Focus on Energy Commodity Index Exposure
The main commodity indices have an energy commodity index component as part of their overall diversification across this asset class.
Given the huge significance of energy commodities to global economic growth, this component invariably represents the largest sector in the main indices.
The tightness of supply and demand of crude oil means that high prices are likely to remain, and given the way most commodity indexes are constructed, crude oil in particular is likely to remain the major components in these indices going forward.
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Most of the easy oil has been discovered, so further exploration is in more challenging locations.
However, at these price levels most exploration activities in these challenging environments are viable, which should in the medium term stabilise the supply of crude oil.
So how do the various indexes reflect the price of energy commodities?
Take, for example, the S&P GSCI (Goldman Sachs) Composite index and we see that the energy complex represents (as at 11 June 2008) a massive 78.3% of the index value. The surge in crude oil prices over recent months will have contributed to this skew in the weightings, if we look closely at the breakdown of the energy figure.
NYMEX West Texas Intermediate (WTI) is the major component at 40.64%, followed some way behind by ICE Brent Crude at 14.74%. NYMEX traded Natural Gas (7.36%), RBOB Gasoline (Reformulated Blendstock for Oxygenated blending) (4.57%), No.2 Heating Oil (5.54%) and Gasoil (5.45%) make up the balance of the energy component.
The S&PGSCI also offer variations where there are lower percentages of the energy commodities and correspondingly higher allocations for industrial and precious metals, livestock and agricultural commodities.
For example, the GSRE (Reduced Energy) Index has energy at 64.35%, of which WTI makes up 33.4%.
If there was a sudden and significant correction in crude oil prices from the $130-$135 level (May-June 2008), the S&PGSCI, made up almost 4/5ths of hydrocarbons, would fall disproportionately, even when other commodity prices are relatively steady.
US dollar denominated Rogers International Commodity Index (RICI) is compiled in such a way that it reflects the stability and liquidity in a particular commodity sector. Energy is the major component in RICI at 44%, with WTI crude making up 21% while ICE Brent contributes 14%.
The balance is made up of RBOB, natural gas, heating oil and IPE gasoil.
DJ AIGCI has energy just within the limit at 32.9%, with crude oil at 13.1%, natural gas (12.2%) and gasoline and heating oil, each on 3.8%. Energy represents about a third of the Reuters Jeffries CRB Commodities Index (which was changed from the Continuous Commodities Index (CCI) in 2005), made up of the NYMEX contracts WTI, heating oil and unleaded gasoline in Group 1 (hydrocarbons) of the index classification.
The above percentage allocations are not fixed but change depending on the methodology of allocation and valuation used by the compilers.
It is possible for example using the S&P GSCI to have exposure to the commodity universe without the energy sector, with the allocations of the other commodity classes increased correspondingly.
Investors and traders can gain exposure to commodities using vehicles called exchange traded funds (ETFs) or exchange traded commodities (ETCs).
These funds can follow the movements of some of the mainstream commodity indices and act as an alternative to trading futures or options.
It is possible, for example, to have exposure to the DJ AIGCI Energy sub-index or even to the single commodities, like crude oil, in the DJ AIGCI Crude Oil sub-index, or say a combination of WTI, heating oil and gasoline in the DJ AIG Petroleum sub-index.
Over the long term as the main sources of petroleum decline, we may well see the inclusion of Canadian oil sands as a new category in the mainstream energy commodity indexes.
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