USO: Time To Come Back

About: The United States Oil ETF, LP (USO)
by: Cristian Docan

US oil storage buildup accelerates, following a strong advance in net imports.

Net speculative positioning dips for the fifth consecutive week, thanks to long liquidations and robust short covering.

Global economic uncertainty and persistent trade quarrel between the US and China still weighs on the complex. However, upcoming OPEC+ meeting should offset that.

Investment thesis

Lately, global economic uncertainty, accumulating American crude inventories and US-China persisting trade quarrel impacted significantly crude oil futures and United States Oil Fund LP (USO), to the downside. In spite of that, crude market stabilization and a potential OPEC+ supply cut extension points towards an appreciation of USO pricing.

Source: Tradingview

USO – The United States Oil Fund LP

USO tracks US spot oil prices through near-month futures contracts on the West Texas Intermediate (WTI) benchmark. The ETF is one of the largest and most liquid instruments to get direct exposure to the crude markets. Besides, the fund is suitable for long-term investors, given that it replicates systematically WTI evolutions:

Source: Nasdaq

One drawback of USO is that it is particularly sensitive to short-term changes in spot prices, which can result in heavy roll costs, given its concentration on next-month future contract.

Since my last article, the fund’s exposure rolled on July and August 2019 future contract, whilst opening a moderate position on the US dollar.

Source: Bloomberg

Besides, the fund is structured like a commodity pool, implying that long-term holders will be taxed on any gains even if shares are not sold. Despite that, USO replicates effectively short-term moves in crude prices, while providing low incurred costs.

Yet, USO offers an expense ratio of 0.84% and an average spread in the last 60-day of 0.08%, which are slightly above most of its small competitors (OIL, OILX, and DBO). However, USO handles that with a huge asset base of $1.35B and a massive daily liquidity of $296.17m.

Crude and petroleum stocks

In its last report, covering the May 24-31 period, the EIA reported slightly advancing crude oil inventories, up 1.42% (w/w) to 483.3m barrels. With this moderate lift, US crude oil seasonality continues to enhance, establishing in a surplus of 10.7% or 46,680k barrels versus last year levels and 7.1% or 31,981k barrels above the five-year average. That being said, crude oil storage in the US continue to break yearly highs, bringing negative pressure on USO shares and crude futures.

Source: EIA

On the other side, the concomitant appreciation of refined petroleum inventories provides further bearish momentum for crude pricing. Indeed, during the week, gasoline storage increased for the third consecutive week, up 1.39% (w/w) to 234.1m barrels, whilst distillates accelerated stronger, up 3.66% (w/w) to 129.4m barrels, despite the start of the summer driving season and the uptick in refining utilization rates.

Source: EIA

Besides, crude production in the US posted a new record high on the corresponding period, advancing by 0.81% (w/w) to 12.4m bpd. Going forward, the output figure in the US should stabilize, given that Baker Hughes Rig Count report indicates that active rigs in the country declined slightly on the May 30 – June 8 period.

Source: Baker Hughes Rig Count Report

Meanwhile, the crude oil balance deteriorated considerably over the week, following slightly decreasing exports, down 0.57% (w/w) to 3.3m barrels and skyrocketing net imports, up 30.58% (w/w) to 4.63m barrels.

Source: EIA

Speculative positioning

Latest Commitment of Traders Report published by the CFTC on the May 28 – June 4 period shows a new robust decline of net speculative positioning. Indeed, bets on crude oil futures dipped 8.83% (w/w) to 400,168 contacts, whereas USO lost 8.75% (w/w) to $11.16 per share.

Source: CFTC

That plunge is due to both long liquidations, down 4.52% (w/w) to 538,947 contracts and short coverings, up 10.59% (w/w) to 138,779 contracts. With this sixth consecutive dip, speculator interest for the black commodity declined 37%, since its latest high reached in late April, following accrued global economic uncertainty and increasing trade tensions between China and US.

Since the beginning of 2019, net spec positioning on Nymex crude increased 44.36% or 122,957 contracts, whereas USO YTD performance lifted moderately, up 6.95% to $10.5 per share.

Backdrop changes

In my previous piece released on May 22, I maintained my bullish view on USO, even if the complex witnessed a sharp pullback. Since then, crude oil futures somewhat stabilized, and the bloodshed seems now over.

Going forward, the next major catalyst which will significantly impact crude markets is upcoming OPEC+ meeting set to take place at the end of June. For the time being, expectations are turning toward an oil quota extension. According to declarations of Saudi Energy Minister Khalid al-Falih, Russia is still undecided on the need to extend an output deal among top oil producers, which could propel USO to new lows.

On top of that, trade tensions between US and China continue to threaten global demand and with no clear sign of an end to the dispute, the quarrel persistence may continue to pressure crude oil markets.

Besides, WTI futures curve edge slightly higher on medium-term deliveries, sending the curve into a steeper backwardation pattern, even if a contango is still present on close-by maturities. In that vein, USO’s performance will likely suffer in the near term, given the negative roll-yield implied by the short-term contango pattern.

In this context, characterized by accrued geopolitical uncertainty, ramping crude oil storage in the US and dipping net speculative positioning on crude future contracts, all signs point towards renewed bearishness for USO shares.

I look forward to reading your comments.

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.