Welcome to Trillions. I'm Joel Weber

>> and I'm Eric Valis.

>> Eric, we had plans for this episode and

then uh the situation in the Middle

East, specifically around Iran, has

continued to escalate. So, we need to

talk about energy.

>> Yeah. Oil. What really got me thinking

we should call an audible this week is

USO. This is the oil ETF that has come

back from the dead like three times. I

swear I've written this thing off. Um

remember during CO it actually had

futures that were about to go negative

because nobody wanted an oil reversed.

Now you've got this thing's up um at

least it was up 12% on this particular

day and before that it had gone 40% in a

month and the volume was massive $22

billion in a week and it's been in the

top five most traded ETFs. So, it's come

out of its sort of grave to come back

and take over. This is the kind of ETF

that my friends from college will text

me about like, "Oh, I want to buy oil.

USO looks like the one." And it's the

ETF we really uh made the whole traffic

light system uh on be because it's

holding futures and they roll and it can

be hidden costs in there and people it's

like a wolf in sheep's clothing. But

when it goes up, man, it really works. I

think we should go over that. And then

also alternative ways to play energy

because if you don't want to mess with

derivatives, you got to go to the equity

market. So there's like XLE, XOP. So

when you want to play oil or invest in

oil or feel like you want more exposure

to it, you this is a perfect thing to

cover on this podcast because there's

multiple options and each have their

trade-offs.

>> You mentioned your traffic light system

at Bloomberg Intelligence. What traffic

light color are you giving this episode

as we go into it?

It's kind of the whole spectrum because

USO is red. Um, XLE and XOP would be

green. Although XOP gets one mark for

being not market cap weighted, but yeah.

Um, I would say flashing everything.

>> Yeah, this is that's why this is

complex. Um, investing in oil, the

bottom line is if you think about the

thing you want to invest in, say a

barrel of oil, think to yourself, how

annoying would this be to actually

invest in directly? you have to buy a

barrel of oil somewhere, put it in your

backyard, it's toxic. The more annoying

and exotic it sounds, the more you're

going to have to deal with some

frictions or things you don't like like

costs. And that's the case here.

>> So, joining us to walk through these

options, Vincent Piaza, who's the

Bloomberg Intelligence Senior Industry

Analyst for Energy, as well as James

Seaffort, ETF analyst at Bloomberg

Intelligence.

This time on trillions, the complexity

of the oil trade.

>> James Vince, welcome to Australians.

>> Thank you.

>> Thanks for having me.

>> James, I want to start with you. Can you

break down why USO

is like Eric said, it goes up and it

comes down. What what about how does

this thing structured that makes it so

volatile like that? Yeah, I don't I this

this wording is going to sound mean, but

it's called the United States Oil Fund.

And Eric said it's the it's one of the

primary reasons we went with the traffic

light because it's kind of like a wolf

in sheep's clothing. Like United States

Oil Fund. Like it just sounds like, oh,

it just holds oil. It's simple. And it's

so much more complex than that because

as Eric said, you got to roll futures.

It tries to stay as much in the front

month as it can typically. We can get

into what happened when oil went

negative, which is going to be

interesting to what's going on today,

but it it it it can change exactly what

it's holding. And when when when oil

went negative, things drastically

changed exactly how the ETF was working.

But what what ends up happening is even

if you think oil is going to go up over

a certain time period, that's not what

you're investing in. Everyone when oil

went negative would have would have

taken the bet that oil was going to go

up from here, but you can't just make

that bet in the markets because the

markets are smarter than that. They know

that oil is likely to go up and these

contracts end every month. So you need

to trade each contract. Um so and if

you're on the front month, you either

got to get out of that contract or you

have to take delivery of the oil and all

of this just gets very complicated. So

exactly why we're going to call this the

complexity of the oil trade.

>> And let me just paint a visual. If

you're picturing futures, right, um

April, May, June, July, it goes out like

a year. Picture the curve typically

slopes up. So like as you roll from like

April to May, you pay a little more for

the next month. That is called roll

costs. And this curve is in the state of

contango. Now if everyone wants oil in

an instant, the curve goes the opposite

direction. So you actually pay less when

you roll. That's where it's at right

now. And USO obviously this is a good

time to use it. But normally that roll

costs when it's in a state of contango

could be anywhere from 10 to 30% a year.

So you could make a call that oil is

going to go up in January and it goes up

40% or 30%. And you basically are flat

because of all the roll costs. That's

why this is a wolf and sheep's clothing.

But because it does hold the near

months, right, the months closest to the

actual barrel of oil, it does have a lot

of sensitivity to to the price today.

