Pipeline Worries Give Oil ETFs A Boost

by on September 13, 2010 | Updated September 14, 2010 | ETFs Mentioned:

For the last several months crude oil prices have generally moved in unison with global equity markets, as the demand outlook for the critical fuel has changed along with macroeconomic prospects. But crude prices got a boost last week from an unexpected source; the rupture of a pipeline outside of Chicago caused a Canadian company to shut down a critical flow of crude between the U.S. and Canada. With crews scrambling over the weekend to uncover the source of the leak, crude figures to be in focus during Monday trading as investors attempt to uncover the extent of the infrastructure damage.

The rupture came on a pipeline owned by Enbridge, Inc. that has the capacity to bring nearly 700,000 barrels of oil daily from Canada to the U.S. The pipeline in question is part of the key Lakehead system that accounts for about 70% of the oil that flows into the U.S. from the north each year, and the recent incident represents the second time in three months that oil has leaked from an Enbridge pipe. The first came in July when a leak resulted in nearly 20,000 barrels of oil spilling into the Kalamazoo in Michigan; that pipeline remains offline. Last week’s leak came on a much bigger pipeline, and could have a significantly bigger impact on the U.S. energy picture [see Oil ETFs: Five Ways To Play].

Oil prices spiked on Friday, thanks in part to concerns that one of the primary arteries bringing crude to the U.S. could be offline for an extended period of time. The series of incidents in recent weeks also raises some concerns over the aging network of pipelines running throughout the country. “Last week’s rupture occurred on a much bigger pipeline and raises concerns about the reliability of the infrastructure that carries vital resources to and around the U.S,” writes Jerry DiColo. “Such worries became more acute following Thursday’s fatal explosion of a natural-gas pipeline in San Bruno, Calif.”

Oil ETFs In Focus

With crews working throughout the weekend to begin excavating the pipeline–the Environmental Protection Agency has ordered that the leak be closed by Monday–details on the cause of the leak or expectations for the length of any shutdown have been slow to emerge. Oil stockpiles are at their highest levels in nearly 30 years, so even en extended shutdown of the pipeline likely wouldn’t result in a shortage of crude. But some investors believe that recent developments may eat into those stockpiles, which could send oil prices higher even if the outlook for the U.S. economy remains bleak. With lingering uncertainty, we profile three different ways to play crude oil prices through ETFs [see the entire list of funds in the Oil & Gas ETFdb Category]:

  • Unites States Oil Fund (USO): The ultra-popular USO invests in crude oil futures traded on the NYMEX, offering investors an efficient way to access a futures-based commodity strategy. USO, which has nearly $2 billion in assets, has struggled this year as a dismal outlook for the developed world has weighed on oil prices and contango in futures markets has eaten into returns.
  • ProShares Ultra Dow Jones-UBS Crude Oil (UCO): This leveraged ETF from ProShares offers investors an opportunity to double down on crude oil; UCO seeks to deliver daily results that correspond to 200% of the daily change in the Dow Jones-UBS Crude Oil Sub-Index. Because UCO is a leveraged ETF, its returns over multiple trading sessions depend not only on the change in this index, but in the path it takes.
  • PowerShares DB Crude Oil Double Short ETN (DTO): For investors who think Friday’s mini-rally in crude prices may have been a bit premature, this exchange-traded note may be an interesting option. DTO offers 200% leverage, but unlike many of the leveraged ETFs from ProShares and Direxion, maintains a monthly rebalancing timeframe. That means that if the underlying index (in this case the Deutsche Bank Liquid Commodity Index-Oil) loses 2% during the month of September, DTO would gain approximately 4%. ProShares also offers an ETF featuring daily inverse leveraged exposure to crude; SCO is the bear counterpart to UCO.

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Disclosure: No positions at time of writing.