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Tired of WTI: Tim Pickering introduces the Canadian Crude Oil Index ETF

Canadians lack the ability to track the price of Canadian oil. That’s changing. Now it’s time to give investors some of that market

Jul 22, 2015

by Jesse Snyder

The Canadian Crude Oil Index ETF launched on the Toronto Stock Exchange in May. It gives investors a means to invest in Western Canadian Select, the heavy-sour blend produced in the oil sands

Tim Pickering is tired of talking about WTI. Every time he hears news about fluctuations in oil prices, it is measured and contextualized in terms of West Texas Intermediate – which fell from over $100 per barrel in mid-2014 to less than $50 in February. “What are we talking about WTI crude for?” asks the founder and president of Auspice Capital Advisors, a hedge fund. “It’s irrelevant.” And it’s not just in the news: if you were to ask most Calgarians – if you ask most Canadians, for that matter – what the price of oil is on any given day, those who have an answer for you are likely referencing WTI.

Pickering has good reason to question this long-standing convention. Most Canadian oil producers don’t receive WTI prices for their product. In fact, Western Canadian Select (WCS), or the heavy-sour blend that is typically likened to bitumen produced in the oil sands, trades at a differential to WTI. When the differential was at its worst, WCS was trading more than $40 below its American counterpart. In 2014, Pickering’s firm launched the Canadian Crude Index, which tracks WCS to provide an accurate price reading for anyone interested in the price of oil. Other companies launched similar indexes.

But Pickering thought more needed to be done. “While an index is nice, and it’s a great way for people to see the price of Canadian crude, the next step is to provide a product people can invest in,” he says. His response is the Canadian Crude Oil Index ETF (CCX), an exchange-traded fund linked to CCI that launched in May on the Toronto Stock Exchange. The ETF (a security that is bundled with various investments like a mutual fund, but sells on public exchanges) generated some early buzz, and locked down significant commitments before its launch. It’s too early to predict how much liquidity the fund could generate, but Pickering sees major market potential for the product. “There’s no reason why Canadian crude couldn’t have $1 billion worth of international interest.”

But it could be significant not just for its size. ETFs have, in past years, connected investors to many otherwise inaccessible markets. The SPDR Gold ETF managed by State Street Global Investors, for example, gave retail investors access to the international gold market that previously couldn’t be tapped.

At its peak in 2013, the fund reached a total asset value of over $50 billion and democratized the gold market.

Pickering’s CCX fund may be too specific to generate that kind of liquidity, but the size of the commodity it represents is nothing to sneeze at. “In terms of access, in recent months – and even in the last couple of years – I can’t think of an ETF that would’ve provided access to a market the size of this one,” says Yves Rebetez, the managing director of ETF Insight, a company that tracks Canadian ETFs. “It’s not hard to fathom that it could become a relevant and meaningful ETF in terms of size in the Canadian space.”

It also opens doors for retail investors – whether they choose to invest in it or not. Before the launch of CCX, there was no easy way for them to invest directly in Canadian oil. Average investors can’t buy futures contracts through the Chicago Mercantile Exchange or the Intercontinental Exchange, an opaque platform dominated by trading companies, hedged oil producers and investment banks. Those retail investors were instead left to invest in companies, exposing them to operational risk. Moreover, such investments aren’t direct investments in Canadian oil. “If you have a view on a commodity, don’t express it in a company. Express it in a commodity,” Pickering says.

Yet Rebetez wonders whether CCX is the right investment for average retail investors given recent price swings on the international oil market, not to mention the comparative advantages of investing directly in companies. “Considering the volatility of the commodity, maybe not,” he says.

But Auspice has structured CCX to minimize losses, particularly those that happen when futures contracts are above the expected future price of oil – a phenomenon known in the industry as “contango.” It has a rolling three-month exposure rather than a one-month, which theoretically reduces “negative roll yield” (essentially, losses) by extending the length of contracts and potentially lowering exposure to contango. There are other safeguards: The ETF will not be leveraged, and as a result it will invest in various financial instruments and derivatives, including treasury bills.

Other commodity-linked ETFs have been tried in Canada before. In 2008, Claymore Investments launched an ETF alongside Auspice that was linked to natural gas. There was high activity in the early years but the fund was shelved in 2012 after iShares, a division of BlackRock Investments, acquired Claymore and investment activity dropped.

Pickering is determined to make sure investors know his latest ETF won’t have a similar fate. He went on a sort of roadshow before the launch of the ETF, making countless pitches to banks and private institutions about why he believed the product was needed. He can’t count how many times he’s made the pitch. “Hundreds of times,” he says. Pitching the concept to investors, not to mention filing with the regulators, has also been strenuous. “It’s hard, it’s time consuming, and that means it’s expensive.”

Until now, investors were left to invest in companies, exposing them to operational risk. “If you have a view on a commodity, don’t express it in a company, express it in a commodity,” Pickering says

Generally speaking, the Canadian ETF market is growing fast. In 2010, Canada’s assets managed through ETFs totalled about $34 billion. Today that figure is $80 billion. That’s nowhere near the $1.1 trillion currently under mutual funds, but new players are always entering the marketplace. (Auspice marks the 11th provider in Canada.) “There’s ample room for a massive further uptake in ETFs,” Rebetez says.

Vanguard Canada, an ETF provider that recently expanded into Canada from the U.S., has grown from a marginal player to a company with a wide range of products, and today manages over $5 billion in assets. Vanguard remains too small to be compared to Canada’s larger providers like iShares or BMO, but its rise mirrors a trend toward super-cheap ETFs which create a highly competitive space in the ETF market. Smart beta ETFs, or funds that are managed by computer algorithms rather than human fund managers, automatically filter companies using a set of predetermined metrics, lowering costs.

The ETF market could see even more growth as regulators tighten disclosure laws for mutual fund managers, a decision that is currently being rolled out under Client Relationship Model – Stage 2. Depending on the implementation of CRM2, Rebetez says, mutual funds could take a hit in activity that could give rise to ETFs.

That may boost CCX’s exposure in general, but volatility in the international oil markets could scare away investors. Even so, the closing spread between WCS and WTI, which fell from $17 to $8 in the early part of 2015, could create opportunities for anyone willing to take that bet.

WCS has suffered from that differential largely because of a lack of export pipeline capacity. But there is more to that differential than pipeline bottlenecks or WCS’s ultra-heavy grade. Foreign blends of crude oil that are similar to WCS in grade, like Mexico’s Maya, tend to trade on par or even at a premium to WTI. Pickering says that is partly due to a lack of liquidity in the WCS market, and partly due to a lack of awareness of the WCS brand. “For any market to have true price discovery, it needs to have participants of all types,” he says. “It needs the hedge fund guy, and it needs the pension guy, and it needs the guy who has a big fuel bill and decides he needs to hedge it. We do not have that.” By bringing that differential into ETF format, CCX has the potential to actually add liquidity and raise awareness and transparency for WCS. But there are limits to that theory. While the CCX creates market access for investors, the market access troubles faced by Canadian oil producers seem unlikely to subside any time soon.


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