ETF Spotlight: USO Moves With Volatile Oil Price

Crude fluctuated on China demand and Hurricane Francine threat.

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kent
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Senior Content Editor
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Reviewed by: etf.com Staff
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Edited by: Ron Day

The largest exchange-traded fund to track WTI crude oil, the United States Oil Fund (USO), followed the commodity’s price to a multi-year low this week before it bounced higher on hurricane disruption concerns. 

Oil prices have dropped this year as supplies have gained, in part because China, the world's biggest oil importer, has trimmed demand. Middle East tensions are also easing from elevated levels. These factors combined to bring crude prices to their lowest level in three years this week.  

USO tracked oil 4% lower Monday, pushing it down into the red for the year. 

Oil prices spiked higher Thursday as 39% of crude oil production and 49% of natural gas production in the Gulf of Mexico shut down to evacuate Hurricane Francine, according to a U.S. Bureau of Safety and Environmental Enforcement press release

The disruption of oil production moved prices higher on lower supply concerns, pushing USO 2.6% by midday trading Thursday. 

How USO Tracks the WTI Crude Oil Price

USO tracks the price of West Texas Intermediate (WTI) crude oil futures contracts, providing a way to invest in oil prices without physically owning the commodity. This ETF can be beneficial for investors who believe oil prices will rise in the future or to diversify a portfolio to help reduce risk, as oil prices often move independently of other assets. 

USO does not purchase physical barrels of oil but rather invests in oil futures contracts, which are agreements to buy or sell oil at a future date. The oil-tracking fund aims to reflect the daily percentage changes of oil prices through these contracts. The fund's performance is tied closely to the near-month futures contract (the contract that is set to expire soonest), although it can also hold contracts that are further out. 

Risks Associated With USO, Futures-Based Funds

While USO aims to track the price of WTI crude oil, the rolling of futures contracts can cause its performance to differ from the spot price of oil, especially over long periods. Rolling refers to selling the soon-to-expire contract and purchasing a contract with a later expiration date.  

Since futures contracts have expiration dates, USO needs to "roll" its contracts regularly. This process is key to how the fund operates but can introduce challenges such as contango and backwardation: 

  • Contango: When the price of future contracts is higher than the spot price (current price), rolling can result in losses because the fund sells lower-priced contracts and buys higher-priced ones. 
  • Backwardation: The opposite situation, where future contracts are cheaper than the spot price, can be beneficial because the fund buys lower-priced contracts and sells higher-priced ones. 

Bottom Line on Investing in USO

USO provides a convenient means for investors to gain exposure to oil prices without directly owning physical oil, though it comes with risks associated with the futures market. The fund's performance is sensitive to factors such as geopolitical events, supply and demand shifts, and macroeconomic changes.  

Short-term investors may see better correlation with oil prices, while long-term investors may experience discrepancies due to the effects of contango or backwardation. 

Kent Thune is Senior Content Editor for etf.com, focusing on educational content, thought leadership, content management and search engine optimization (SEO). Before joining etf.com, he wrote for numerous investment websites, including Seeking Alpha and Kiplinger. 

 

Kent holds a Master of Business Administration (MBA) degree and is a practicing Certified Financial Planner (CFP®) with 27 years of experience managing investments, guiding clients through some of the worst economic and market environments in U.S. history. He has also served as an adjunct professor, teaching classes for The College of Charleston and Trident Technical College on the topics of retirement planning, business finance, and entrepreneurship. 

 

Kent founded a registered investment advisory firm in 2006 and is based in Hilton Head Island, SC, where he lives with his wife and two sons. Outside of work, Kent enjoys spending time with his family, playing guitar, and working on his philosophy book, which he plans to publish in the coming year.

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