USO ETF pushes oil futures exposure out to June 2021
United States Commodity Funds (USCF) has announced substantial new changes to the investment strategy of the $3.6 billion United States Oil Fund (USO US), the largest ETF worldwide to provide exposure to oil prices.
In a series of filings, USCF has revised USO’s mandate to invest in a mix of West Texas Intermediate (WTI) futures contracts with delivery dates stretching out as far as June 2021.
The sponsor has also revised the contract roll process, extending the roll period from four to ten days, and expanded the mandate to include futures contracts for other types of oil and hydrocarbon fuel.
Combined, the changes represent a determined effort by USCF to permanently address regulatory and operational concerns about the fund’s viability and its impact on oil futures prices in the present market environment.
Historically, USO invested exclusively in front-month futures contracts for WTI trading on NYMEX and ICE; however, the fund began diversifying into contracts for later delivery in mid-April following weeks of strong net inflows that saw it breach position limits for individual contracts.
USCF initially shifted 20% of USO’s exposure to second-month contracts to satisfy regulation from the Commodity Futures Trading Commission (CFTC) which states that no single investor may purchase over 25% of a given futures contract.
With oil prices crashing spectacularly last week, even plunging deep into negative territory for the expiring May contract, and the market in a super contango (the price of futures contracts with later delivery is higher than those with nearer delivery), USCF has further revamped the strategy in a bid to adapt to the rapidly changing environment.
Under an amendment filed today, USCF has determined that the USO will invest in WTI crude oil futures contracts on NYMEX and ICE as follows: approximately 30% of its portfolio in the July contract, approximately 15% in the August contract, approximately 15% in the September contract, approximately 15% in the October contract, approximately 15% in the December contract, and approximately 10% in the June 2021 contract.
USCF will roll the current portfolio positions into the positions described above over a three-day period with approximately one-third of the investment changes taking place each day on each of April 27, April 28, and April 29.
USCF has 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 shift into longer-dated contracts and substitute oil-related products is, in part, a function of a direct order from the CME, the parent company of NYMEX, that imposes position limits on the ETF’s holdings.
Specifically, CME restricted USO to holding 15,000 long futures contracts for June delivery, while the limits on July, August, and September contracts were set at 78,000; 50,000; and 35,000 respectively.
In addition, USCF has extended the roll period. Typically, the roll of USO’s positions in oil interests has occurred monthly over a four-day period. USCF has determined that commencing with the monthly roll occurring in May 2020, USO’s positions will roll over a ten-day period beginning on May 1, 2020.
Together, the moves aim to reduce USO’s impact on contract prices for any specific month and mitigate the destructive effect of negative roll yield.
Regulators have become increasingly concerned about USO’s growing influence after investors continued to add new money to the ETF despite, or perhaps because of (some of the new shares are being created by market participants for the express purpose of shorting), last week’s market turmoil – the fund has seen over $3.5 billion in net inflows this month.
Meanwhile, the shift to later-month future contracts will help ease concerns over the massive rolling costs facing investors in the ETF due to the oil market displaying drastically steep contango.
For example, the price differential between June and July contracts currently implies a rolling cost of approximately 25%. Further out along the futures curve, however, the effect is less pronounced. The implied roll cost between July and August is 12.5%, for instance, and between August and September it is 8.3%. In contango, roll cost typically declines, commensurately with tenor, as the curve flattens.
While the changes will come as welcome relief for regulators, exchange operators, and potentially even physical market participants, they have implications for the fund and its investors – long and short. Foremost among these is the increased likelihood of deviation from the fund’s target benchmark which remains the near-month crude oil futures contract traded on NYMEX.
Although USO’s managers will continue to focus primarily on WTI contracts, any migration into other petroleum-based fuels will certainly hinder the fund’s investment objective, as will the shift out along the futures curve as front-month futures contracts tend to display the greatest sensitivity to updated market news and changes in expectations.
USO investors will likely now experience a smoother ride because of the changes, but the destination might not be quite what they signed up for.