So, it does move very sensitively and

that's why the trading crowd likes it.

So, decent trading tool, bad long-term

holding. Vince, um, as an energy expert

at BI, I know you cover the equities. Is

that a fair assessment of the futures

market in your opinion?

>> That that is the uh I couldn't have said

it any better. That is the uh perfect

way of describing the difference between

a contango setup versus a backradation

which is what we have uh today. Um and

because of the volatility and also keep

in mind that the back end is fairly

illquid. Uh so the front end is more

liquid. There's much more volume on the

front end of the curve. the back end

because of that illi liquidity or the

less liquidity relative liquidity um you

you could see very very sharp changes in

the underlying price of those contracts.

>> Okay. Okay. So, Vince, one of the things

that I wanted to talk to you about was

not that long ago, like weeks. Uh, it

seemed like the world was in an oil

glut. Like, there was more oil on ships

than ever before. The price had been

dropping. We were talking $50 a barrel.

Now, it's like the reverse. How

sensitive is the oil market to just

disruptions and why is that? Oh uh we

have several significant choke points in

the world and the straighter hormuz is

probably one of the more significant

choke points. Uh roughly 20% of LNG uh

roughly 18 19 call it 20 million barrels

of crude run through that particular

very narrow passage. So a delay in

transporting those molecules has a

significant ripple effect across

several other of the choke points. That

choke point, that very narrow choke

point marries European supply, European

capacity

with

Asian demand. So, Middle Eastern supply

running through that up to Europe down

to Asia, that's a very significant choke

point that could have considerable

impact on balances both in the short

term and also in the long term.

>> One more followup, Vince, because you're

following this very closely and from a

like you're looking at the investment

side of it. How long can this last? like

um is this something that it just seems

like they're going to try to get the

choke point opened as fast as possible?

I mean I I'm sure I'm sure that the

pressure especially if it hits a you

know a price of gallon of gas is going

to be intense. So is this something that

could last for a long time or like I

guess in this trade

is it kind of like one of those things

that could reverse pretty quickly? So

the analog here that we have the closest

analog is uh 2022 uh Russia Ukraine uh

where Brent let let's use Brent right

Brent is considered the uh a global

seaborn benchmark. Yeah. So we had Brent

in February of 2022

spike

to a peak in March and retrace by early

2Q. So ret it retraced that gain that

peak of roughly from 90 to 12 80 to 120

and then back down again to a 90 handle

sometime in April. So it retraced very

quickly. Now in the case of uh the

straight of hormuz and Iran in general

we want to look at three things right. I

call it a delay.

I call it disruption and destruction.

Delay is the hydrocarbons

get to their destination a few days

later. We're not here. Disruption is I

shut down a well. I shut down capacity

because I fear that these barrels, these

molecules can't get to their final

destination. That's where we are now.

The destruction phase where all bets are

off. global economies are severely

impacted is if assets are taken off the

chessboard because of destruction. So

that there is significant capital that

needs to be invested

to bring these facilities and bring this

back up to snuff. So supply chain

delays, maritime logistical delays,

those are days. We're now in the case

where we could see significant barrels

off the market for significant periods

of time causing a collapse of the global

economy because we're staring at, you

know, uh, not long ago it was 120 being

bid before the US market opened. We're

staring at over $100.

That volatility is significant.

Let's say um you know we were college

roommates. This is a true story.

>> And I text you and I say, "Vince,

listen,

>> I'm not selling my Vanguard funds, but I

I want a little piece of this oil

action.

>> I want to make sure that I'm

participating in all this craziness.

>> Um I I was looking at USO, but I don't

know. I know you cover the stocks. What

should I do?" How would you answer that

question to to them? You can start with

this is not investment advice.

>> Yeah.

>> Yeah. Yeah. Yeah. Yeah.

>> Yeah. No, definitely.

>> That's true. I'm not trying to because

we we can't give investment advice, but

I guess maybe as as somebody who knows

as much as you

>> just be interesting to hear what what

you would say in terms of just somebody

who wants to get more exposure to this

market.

>> Yeah. So, so if you think about from a a

broader perspective,

um you have the ETF complex. The XLE is

probably the broadest, the most liquid,

the cheapest form of exposure across the

equity energy space, but that exposure

encompasses not only the upstream, but

also the downstream, the mid-stream

component. So, it gives you what I call

the energy value chain. So, so you you

like that vehicle as just like a proxy

for the indust energy complex.

