United States Commodity Funds (USCF) has announced that the $1.3 billion United States Oil Fund (USO US), the largest ETF to provide exposure to oil prices, will begin reverting back to a front-month futures strategy next month.
Oil market stability appears to be returning to pre-Covid levels.
USO’s investment objective is to track the spot price of light sweet crude oil delivered to Cushing, Oklahoma. The fund traditionally sought to achieve its objective by investing in front-month futures contracts of West Texas Intermediate (WTI) crude oil; however, it changed its strategy in 2020 amid turmoil in global oil markets at that time.
Oil prices plummeted in 2020 due to a sharp reduction in energy demand resulting from the Covid-19 pandemic-induced economic shutdown at the same time that a feud between key producers Saudi Arabia and Russia led to an oversupply of crude oil.
Despite depressed oil prices, USO’s assets swelled to over $3 billion at that time as the oil market rout brought out many speculative traders seeking to profit from a potential rebound in oil prices. The ETF’s sudden increase in AUM caused the fund to breach regulation from the Commodity Futures Trading Commission which states that no single investor may purchase over 25% of a given futures contract.
Regulators pushed USCF to change USO’s strategy, citing concerns that the ETF’s sheer size could exacerbate volatility in oil markets when the fund began rolling its position from the expiring front-month contract into the next month’s contract.
USCF responded by investing USO’s assets in a mix of WTI futures contracts with delivery dates diversified across the futures curve. The firm also expanded the fund’s mandate to include, if necessary, futures contracts for other types of crude oil, diesel-heating oil, gasoline, and natural gas.
The altered strategy has remained in place ever since, likely a reflection of how Russia’s invasion of Ukraine, as well as concerns over a slow-down in China’s economic growth, have kept market observers on edge over oil price volatility – as of 29 August, USO is 20% invested in WTI futures contracts for October 2023, 20% in November, 15% in December, 15% in January 2024, 10% in February, 5% in March, and 15% in June.
The announcement from USCF that USO will begin shifting back to a front-month futures strategy from next month indicates that the firm believes that oil market stability is returning to pre-Covid levels.
The move has implications for USO and its investors. While the ETF is expected to better track its target benchmark, which always remained the near-month crude oil futures contract traded on NYMEX, investors may be exposed to more significant rolling costs, especially when oil markets are in steep contango.
USCF has also noted that it will retain the ability to invest USO’s assets in later-dated WTI contracts as well as other energy derivatives should adverse market conditions warrant such a move.