Understanding Oil Investing
33 Pages Posted: 20 Jun 2016
Date Written: June 18, 2016
The price of oil has fluctuated wildly in the last few years and has placed a spotlight on oil investing vehicles. Of particular interest has been the discrepancy between oil investing returns and the hypothetical returns to spot oil. We attempt to understand the source of that discrepancy by examining the behavior of oil investing returns over the last 20 years.
We find that spot oil is not a realistic investable benchmark for oil investing and propose a better benchmark for oil investing that takes into account storage and insurance costs. Asset allocation studies that use spot oil are flawed and will give oil more importance than it should have relative to other commodities and other asset classes.
We also find different strategies of rolling oil futures can have very different return and risk characteristics. The futures curve has transitioned over the last 20 years from backwardation to contango leading to a drag on oil investing relative to prior periods when backwardation was the norm and investors could benefit from the futures roll.
We compare different oil investment vehicles and find that investment vehicles that purchase direct stakes in oil companies avoid the contango drag, but do not track oil well and assume other unwanted risks for oil investors. The greatest exposure to oil is achieved by investment vehicles that buy oil futures.
Keywords: oil investing, futures investing, exchange-traded funds
JEL Classification: G0, G13
Suggested Citation: Suggested Citation