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Investor Losses in Oil and Gas Structured Products

With the recent drop in oil and gas prices, investors who hold structured products (also known as “structured notes”) tied to that sector may be at risk of significant losses.   This may include structured notes tied to the following stocks, among others:

  • Western Midstream Partners, LP (WES);
  • Apache Corporation (APA);
  • Targa Resources Corp. (TRGP);
  • Continental Resources, Inc.;
  • Cenovus Energy Inc.;
  • Occidential Petroleum Corp (OXY);
  • Marathon Oil Corporation (MRO);
  • Weatherford International PLC (WFTLF);
  • Sasol Limited (SSL);
  • Diamondback Energy, Inc. (FANG);
  • Parsley Energy Inc.;
  • Halliburton Company (HAL);
  • Hess Midstream LP (HESM)

Similarly, investors who hold structured notes tied to oil and gas ETFs may be at risk of significant losses.  These ETFs may include, among others:

  • United States Oil Fund (USO);
  • United States Brent Oil Fund (BNO);
  • iPath Series B S&P GSCI Crude Oil Total Return Index (OIL);
  • ProShares K-1 Free Crude Oil Strategy ETF (OILK);
  • United States Gasoline Fund (UGA);
  • Invesco DB Oil Fund (UNG);
  • ETRACS S&P GSCI Crude Oil Total REturn Index (ETN);
  • iPath Series B Boomberg Energy Subindex Total Return ETN (JJE)

What are structured products (aka “Structured Notes”)?

Structured notes are marketed as bond-like investments that promise a favorable rate of return.  Structured notes are typically tied to a sector of equities, or, in some cases, individual stocks, the underlying performance of which impact the performance of the structured note.  Structured notes often have limited upside, meaning their rate of return is capped at a specificed interest rate.  Conversely, structured notes can have unlimited downside and can be automatically “called” if the corresponding value of the equities or sector to which it is tied falls by a specified percentage or amount.

How do structured notes work, and how can an investor benefit?

Example: Suppose an investor purchases a structured note tied to basket of oil and gas stocks for $100,000.  The note promises an 8% interest rate for one year.  The note will continue to pay that 8% interest rate even if the underlying value of the oil and gas securities to which it is tied increases more than 8%.  This “caps” the structured note’s return at 8%.  Therefore, assuming the underlying value of the oil and gas stocks do not decrease significantly (more on that below), or increase within the course of the one year period, the investor will receive their promised 8% interest rate and their principal (i.e. the initial $100,000 investment) will be returned after one year.

Therefore, on the surface, structured notes appear to operate like a bond in that they seem to offer a favorable yield/interest rate.

What’s the risk associated with structured notes?

But what if the underlying value of the oil and gas stocks to which the structured note was tied decrease significantly?  Regularly, a structured note’s promised rate of return will be contingent on the underlying securities to which it is tied not falling a certain amount or percentage.

Suppose the 8% interest that the hypothetical structured note above promised was contingent upon the oil and gas stocks to which it was tied not falling more than 30%.  If the oil and gas stocks fall 30% or more, the structured note allows the issuer to automatically “call” the structured note for 50% of the initial investment.  Between March 3, 2020 and March 9, 2020, in less than one week, oil and gas stocks fell approximately 31%.  Suppose the investor purchased such a structured note on March 1, 2020, as of the date of this post (March 12, 2020) their $100,000 hypothetical investment would have been “called” and the issuer would have returned only $50,000 in cash to the account having not received the benefit of the 8% interest the note promised, and causing the investor to incur a 50% loss in two weeks.

There are numerous variations of structured notes, and the above example is commonly known as an “auto-callable structured note.”

The Bottom Line

Structured notes tied to oil and gas are at risk of significant losses given the dramatic fall in oil and gas prices.  If you are an investor that was concentrated in oil and gas related securities, you should consider all legal options. If you wish to discuss your particular situation and the potential for the recovery of your investment losses, or you have information of interest, please contact us for an evaluation of your potential case.