Calm on troubled waters
Investors using leverage Exchange-Traded Products (ETPs) to maximise returns on the oil price are likely proving to be the chief beneficiaries of recent geopolitical events. For example, President Donald Trump’s decision to terminate the nuclear arms deal with Iran pushed the price of oil: Brent crude rose to over $77 a barrel and US WTI oil closed last Friday at $71.70 per barrel. Those with a leveraged ETP on WTI could have made a profit last week as the price jumped over 5% from $68.28 to $71.72 over less than 2 days, with ETPs such as SG28 and & SG34 offering leveraged exposure to WTI, seeing rises in excess of 20%.
Brent crude oil is typically extracted from the North Sea and is considered the global benchmark for oil prices across Europe, Africa and the Middle East – this means that it can be more volatile because it is more susceptible to geopolitical risk. WTI refers to oil that is produced and refined in the US and is therefore less impacted by geopolitical risk. However, the shale gas revolution in the US has meant that WTI has suppressed prices.
There has been a lot of volatility in oil this year as a result of geopolitical issues and the shale gas revolution which has resulted in leveraged ETPs being used as directional trades. However the rise in the price of oil has been relatively sedate, despite supply cut backs by OPEC members, the strong supply of oil from US shale and uncertainties over prospects for the global economy possibly being to blame. If and when Iranian oil stops arriving on the market, Saudi Arabia could pick up some of the slack.
Data from the London Stock Exchange shows that WTI oil 3x leverage daily ETP was the most traded this year-to-date, with 16,321 trades. It was also the most traded at the beginning of May with 836 trades, accounting for over 5% of the total trading this year.
Leveraged ETPs are popular because they can save investors’ money by enabling them to put smaller amounts of money to work. For example, from £100 an investor in a 3x leveraged product would only need to put £30 to work.
The price of oil could continue to rise. A report from Bank of America for example found that Brent crude oil will hit $70 a barrel on average this year with it potentially rising to $100 a barrel next year. It’s underpinned by strong global economic growth, which is expected to increase oil consumption, while geopolitical issues from Iran and Venezuela will keep a lid on imports.
But uncertainty is set to remain Back in 2000, former Saudi oil minister Zaki Yamani said: "Thirty years from now there will be a huge amount of oil - and no buyers. Oil will be left in the ground. The Stone Age came to an end not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil."
In a research paper published this year, BP chief economist Spencer Dale and Bassam Fattouh of the Oxford Institute for Energy Studies, did not disagree: “The world isn’t going to run out of oil. It seems increasingly likely that significant amounts of recoverable oil will never be extracted.”
Technology has lead to the efficient use of oil in several sectors, led by electric cars. It has made it possible to extract oil from shale at an economic price. Environmentalists are demanding a reduction in oil consumption to limit climate change.
Dale and Fattouh say Peak Oil is unlikely to happen until 2025, or maybe out in 2040 – Yamani expected a much quicker impact. Concerns over the price of oil, plus environmental issues, make it harder to fund future exploration projects, restricting potential supply. Short term, crude inventories have been tightening.
Interestingly, directional trades are not the only benefit of leveraged and short ETPs in the oil markets. They can also be used to hedge against and trade the widening spread between Brent Crude oil and WTI. Geopolitical uncertainty has pushed the price of Brent Crude oil up this year, while US extraction has meant that the WTI oil price has stayed lower forcing the spread between the two to widen in April to its largest point since 2015.
The spread between WTI and Brent is one of the most widely traded spreads in the commodities markets due to supply and demand factors.
It may make little sense to exit the sector right now, but it may make sense for investors to hedge their positions at certain points, which is where Leveraged ETPs can have a role to play.
But remember, as with most investments, the value can go down as well as up, and as a leveraged investment these products are designed for sophisticated investors, so if in doubt, seek advice.
Post by: Zak de Mariveles, Head of UK Exchange Traded Products
Risk Warning: Short & Long Leveraged ETPs are suitable for sophisticated retail investors. Both gains and losses will be accelerated in comparison to a direct investment in the underlying asset.
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