentially maximize the roll benefits in backwardated markets and minimize the losses from rolling in contangoed markets (see: all the energy ETFs here).


The fund has amassed nearly $508 million in its asset base while charges 78 bps in annual fees. It trades in good volume of 367,000 shares a day on average.


In Conclusion


While DBO has better roll strategies with higher potential returns, it lagged USO in terms of investor preference. First, DBO charges a 33-bp higher initial fee. Second, it has some hidden costs in the form of bid/ask spread as the ETF trades in lower volume than USO. Further, the construction of the ETF is a bit complex and requires systematic study of many futures contracts.  


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US-OIL FUND LP (USO): ETF Research Reports
 
PWRSH-DB OIL FD (DBO): ETF Research Reports
 
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