>> Exactly. Exactly. Because within within

that ETF, as uh both James and Eric

know, three names make up the bulk of

that exposure and those are the

integrated. You have Exxon, Chevron, um

and you have what I call a a a mega

independent like uh KICO. They make up

the bulk of that exposure. So they have

exposure across not only the upstream

side of the business. So the extractives

right the EMPs but also have downstream

downstream refining and also

petrochemicals. So that provides you

with the value chain exposure as you get

more granular and you think about the

EMP space. Um the XOP um is an area that

that we've discussed um in the past. Um

but the XOP or the uh US oil and gas EMP

ETF which I think is I

EO um they're not pure proxies uh for

the upstream exposure because they too

have uh much more broader exposure to

the downstream and also some LNG

components. Really, when you think about

the exposure and what tends to to to to

do well in instances like this, it tends

to be that downstream side, right?

Because as prices go up, the refiners

repric to the consumer at the retail

level

the gas and diesel that go into on-road

uh vehicles. And so that price tends to

come across pretty instantly.

But when prices revert

at the wholesale level, at the crude

level,

prices at the pump don't correlate as

quickly. So, in the refining space, in

the downstream space, uh you have

probably one of my favorite uh uh uh uh

ticker symbols of all time. Um C R A K.

You guys can pronounce it for me. Um

>> um V Vince wrote a primer recently,

which is basically an introduction to

stocks usually. He wrote one for XLE.

And in it, I'm reading it and I could

tell he he loves crack. Joel, cuz I'm

like I'm like Vince. Why don't you just

>> Why don't you just say you love crack in

the headline? I mean, that's really

what's going on here.

>> Okay. So, talk to us about about uh the

ETF crack, Vince.

>> Yeah. So, it provides you with uh pure

play downstream exposure. When I mean

downstream exposure, the upstream side

are the companies that extract the

hydrocarbon.

The downstream the refiners are the

companies that uh uh uh refine the

product the raw material the feed stock

into the things that we use. Uh so the

gasoline and diesel that cars and trucks

and vans uh use in their everyday. Um

now as as spreads widen

there is an outsized profitability that

ends up in the hands of the refining

companies and most likely for longer uh

even after the price reverts. So it is a

pure play exposure to the downstream.

The reasoning being that you have margin

expansion and higher profitability for

longer as this crisis persists for

longer. You also most likely have what I

would call a geopolitical risk premium

that remains uh in the in the commodity

for longer as well.

Eric, to bring in just a little bit of

flows and and comp between the ETFs

we've talked about so far, like what's

the action look like for this suite of

ETFs in the energy space?

>> Yeah. So, he went over a I think four of

the big ones. Um maybe five, but XLE is

the king. It sounds like from what Vince

is saying and what I would you know also

echo is like you you can't really get

too hurt with XLE. Um it holds a lot of

stocks. It's diversified. The only thing

is just it's not going to have the

sensitivity to um short-term moves in

oil. Like if you look over the short

term, USO is blowing away XLE in the

past like week or month. But XLE is up

like 168% in the past 10 years,

something like that. And USO is like

down. So it's that rolling of the

futures that makes USO almost like a hot

potato. You cannot hold it for longer.

It will just eat you alive. XLE you can

hold for longer. So I think that's the

main takeaway. Okay. And then XOP, XES,

they're going to have like um more

specific parts of the oil industry. So,

it's like almost like a subsector.

>> Yeah. Like a specific niche bet.

>> But if we look at this year, the number

one ETF by flows is XLE with 5 billion.

Number two isn't even a billion. Um I

funny number two is URA uranium Joel

even though uh that's energy. Uh VDE XOP

is fourth. OIH is another one. So I

guess you know this is part of the

dilemma. I want to go to James on USO.

Um James, obviously holding these equity

ETFs is is monitor, you know, that's why

these equity ETFs get a green light in

our system. They're diversified. They

hold equities. Um they have obviously

some sensitivity to oil, but not like

USO. Now, can you go over USO a little

bit here? It came out in like 20 years

ago. It rolls futures. Um, and then

during COVID futures were about to go

negative. And I think it had to like it

was going to owe people money or

something. So, it had to like switch its

strategy to holding all of these

different futures across the curve so

that it wasn't like just holding the

near month. And then I guess it switched

back. Can you go through the story of

USO? Because honestly, I wrote it off. I

thought it it had become neutered by

holding all these months which gives it

less teeth and less sensitivity to oil

but I guess it went back to its uh front

month exposure.

