On 20 April 2020, the price of crude oil turned negative for the first time in history. A brutal combination of weak demand due to worldwide lockdowns and producers unwilling to reduce output led to a scarcity of storage capacity. The situation turned so bad that oil producers were actually willing to pay buyers to store excess oil, hence the negative prices.
Since then, crude oil prices have bounced back strongly over the past few months to cross $60 per barrel on 17 February.
In the investing world, oftentimes, price gains happen too slowly to notice, whereas setbacks happen too quickly to ignore. The story of oil prices since April 2020 has been such as well. Over the past 10 months, the price of oil has been steadily increasing, largely unnoticed. Today, we are going to dive into how one can get exposure to oil as an investment.
Unfortunately, it’s difficult to get direct oil exposure via Indian markets. One has to invest in specific oil companies such as ONGC, Oil India or Reliance or energy funds such as DSP Natural Resources Fund, which include oil-producing businesses. Energy funds are not the best choice to invest in oil, given their large exposure to non-oil entities such as coal and power companies along with renewable energy companies.
Because of the lack of local options, you have to turn your attention to international markets. In the global markets, we have plenty of options via ETFs (exchange-traded funds) to add a commodity like oil to our portfolio. To add to it, international markets are now not beyond the reach of an Indian investor. One can start investing internationally by opening a brokerage account in the US from India in a very easy manner. Further, under the RBI’s Liberalized Remittance Scheme, an Indian resident can legally transfer up to $250,000 to invest internationally.
Now, coming back to oil ETFs, the three top oil ETFs that you can look to get direct oil exposure are the United States 12 Month Oil Fund (USL), the Invesco DB Oil Fund (DBO) and the United States Brent Oil Fund (BNO). However, before you dip into oil ETFs, there are a few things you should know of.
Oil ETFs are of a different nature compared to normal ETFs; they are made up of oil future contracts. Oil futures are legal agreements to trade oil at a predetermined price at a specified time in the future. Since these ETFs track oil futures and as oil futures contract within the ETFs expires, the ETFs must roll the expiring contracts to the next contract—there are costs associated with this. Because of this reason, these ETFs do not track current oil prices accurately. There is also the complicated concept of contango (when oil futures prices are higher than the spot price) that these ETFs suffer from, which further makes them inefficient in terms of exactly tracking the price of oil.
If you are looking for an easier alternative, you can also look at investing in IEO or IEZ as well. IEO is the US Oil & Gas Exploration & Production ETF, whereas IEZ is the iShares US Oil Equipment & Services ETF. Both of these ETFs invest in stocks of companies specifically in the oil and gas sector such as Schlumberger and Halliburton. These ETFs provide a good way to get indirect exposure to oil as a commodity.
There are multiple ETFs in the international markets to invest in oil. If you are looking to directly track the price of oil, then oil ETFs are a decent option, but they have their drawbacks since the underlying instrument that the ETFs hold is oil futures. Look at getting indirect exposure to oil via sector ETFs.
Viram Shah is CEO, Vested Finance.