Thanks to a relatively strong dollar and weak economic growth levels around the world, many energy commodities have been under pressure as of late. Oil, for example, was once routinely above $100/bbl but is now struggling to maintain its momentum above the $90/bbl mark.
However, while the situation has been dire as of late, a marginally better economic outlook and some Middle East tensions have once again pushed energy prices higher. Furthermore on the home front, increased demand for natural gas has also helped to spur that commodity out of the doldrums, although long term pictures for the product still aren't very pretty.
Yet, while all energy products have come back in the summer months, the real winner has been in the world of gasoline, as represented by the United States Gasoline Fund (UGA). This product looks to track the percentage changes in the spot price of RBOB gasoline as traded on the NYMEX (see Time to Buy Oil and Gas Services ETFs?).
This product has handily outperformed the other oil-based ETFs in the segment, gaining about 8.7% in the past three months compared to just a 1.9% gain for Brent Oil (BNO) and a 4.4% loss for WTI crude, as represented by USO.
This is somewhat curious, as gasoline is a by-product of crude oil, as for every three refined crude oil barrels, two barrels of gasoline can be produced. With this relationship, one would assume that UGA would be moving in lockstep with its oil counterparts, although this has obviously note been the case as of late.
Instead, some key changes to the gasoline refining market have helped the commodity to outperform its peers in the most recent three-month period by a pretty wide margin.
First, investors saw a few major pipelines rupture or see other problems across the Midwest, curtailing supply in the region. Then, a major fire at a refinery in California also helped to reduce refining capacity, making gasoline somewhat harder to come by in the short term (read Play an Oil Bull with These Three Emerging Market ETFs).
Investors should also note that some Mideast tensions could also be playing a role in the spike in gasoline prices as of late, especially in regards to Iran. Currently, the nation is the fourth biggest producer of oil and is situated atop the Strait of Hormuz, a crucial oil gateway.
There have been some concerns over an increase in both the rhetoric and military presence by America and Iran in this waterway, which could be acting as a risk premium for oil and gasoline in the near term (see Three ETFs for an Iranian Crisis).
With this being said investors should note that ethanol, while a big contributor to gasoline's rise at the pump, is probably not a big factor for the fuel's surge in commodity contract form. That is because UGA tracks a benchmark that is purely RBOB gasoline, in other words, before the addition of increasingly expensive ethanol.
This means that the increased price at the pump could deviate from returns in gasoline futures since, for the most part, gasoline at the pump must have at least 10% ethanol. Due to this difference, investors should probably try to put end use prices out of their mind, at least when dealing with UGA.
Instead, investors need to focus in on the futures curve and the situation of 'backwardation.' This is when futures contracts that are further out are less expensive than current contracts, making the roll process that much easier on investors' bottom lines.
This is especially important for UGA as the product rolls over into a new contract every month, meaning that, when in backwardation, it is buying a lower priced contract every time. This can translate into huge gains, and the opposite situation, contango, has plagued many energy commodities for at least the past few years (read Forget WTI, Play Crude with This Oil ETF).
In fact, many other energy products, such as crude oil, heating oil, and natural gas, are all in contango at time of writing. This means that products tracking these commodities will have to roll into more expensive contracts on a monthly basis, potentially hampering any return that these funds can generate.
Due to this issue of contango/backwardation as well as the ongoing geopolitical problems and refinery issues, there still could be some room left for UGA to run. This could be especially true when comparing the commodity against the other energy products in the ETF world, suggesting that at the very least, a pairs trade in which one goes long UGA and short a crude oil ETF, could be an interesting way to play the market (see Three ETFs for The Unconventional Oil Revolution).
However, this is probably only a short term trade as backwardation and the refining problems cannot last forever. Still, while these issues are present and before refiners cycle over to cheaper blends in the fall, a closer look at UGA could be warranted by short-term traders looking to make a play on the energy market.
Eric Dutram
Zachs Investment Research
