The United States Oil Fund (USO) is an exchanged-traded product (ETP) that seeks to provide investment results corresponding to the daily price movements of West Texas Intermediate (WTI) light, sweet crude oil. The United States Oil Fund is designed for short-term investors who can continuously monitor their positions and who are bullish on short-term futures contracts on WTI crude oil. Since the fund's benchmark is the WTI crude oil futures contract traded on the New York Mercantile Exchange (NYMEX), the fund may experience contango when rolling the futures contracts, which is unfavorable for long-term investors.
The United States Oil Fund was issued on April 10, 2006, by the United States Commodity Fund. The fund's investment objective is to provide daily investment results corresponding to the daily percentage changes of the spot price of WTI crude oil to be delivered to Cushing, Oklahoma. The daily changes are measured by the daily percentage changes in the price of near-month WTI crude oil futures contracts traded on the NYMEX. If the front-month futures contract is approaching two weeks until its expiration date, the WTI crude oil futures contract expiring the following month is the fund's benchmark. Although the fund invests its assets primarily in exchange-listed crude oil futures contracts and oil-related futures contracts, such as natural gas futures contracts, the fund may also invest in swap and forward contracts.
Since all futures contracts have an expiration date, the United States Oil Fund must actively roll its front-month futures contract to the WTI crude oil futures contract expiring in the next month to avoid taking delivery of the commodity. The fund primarily holds front-month futures contracts on crude oil and has to roll over its futures contracts every month. For example, if it holds WTI crude oil futures contracts that expire in September 2016, it must roll over its contracts and purchase those that expire in October 2016.
The United States Oil Fund has underperformed the spot price of WTI crude oil and has not correctly measured its daily performance over the past five years. Consequently, investors who are bullish on oil over the long term may want to stay away from this fund due to its underperformance. Between June 30, 2011, and June 30, 2016, the spot price of WTI crude oil has only fallen 49.35%, from $95.30 per barrel to $48.27 per barrel. However, the United States Oil Fund has fallen 68.23% over the same period. Additionally, WTI crude oil spot prices were up 31.13% year-to-date (YTD) as of June 30, 2016, while the United States Oil Fund is up only 4.9% YTD. The fund's underperformance and large tracking error are primarily due to the cost of rolling the futures contracts over every month and contango.
Contango and Negative Roll Yield
Contango occurs when the price of a futures contract on an underlying asset is above its expected future spot price. Since the front-month futures contracts are cheaper than those expiring further out in time, the futures curve is said to be upward-sloping. This causes negative roll yields, because investors will lose money when selling the futures contracts that are expiring and purchasing further dated contracts at a higher price. Contrary to contango, backwardation occurs when the price of a futures contract of an underlying asset is below its expected future spot price. Consequently, backwardation causes investors to profit when rolling expiring futures contracts to futures contracts expiring at a later month.
Crude oil and natural gas are among commodities that have historically experienced long periods of contango. Therefore, the United States Oil Fund suffers from negative roll yields when purchasing further dated WTI futures contracts as the front-month futures contract expires. Over the long term, the negative roll yields add up, causing United States Oil Fund investors to experience losses. Therefore, investors planning to gain exposure to the oil market over the long term should avoid investments in the United States Oil Fund.