Is Investing in the United States Oil Fund (USO) Wise for Oil Exposure?

Gordon Scott brings over 20 years of experience as an active investor and technical analyst and holds the Chartered Market Technician (CMT) designation.

The United States Oil Fund (USO) is an exchange-traded product (ETP) designed to mirror the daily price fluctuations of West Texas Intermediate (WTI) light, sweet crude oil. It is tailored for short-term investors who monitor their positions closely and are optimistic about short-term futures contracts on WTI crude oil.

Because USO tracks WTI crude oil futures traded on the New York Mercantile Exchange (NYMEX), it is subject to contango—a market condition unfavorable for long-term holders—when rolling futures contracts.

Key Considerations

In April 2020, amid the COVID-19 pandemic, crude oil prices plummeted to two-decade lows. USO’s share price dropped over 30% to just above $20, leading to a trading halt as the fund’s managers implemented structural adjustments to prevent collapse. Subsequently, USO executed a 1-for-8 reverse share split on April 28, 2020, consolidating shares to increase per-share price, a move often signaling challenges in maintaining value.

Fund Background

Launched on April 10, 2006, by the United States Commodity Fund, USO aims to deliver daily investment returns that correspond to the daily percentage changes in the spot price of WTI crude oil deliverable at Cushing, Oklahoma. This is measured using near-month WTI crude oil futures contracts on NYMEX. When the front-month contract approaches expiration within two weeks, the fund benchmarks the next month’s contract.

While primarily investing in exchange-listed crude oil and related futures such as natural gas, USO may also utilize swap and forward contracts.

Due to futures contracts’ expiration dates, USO must actively roll its front-month contracts to the subsequent month’s contracts to avoid physical delivery. For instance, contracts expiring in September 2020 would be rolled into October 2020 contracts.

Fund Overview

• Objective: Track the performance of WTI light, sweet crude oil.
• Investment Approach: Holds near-month NYMEX WTI crude oil futures contracts.
• Assets Under Management: $1.25 trillion (as of July 25, 2024)
• Expense Ratio: 0.70%
• Year-to-Date Return: 18.99%
• Inception Date: April 10, 2006
• Average Daily Trading Volume: 2.46 million shares

Performance History

Since 2020, USO has lagged behind the spot price of WTI crude oil and has struggled to accurately track daily price movements. Long-term bullish investors may find USO unsuitable due to its underperformance. Oil prices have shown significant volatility over the past 20 years, peaking above $140 and dipping as low as $13 per barrel.

As of July 2024, oil prices have rebounded to around $82 per barrel, recovering from a sharp decline to about $19 in May 2020 during the pandemic. USO generally tracks oil prices well, with trailing returns of 25.13% over 1 year, -3.88% over 5 years, and -12.73% over 10 years.

Contango and Negative Roll Yield Explained

Contango occurs when futures contract prices exceed the expected future spot price, resulting in an upward-sloping futures curve. This leads to negative roll yields as investors sell expiring contracts at lower prices and buy longer-dated contracts at higher prices, causing losses.

Conversely, backwardation happens when futures prices are below expected future spot prices, allowing investors to gain when rolling contracts forward.

Crude oil and natural gas frequently experience extended contango periods. Consequently, USO suffers from negative roll yields when rolling futures contracts, which accumulate losses over time. Therefore, investors seeking long-term oil exposure should avoid USO due to these structural disadvantages.

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