For most retail investors, buying physical crude oil as a commodity is not an option. Instead, many investors turn to exchange traded notes (ETNs) as a way to speculate on changes in oil prices themselves.
But direct oil investment products like USO have always been dicey as investment choices. More sophisticated investors with big Wall Street banks who have high speed trading and information advantages can essentially front run products like USO which trade oil contracts on a predictable basis. As a result, USO has been a far from perfect tool to replicate oil’s price movements.
By the same token, leveraged structured products including some oil ETNs are an even worse choice. For evidence of that, one need look no further than UWTI, the leveraged exchange traded note run by Credit Suisse. Credit Suisse recently announced that it was delisting UWTI and a similar but slightly smaller leveraged ETN also focused on oil.
The problem with products like UWTI is not that the product is unsuccessful, but rather that it is broken. UWTI was supposed to give investors triple the daily exposure to a crude oil index. That meant gains or losses from speculating on oil could be substantially magnified by investors using the product. For that reason, the daily dollar trading value of UWTI was roughly the same as the dollar value of megacap Exxon Mobil’s daily trading volume.
Similarly, UWTI has incredible liquidity – roughly half its shares turned over on any given day. That was largely driven by the fact that ETNs are not appropriate long term investments because of the transactions costs they incur in operations. Unfortunately for traders, those transactions costs add up over time – that’s true in the case of UWTI and virtually all other leveraged ETNs. Related: OPEC November Production Hits Record Highs
In the case of UWTI, this meant that the shares lost 99.6 percent of their value over the last four years even as oil has only fallen by 50 percent. The only thing that stopped UWTI from ending up as one of the cheapest of penny stock investments is that the shares went through multiple reverse splits. Investors in UWTI were virtually guaranteed to lose money on the shares if they held them for even a short time, especially when compared to the alternative of investing in less costly alternatives offering exposure to oil.
Given the total failure of the product, it is little wonder that Credit Suisse is delisting them right now. The bigger question for investors is whether the suspension of further issuances of the ETN will simply be followed by a new similar product that will meet an identically ignominious end in a few years. Based on the success of UWTI, there is clearly a market for such a product – a fact which is an enduring testament to the poor decision making of some investors. Investors often invest in these products as a tool to capture a broad view about the direction of a commodity failing to realize the flaws of the product.
Of course, there are many alternatives to physical oil as an investment for those who see an increase in oil prices coming. Oil stocks and ETFs of oil producers and servicers like XOP are a great option. These investments are correlated with oil prices, but don’t perfectly reflect changes in oil prices. On the other hand, neither did UWTI which is why it will no longer be listed for trading.
By Michael McDonald of oilprice.com
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