As commodity exchange traded funds (ETFs) continue to be examined by the Commodity Futures Trading Commission (CFTC), there are certain implications for investors in these funds ahead of an official decision.
The PowerShares DB Crude Oil Double Long ETN (DXO) will be liquidated on Sept. 9. This is the first exchange traded product (ETP) to be dissolved in the wake of the CFTC’s investigation, says Matthew Hougan for Index Universe.
Last month, DB (as well as many other commodity ETP providers) halted creation of respective fund shares as CFTC investigated speculation in the futures markets after a steep climb in commodities, most notably in oil prices last year. As a result of the investigation, the CFTC pulled its permission for DB Commodity Services LLC to exceed federal speculative position limits on its ETF tracking corn, soybeans and wheat futures.
There is still much debate as to whether the rise in commodities prices can be attributed to speculators. Supporters of speculation point to the fact that open interest in oil futures actually declined as oil prices spiked last summer, indicating that speculators were in fact betting on a decline in prices.
Many people believe that there are no position limits in place for energy futures, but that’s not exactly the case, Hougan notes. The NYMEX has two different levels of position limits of its own for most commodities, including crude oil.
On the three days prior to expiration of each contract, NYMEX places strict position limits on the number of contracts any one party can hold. Currently, firms are limited to 3,000 contracts or less. There’s no wiggle room here. Apparently, there is wiggle room for “accountability limits” which is outside the three-day period. Accountability limits serve as warning bells to the exchange when a firm has taken a significant position in a given commodity contract.
DXO, since it was designed to deliver twice the exposure to its underlying index, had $425 million in assets when it closed. But given its double-long status, it really controlled $850 million in the crude oil futures space. The “regulatory event” phrasing in the note suggests that perhaps the NYMEX used some discretionary power it has had, but doesn’t often employ, Hougan says.
Meanwhile, the trouble for investors still invested in other commodity-focused funds could mean that they’re paying premiums, explains John Jannarone for The Wall Street Journal. In United States Natural Gas (UNG), the fund has had a premium up to 17%. For ETFs still issuing new units, arbitragers can squeeze premiums until they disappear.
Another implication for investors could be a lack of choice if more funds close. DXO was the largest and most liquid exchange-traded product providing leveraged exposure to oil. As Bob Pasani wrote for CNBC after DXO (and several other funds) initially halted new shares, “This is a good example of the Law of Unintended Consequences. We have a problem: We think there are Dark, Mysterious Forces secretly controlling the universe (and the commodities markets), and these must be investigated. But in the process of doing that, perfectly good products get blown out.”
With premiums now a factor in certain commodity ETFs, investors can no longer view them as straight plays on a commodity’s price.
A few other ETFs affected:
- United States Natural Gas (UNG): down 61.1% year-to-date
- United States Oil (USO): up 6.7% year-to-date
For more stories about the CFTC and commodities, visit our commodity ETFs category.