Oil ETFs Surge As Russia Struggles To Sell Crude
Oil prices spiked to levels not seen in more than a decade on Wednesday amid supply concerns. U.S. WTI crude oil prices briefly topped $112/barrel, while European Brent crude oil prices eclipsed $113.
The United States Oil Fund (USO) and the United States Brent Oil Fund (BNO), which track their respective benchmarks, added to their hefty gains for the year. The funds are now up 33% and 44% year-to-date, respectively.
WTI Crude Oil Prices
In recent days, Russia’s war against Ukraine has caused the West to levy harsh sanctions on the aggressor. Those sanctions, along with the growing reluctance to deal with what is increasingly a pariah state, has caused many companies to stop doing business in or with Russia.
BP, Shell and Exxon have all abandoned their Russian operations; shipping companies are refusing to enter Russian territory and Western countries are discussing banning Russian ships from entering their ports.
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So far, the Russian energy sector has been spared from the severe economic constraints imposed on the country. Russia is a massive producer and exporter of oil and natural gas (as well as other commodities like wheat and palladium), and so commodity importers like Europe and the U.S. are reluctant to cut off those key supplies.
However, even though the buying of Russian oil barrels is still unrestricted, it doesn’t mean that anyone wants to buy them.
Few Buyers
The problem, according to industry participants, is that in addition to anything related to Russia being toxic, potential buyers of Russian crude are having issues securing financing and ships. Without normal access to Russian oil, buyers are scrambling to secure supplies elsewhere, driving up prices around the world.
It’s not clear whether these circumstances will lead to an actual reduction in the amount of oil Russia exports, or whether those exported barrels will still sell, just at heavily discounted prices.
But it may be a moot point if the West sanctions Russia’s energy sector, as President Biden has threatened to do. Responding to a question about energy sanctions on Wednesday, Biden said, “Nothing is off the table.”
According to the International Energy Agency, Russia is the world’s third largest oil producer and the world’s largest oil exporter. It exports 5 million barrels per day of crude, or 12% of global trade. Including refined products, its exports account for 15% of the global petroleum market. Of Russia’s exports, 60% go to Europe and 20% go to China, though because of the interconnected nature of the oil market, all oil importers would be impacted by curbs on Russia’s exports.
Market On Edge
In a market that was finely balanced prior to the latest geopolitical events, just the prospect of major oil supply disruptions would put the oil market on edge. Now that there is evidence that supplies are actually being impacted, prices are moving aggressively higher.
It’s fair to say that if Russian exports were completely taken off the market, oil prices would be much higher than they are even today. In that event, it’s not hard to imagine prices topping their all-time high of $146 a barrel from 2008.
On the other hand, these high prices will do a lot to incentivize supply growth and dampen demand growth on the margin. Global oil consumption was projected to peak this decade; that peak could now happen sooner.
The steep backwardation in the oil futures curve suggests that these high oil prices aren’t here to stay long-term—though they could certainly continue rallying in the short term.
Investor Impact
For investors in oil ETFs like USO and BNO, a futures curve where later-dated contracts are cheaper than near-month contracts—a phenomenon known as backwardation—is a positive for returns. As these funds roll these positions from contract to contract, they sell oil at a premium and repurchase it at a lower price.
Still, investors should keep in mind that while the roll yield from backwardation can boost returns, they don’t guarantee a positive return. Anyone holding these funds is still exposed to volatile oil prices, and there is an especially high degree of uncertainty with regard to where those prices will be a week or months from now.
Follow Sumit Roy on Twitter @sumitroy2
In a move that will reverberate through emerging marketETFs, two index giants have decided to pull Russiaequities out of their indexes.
On March 2, MSCI announced that the MSCI Russia indexes will be reclassified from Emerging Markets to Standalone Markets status. This change will be implemented across all MSCI indexes as of market close on March 9.
That same day, FTSE Russell announced that Russia will be deleted from all FTSE Russell Equity indices effective from the market open on March 7. The market will be classified as an "unclassified" market, and will be reevaluated during the annual country classification process.
Both index providers said that index constituents would be priced at zero, with MSCI noting that “the Russian equity market is currently uninvestable.”
MSCI and FTSE Russell are the index providers behind some of the largest emerging marketETFs, such as the Vanguard FTSE Emerging Markets ETF (VWO) and the iShares Core MSCI Emerging Markets ETF (IEMG). This means that the decision to remove these equities from the index will affect billions of dollars in assets.
Though the value of Russiaequities has plunged due to economic sanctions enacted against the country, Russia accounts for 2-3% of these broad-based cap-weighted ETFs.
S&P Dow Jones Indices is also considering what action to take within its indexes that hold Russiasecurities. The firm is expected to announce its plan after the close of business on Friday, March 4.
Follow Sumit Roy on Twitter @sumitroy2
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