USL Oil Fund Struts Its Stuff

by Brad Zigler

Back in December, when trading in the United States 12-Month Oil Fund (AMEX: USL) was launched, we decried its unfortunate timing (see "USL Oil ETF: The Early Innings"). USL, remember, was devised to combat the ravages of contango on oil investors' returns by valuing itself against the average price of the dozen nearby NYMEX crude oil contracts.

A contango is usually thought to exist when futures prices are higher in the back, or later, months than those in more nearby deliveries. Contango is a bane for index fund investors because it saps returns as expiring futures are rolled forward: Each roll ends up costing the fund money as it sells low-priced contracts and buys higher-priced replacements.

USL took so long to work its way through the registration process last year that the oil market flipped from its then-prevailing contango into backwardation. Backwardation, as the name seems to imply, is "contango" writ backwards: Nearbys trading at higher prices than deferred deliveries.

A forward roll into a backwardated market yields a positive return for index investors as the higher-priced nearbys are sold at a premium to the purchased distant contracts.

By averaging the prices of a year's worth of futures contracts, USL's manufacturers thought, the pricing distortions occasioned by the oil market's flip-flop between contango and backwardation might be minimized.

In June, a contango started to build in the crude oil market, growing to a quarterly spread of some $1.37 a barrel now. Over that time, USL's return has outdone that of its more conventionally priced sibling, the United States Oil Fund (AMEX: USO). Since the first trading day in June, USL has appreciated 13.2% against USO's 11.6% gain.

Performance Since June: USL Vs. USO

Any lessening of supply concerns in the oil market will likely follow with a deepening of the contango, giving USL further advantage over USO.

Stay tuned.

Comments

[mangolfer]

OK....

[morgan77]

Interesting.
For those interested in USO, USL, and the likes, check out this technical analysis on greenfaucet- The author argues that once the Iran missile issues fizzles, the threat to gas transport lines in the middle east will disappear allowing oil to make a much needed correction. Once that happens speculators will get rid of their longs, and this will bring oil down even more- she argues that oil has $10 to go down.
Here's the link:
www.greenfaucet.com/en...

[sbenard]

Great article. I had been wondering about this for some time. USO and USL were both developed by the same company. However, I haven't traded USL because the volume and liquidity have been rather poor, IMHO.

[sbenard]

USL even today has only about 1/10th of 1% of the volume of USO, and the spread is about 15 cents. The spread of USO is 1 cent. I would really like to see USL reach a size where I can feel good about trading it. It's simply a better way to trade oil.

[phdinsuntanning]

spot oil price = f( oil stocks , panic)
oil stocks = f(future prices)
future prices = f (oil commercial corps, non commercial traders)
oil commercial corps= f(oil profits)
non commercial traders = f( panic, oil profits)
oil profits = f(spot oil price)
panic = f (bigbro)

[User 51169]

Starkoski is troubled participant. He continues to speak about "Peak Oil" as if he's M. King Hubbert himself. Flow rate is not the only factor in the price of oil, even starkoski should know better. (Though he apparently does not.) Supply and demand is a factor, and nothing in supply and demand suggests oil doubling from $70 to $140 in a single year. Dollar destruction is a factor, and in the near term, it may indeed appreciate against world currencies. Speculation is a factor, and with 20 times more oil being traded than delivered, speculators have moved from dot-com to real estate to commodities. Psychology is a factor, and everyone has been pushing the long side. But if there's enough of an economic slowdown, a push to drill, a push for alternatives, oil can and will come down in price. Starkoski, get a grip.