CALGARY — The only exchange traded fund that allowed investors to trade Western Canadian Select heavy oil closed last week due to lack of investor interest and continued uncertainty around the Canadian oil sector.
Auspice Capital Advisors-managed Canadian Crude Index, an ETF with CCX as its ticker, stopped trading last Tuesday after several years in which Pickering and his team promoted the importance of a fund linked to the WCS benchmark.
Tim Pickering, founder and chief investment officer of the Calgary-based investment firm, said it was a “very painful decision” to shut down his company’s pet project.
“With the negative sentiment around energy, oil and Canada, we couldn’t get a commensurate interest in the product,” Pickering said. “Getting people to realize the importance of this barrel has been part of my quest but it’s been very tough to do.”
As of May 20, the fund had $5.3 million in assets under management, and had fallen nearly 55 per cent in three years, according to the company website.
The last several months have been particularly rough for oil-linked ETFs. Fund managers at United States Oil Fund, which trades under the ticker USO, made multiple structural changes to the fund after extremely volatile price swings in the West Texas Intermediate oil benchmark led to a massive drop in its value.
With the negative sentiment around energy, oil and Canada, we couldn’t get a commensurate interest in the product
Tim Pickering
The fund began the year trading close to US$100 per unit, but has collapsed more dramatically than the crude prices it’s linked to and was trading at US$25.46 per unit on Friday.
In April, Horizons ETF Management also suspended the issuance of new shares in two crude oil-linked exchange traded funds after the price of WTI collapsed and closed at an unprecedented –US$37 per barrel as contracts for oil delivered in May expired.
Some banks have also begun to limit trading in oil-linked ETFs as a result of the extreme volatility, which could further dampen volume trading in the commodity-linked ETFs.
Oil-linked ETFs have contributed to some of the oil price volatility, which in turn is leading to increasing regulatory scrutiny of the trades. Analysts say this could change the way the benchmarks, including the North American benchmark WTI, is settled in the future.
The International Energy Agency said in a May 14 report that WTI’s dip into negative prices for expiring contracts could lead some Middle Eastern producers and price setting agencies to rethink their use of WTI to calculate prices for their barrels, including the Argus Sour Crude Index that is priced off of WTI in American markets.
“This could be seen as a failure of the benchmark as the negative prices reflected market fundamentals at (oil storage facilities in) Cushing, not those for the Middle East exports, which had alternative market/storage options,” IEA analysts wrote. “This incident may cause (price reporting agencies) to consider alternative methods of price determination and could damage WTI’s status as a reliable global benchmark.”
The IEA also noted that the one-day dip into negative territory for expiring WTI contracts in May has also raised alarm bells at the U.S. Commodities Futures Trading Commission, that regulates the U.S. derivatives market, and “is now investigating the possibility of market manipulation.”
The CFTC issued an advisory letter to commodities traders and merchants on May 13 that warned market participants to ensure they’re complying with all commodities trading rules and to adopt multiple new policies “to ensure that customers understand the mechanisms of contract settlement at negative prices.”
The regulator and the exchanges were “deeply unhappy” about WTI’s dip into negative territory at the end of April, said Ed Morse, Citi Group managing director and global head of commodity research, in an interview with the Financial Post.
“I think we can expect some changes in the nature of that settlement process (for WTI prices),” Morse said. In the meantime, he said, ETFs trading in crude oil contracts will continue to cause volatile swings in WTI prices.
Morse also expects the longer-term outlook for WCS to improve as new Canadian pipelines will enable Canadian heavy oil producers to ship more of their product to refineries that are looking for that grade of crude.
The price for a barrel of WCS heavy oil is calculated by taking the average price for WTI during a calendar month and applying a discount to it. That discount fluctuates each month largely as a result of the cost of transportation to get the barrels of oil to refining markets in the U.S.
As oil supply out of Canada has exceeded pipeline capacity in recent years, that discount has reached historically high levels. The discounts could theoretically narrow once the new pipelines come on line.
“There should be a super abundance of takeaway capacity,” Morse said, referring to new pipelines projects including the west-bound Trans Mountain Expansion, the Line 3 replacement connecting to Midwest refineries and Keystone XL pipeline connecting Alberta to the Gulf Coast.
In recent years, the discount for WCS has reached as much as US$50 per barrel, leading then Alberta premier Rachel Notley to warn the province was losing out on $80 million per day.
Now, with new projects under construction, the future discount could be significantly smaller.
“I don’t see why it couldn’t possibly be under $10,” Morse said of the differential.
In the beginning of May, the difference between WCS and WTI prices shrank to US$3 per barrel — much lower than the average US$20 discounts over the past few years.
The abnormally tight differential between WCS and WTI resulted from Canadian oil producers shutting in large volumes of oilsands production in response to the coronavirus-induced oil price crash while, at the same time, U.S. Midwest oil refineries were beginning contracting to buy WCS heavy oil a month ahead of time, as the U.S. economy prepared to re-open.
“Refinery runs are down but they’re still pulling more Canadian heavies,” said RS Energy Group senior associate Stephanie Kainz, noting that Canadian oil companies have also shut in so much production that there is now available pipeline space to move all the barrels currently being produced.
Canadian oil exports to the U.S. slipped to 3.04 million barrels per day on average in the first three weeks of May, its lowest level in close to four years, according to the U.S. Department of Energy.
On Monday, WCS was trading at US$24.67 per barrel midday, around a US$10 discount to WTI. That spread is still smaller than the average WCS/WTI differential over the last three years, but it’s a much more accurate reflection of the roughly $8 per barrel cost to move oil through a pipeline to the U.S. Midwest, said Kevin Birn, IHS Markit’s vice-president, North American crude oil markets.
Currently, the vast majority of Canadian oil is shipped to the U.S. Midwest market and that has “has contributed to a tremendous amount of price uncertainty (with WCS),” Birn said.
In the future, if the Trans Mountain Expansion and Keystone XL pipelines are built, WCS prices should also be less volatile as Canadian heavy oil producers will have the option to send their crude to multiple markets, including Asian markets, the U.S. Gulf Coast or the U.S. Midwest.
Having the choice to send crude to different destinations will make the WCS price less volatile.
“You’ll be subject to the volatility of the global market but you won’t be subject to even greater volatility than the global market,” Birn said.
At Auspice Capital, Pickering says he’s aware that the outlook for WCS production and pricing is better in the coming years than it has been in the past five years as new pipelines are built.
Still, he said, his company’s main business is managing funds for major investors including parts of Alberta’s teachers’ retirement funds and it wouldn’t indefinitely continue supporting an ETF that investors treated with apathy.
“We knew this was a great market to trade. We knew it was becoming an extraordinarily important barrel to the U.S. refinery system. We didn’t think it would take five years to get to where we are on Trans Mountain and everything else,” Pickering said.
Ironically, Pickering said he’s had hundreds of phone calls and emails in recent weeks from investors that want to trade the commodity while WCS and WTI prices were gyrating. But it was too late.
While new pipelines are under construction their completion dates remain uncertain, which left Pickering and his team wondering: “How long do we have to wait?”
Financial Post
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