Yeah, that's exactly right. So what

happened oil oil went negative or was

going negative things things were going

bad because the government the world was

shut down due to COVID and what ended up

hap what really there was a few big

drivers. One they were heavily in the

front month and second month contracts

which is what this product does and they

were not doing well. The other problem

was the ETF was this was a case

sometimes ETFs like they're they're a

fish that gets too big for the pond that

they're in. And in this case, USO owned

like well over 30% of the contracts of

the open interests of the futures that

were getting exposure to the to the oil

contracts. It was basically the tail

wagging the dog and the SEC was getting

concerned, the CFTC was getting

concerned. They had to go in and break

like bake the rules that they basically

had in their in their perspectives

saying what the fund would do because

all of a sudden you have all this money

in this fund that's holding this

contract and it's all going to flow out

because it rolls to the the next month

contract like it's set to keep rolling

and all of a sudden you're going to have

a ton of money pour out towards the end

of this contract. It's already heading

negative. So they're going to dump more

of these contracts onto the market as

it's negative. ETF can't go negative.

All these problems were happening. So

what they did is as you said they they

went to all these other months. They

went out 12 months essentially. So they

went from we have high octane exposure

to what's going on in oil right now to

we own the entire curve. Essentially we

own the curve out one year. And so one a

lot of investors who were trying to bet

on oil rebounding all of a sudden didn't

have a bet on oil rebounding because

they were just bet across the curve. And

the funny thing is thei US commodity

funds actually has another fund that

does this already. It's called USL and

it holds the 12month contracts. So

essentially USO started mirroring its

its sibling of USL and it it wasn't

great. It took a few years but in 2023 I

believe they started moving back from

the 12-month contracts just to the front

two months and I I yeah so it this all

happened. It was kind of crazy in 2023

time range. Um but it they got back by

January 2024 they were in the front and

second month contracts.

>> Okay. So change in strategy there.

That brings us back to basically being

like this thing was originally, right?

So, we'll be curious to see how this one

plays out since it's so volatile.

>> Yeah. I mean, looking year to date, um,

USO is up 57%. UNL is up 2%. So, but if

you went back, UNL would have probably

gone down less. It it also doesn't have

as much roll costs. But honestly, here's

my take. If you're looking for quick

sensitivity and a short-term trade, I

mean, USO will do the job, but you can't

hold it. You just you can't hold two

things long term. You can't hold

anything that rolls futures and you

can't hold anything that has leverage.

>> You have to treat it like a chainsaw or

>> juggling the chainsaw.

>> Yes. Um XLE, XOP, these are diversified

ETFs that you can sort of bolt onto your

portfolio as if you're, you know, one a

long-term overweight to the sector. I

noticed you didn't mention crack when I

asked you about uh you know the comp

screen. You want to talk about

>> there's also frack. They're like

siblings. Frack and crack. Um

>> so yeah, I mean look uh crack is uh a

very specific oil refiners. I I Vince's

case is good to me because

>> you you can go out and speculate and try

to drill the oil, but you have to refine

it. So the refiners are kind of like in

a sweet spot of like you have to come

through us anyway. And that's a good

spot to be in. I guess just depends on

and also I think um the more you get to

sub- sector ETFs outside of XLE the more

you are not overlapping your regular

portfolio because a lot of people own VU

and a lot of XLE's top holdings are in

VU already or IVV or SPY the more you go

to subsectors the more you're getting

unique exposure that we call portfolio

completion so I I think crack is a you

know a good novel choice for something

that's like you know not the obvious

one. Um, we try to do that when we write

our notes, too, is like here's the big

one, here's the cheapest one, and here's

sort of like a wild card you might not

have thought of.

Okay. Another wild card that I wanted to

bring up, the Breakwater ETF.

>> Yeah.

>> Did you talk about that one?

>> Yeah.

>> Cuz V, you know, Vince, we're talking

about stuff that's industry specific,

but then there's going to be the stuff

that's sort of like peripheral, right?

So,

I didn't even know this existed.

Sometimes I, you know, there's 4,800. I

I I I was like,

>> "Come on, you got to know these."

>> So, this is called the Breakwave Tanker

Shipping ETF.

>> Oh, I said Breakwater. Breakwave.

>> Breakwave. Yeah. And the ticker is Bwet.

And uh the day after the Iran,

>> do you know this one? Do you know what

it holds?

>> No. He He says, "No, James, do you

know?" Of course you know.

>> Well, because he he found out.

>> I do know now. Yeah. I knew what B dry

was, but I didn't know what B wet was

until this till the last couple weeks.

The day after the Iran strikes, which

would be Monday the 2nd of March, it

went up 28%. That is insane for a

non-leveraged ETF. I mean, that is

unbelievable. A one day change.

>> Yeah, it went up more than USO. Uh went

up more than anything I could see. It

was perfectly position. Okay. What does

it hold?

