Goldman Sachs’ energy analysts are the latest to warn of the unprecedented inflows into oil ETFs in their most recent research note. In fact they attribute the small spike in oil prices in the last few weeks largely to this, a US cold snap, storage demand for products, fuel switching and a spike in refining margins.
Most interestingly, however, the Goldman oil bulls believe the spike is only transient as most of these factors are likely to reverse in the near term, hence they do not believe it represents the impending end to the current bear market (which they are still expecting before the end of the year).
The above certainly fits their view that the new bullish cycle will only reappear when the contango flattens out, in itself only likely to happen when most spare production (most likely from non-Opec producers) is brought offline.
Needless to say their warning about ETFs is particularly interesting. They believe it is only now that most of the investors that have piled into oil funds thinking the commodity was cheap will begin to realise the losses they are experiencing on the “negative roll“. As Goldman explain (our emphasis):
Finally, due to the low oil price environment that characterized the past several weeks following a New Year’s price spike above $50/bbl, the market has witnessed unprecedented inflows into oil ETFs (see Exhibit 7), pushing ETF owned barrels from a low of 10 million barrels in November to a high of above 100 million barrels last week. Given the large negative carry in the current oil market, we believe that unless the market can sustain further sharp rises in prices as we witnessed last week (which we do not believe is likely), there is a high risk that either this recent inflow stops or actually reverses sharply.
Eg, unless there’s a massive spike in the next few days/weeks investors in these funds will begin to realise losses, hence be inclined to pull out on a massive scale – potentially leading to a lot of selling by passive-style or ETF funds.
Goldman also note the number of barrels owned by investors is only 13 per cent less than the number owned when the market was peaking in July 2008. In fact, they estimate index investors now own 837m barrels versus 1,032m when oil prices peaked. But the type of investor owning the barrel has changed, the most recent surge coming from ETFs (investors who don’t know what they’re doing). As they put it:
We believe that this has come mostly from the retail and private banking sectors, which tend to be focused more on the price level of oil. This stands in sharp contrast to the institutional investor that focuses primarily on curve shape and the implied carry of the position.
And as prices have trended down despite these massive fresh investment inflows, the reverse of what happened during the summer peaks (when investor-owned barrels were declining as oil prices surged), it also leads GS to believe that what positions investors take have relatively a minimal impact on oil prices and volatility. So maybe it won’t really matter when they pull-out on a large scale after all? (Note the charts below).
Related links:
Roll-yield losses, redux – FT Alphaville
How contango affects ETFs – FT Alphaville
Nymex Light Sweet Crude Oil forward strip – Nymex