The United States Oil Fund (NYSEArca: USO), which tracks West Texas Intermediate oil, and the United States Brent Oil Fund (NYSEArca: BNO) are down 15.8% and 8.1%, respectively, year-to-date after falling an average of 45.5% last year.
However, USO and some other futures-based oil exchange traded products present problems to buy-and-hold investors beyond falling oil prices. Structural issues, including the need for USO to constantly roll into new futures contracts has consistently hampered returns for investors opting to hold these products for long time frames.
ETFs such as USO and the iPath S&P GSCI Crude Oil Total Return Index ETN (NYSEArca: OIL), which is down more than 18% this year, “must perpetually buy high and sell low as they ‘roll’ expiring futures into new ones,” reports Chris Dieterich for Barron’s.
That leads to expense ratios that are well above the typical equity-based energy ETF. For example, USO charges 0.45% per year while OIL charges 0.75%. On the other hand, the least expensive equity-based energy ETFs charge just 0.12% per year. [Cheap ETF for an Energy Sector Rebound]
“Those costs accrue with each passing month. The United States Oil fund saw comparable demand from investors in February 2009, the last time oil prices imploded. From there, spot crude more than tripled from $34 a barrel in about two years. Yet, investors holding the fund captured only about a third of that,” according to Barron’s.
Even with those disadvantages, investors and traders continue flocking to ETFs like USO, giving the funds an outsized impact on the oil futures market. to the robust interest in oil futures-backed ETFs, ETF Securities analysts calculate that the ETFs now hold between an equivalent 175 million to 180 million barrels of WTI for delivery in May, or about 30% of combined open interest for May WTI futures contracts. [Oil ETFs Dominate Futures Market]
Olivier Jakob, managing director of Petromatrix, points out that USO’s WTI holdings are still short of its record of 96,523 contracts in 2009, compared to 61,793 contracts Tuesday, but it is still nine times higher year-over-year, according to the Financial Times.
USO has added over $2 billion in new assets this year, though much of that has come by way of short sellers opting to short USO rather than establish long positions in inverse oil ETFs.
As more people get into oil ETFs, new investors should understand the potential risks of trading futures-backed funds. Specifically, oil traders should be aware that USO tracks front-month WTI future contracts and the underlying oil market is currently in a state of contango. Consequently, USO could experience a negative roll yield when rolling a maturing futures contract.
U.S. Oil Fund