>> It basically holds these tanker futures

that are linked to shipping oil from the

Middle East to Asia and Europe. So, I'm

like, this is like it's like literally

the

>> he literally made it for this situation.

It's a little dark thinking something's

going to benefit from war. I don't want

to go too heavy into this, but this was

custom made for this. Now, it is so

crazy sounding though. The volume was

nowhere near what we saw in USO. It did

trade about $15 million, which is pretty

good for a real exotic ETF like this.

But the average Joe Deen is going to use

USO. This is just probably even a little

too crazy for them. James, what can you

tell us about this that that we might

might not know?

>> Um, you hit most of it. I mean, what the

way to think about this is it's futures

contracts, like you said, on shipping to

Europe, Middle East. It's really

basically the futures contracts on those

actual tankers. Think those massive

massive ships that are holding the oil

and and whatever other hydrocarbons as

as Vince talked about. Um, and then the

the the flip side, the B dry one was one

that we talked a lot about with Russia

and Ukraine, and that's going to be

holding, you know, dry goods, whether

that's commodities like agriculture and

mining materials and things like that.

So, they're kind of like twins or same

side, different sides of the same coin.

But BW is these futures contracts on

these massive shipping oil tankers, most

of which are sitting right now in that

canal waiting to go by um in the

straight of Hermuz. And by the way, you

know this idea that like poly markets

like oh all these dens can bet on two

it's too crazy. I mean the honestly this

future is called Middle East Gulf to

China. I'm sorry the institutional world

is pretty den when it comes to betting

on stuff. I didn't even know there were

futures. I mean a lot of it is like

they're using it for hedging purposes.

Like a lot of these ships, one of the

huge things that happened is like their

war insurance stopped and basically

because anybody who's offering that

insurance can give a notice of like a

certain days beforehand and they can

pick up insurance again and then they

have to pay more for it. So war

insurance now is like 5x what it used to

be just before everything happened here.

So all these things are just hedging

insurance. It's this is all it is and

you can everything is financialized.

>> Vince I I know Vince. I work with him a

lot. Um, and his out is filled with

earnings calls, like literally from like

6:00 a.m. to like 6:00 p.m.

>> of all these energy companies. So, you

clearly have your your ear to the ground

in terms of what they're talking about.

>> What do they think of something like

this? Like, if you're in the energy

industry, is this good, bad, and

different? What's the vibe there?

So I can tell you from our conversations

with the management teams that they look

at this with a great deal of caution,

right? Because you're now at a point

where you're in the realm of demand

destruction and that is very bad. Okay?

when you sell a product whose price is

so high that it reduces the amount of of

consumption or uh it creates that

inflationary pressure across the value

chain. That's bad. When you think about

prices along this curve, right, we've

seen the front end of this curve pop.

the back end of the curve, let's call it

uh the second half of the year, that's

averaging somewhere around 80 bucks or

so. What you're likely to see from

operators over the course of call the

next earning season is

layering on additional hedges. And

what's a hedge? It's risk protection. I

am selling my output forward. I am

receiving a price, a confirmed price. It

creates transparency for me. It creates

cash flow. It protects my drilling

program. Okay? And I think that's what

the operators are looking for because

the investor base, what you all have

told them is I do not want to see

production. I do not want to see capital

being invested to grow output. What I

want is the return of free cash flow.

What I want to see is better balance

sheets. So, the operators have

rightsized their balance sheets in this

environment since uh uh 2022. Uh they've

gotten their financial leverage down.

Free cash flow is relatively robust now.

And so you're seeing distributions,

you're seeing distributions of what we

consider base dividends and on top of

that supplemental distributions. So the

capital is coming back to the investors.

That's what uh you all have said you all

wanted. We don't want a production. So I

do not see any I I shouldn't say any uh

I would be surprised if we were to see

an acceleration of production growth in

this environment. What I will see, what

is likely to to occur is an increase in

the amount of hedging over the over the

year 2026 because of a way not only the

front of the curve has responded, but

also the back end of the curve most

recently granting these operators an

opportunity to slap some additional

hedges on, protect uh their drilling

programs, and grant them some

incremental free cash flow to give back

to all of you.

>> A hedge feels like the perfect way to

end this episode.

>> Vince James, thanks so much for your

time.

>> Thank you.

>> Thank you for having me.

>> Thanks for listening to Trillions. Until

next time, you can find us on the

Bloomberg terminal, Bloomberg.com, Apple

Podcast, Spotify, or wherever else you

like to listen. We'd love to hear from

you. Hit us up on social. I'm Joel Weber

Show. He's Eric Baltchas. Trillions is

produced by Magnus Hendrickson.