Why USL Beats USO In The Battle Of Oil ETFs

Dave Dierking, CFA profile picture
Dave Dierking, CFA
5.94K Followers

Summary

  • The U.S. Oil ETF is by far the largest oil ETF in the marketplace, but right now, it isn't the best choice.
  • The U.S. 12-Month Oil ETF spreads its futures exposure over 12 months instead of one helping to limit portfolio costs due to trading.
  • The contango market in the oil futures market is destroying value at a faster pace in USO.
  • If contango flips to backwardation, USO likely becomes the better choice.

Trading more than 30 million shares a day, the United States Oil ETF (NYSEARCA:USO) is easily the most popular proxy for traders wishing to trade on oil prices. That doesn't necessarily mean that the fund does a good job of it. The price of a barrel of WTI crude oil is up nearly 17% year to date but the U.S. Oil ETF is down about 8%.

The high cost of futures contract trading along with contango in the oil futures market make this fund less than ideal for a holding period any longer than a few days.

The issues the fund has in closely tracking the price of oil, especially around the time that the monthly contracts roll over, can make any trade a potentially costly one. But there is an ETF that does a better job in tracking oil prices than the U.S. Oil ETF - the U.S. 12-Month Oil ETF (NYSEARCA:USL).

Background

For a quick tutorial on how the funds work, the U.S. Oil ETF purchases oil futures contracts for the most relevant delivery date, which in most cases is the following month. As the delivery date approaches, the fund liquidates its $3 billion position and reestablishes a position in the following month's contracts.

The contango state of the oil futures market makes a full monthly turnover of the entire fund's assets very costly. Since the cost of next month's contract is higher than the current month, the fund ends up selling at one price and buying at a higher price and does this every month. In this scenario, the fund ends up owning fewer and fewer contracts decaying the fund's value on a constant basis.

The U.S. 12-Month Oil ETF holds an advantage over the U.S. Oil ETF in a contango market because it only ends up turning over

This article was written by

Dave Dierking, CFA profile picture
5.94K Followers
Editor of ETF Focus on TheStreet.com. A top 5 Seeking Alpha contributor in ETFs. Speaker at events, such as MoneyShow Orlando 2018. To receive notifications of new articles and blog posts as soon as they're published, click on the orange Follow button and become a real-time follower.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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