If You're Betting On Higher Oil Prices, USO Is Not The Right Vehicle

Apr. 17, 2020 7:54 PM ETThe United States Oil ETF, LP (USO)599 Comments

Summary

  • A lot of people are buying USO to bet on a rebound in oil price. That's the wrong vehicle to do it in.
  • USO will suffer greatly in the near term due to the super contango we are seeing in the market.
  • Cushing inventory as of April 14 already is sitting at ~60 million barrels. It will be filled in three to four weeks.
  • Once storage hits tanktop in Cushing, June WTI is likely to blowout vs. July, making USO holders very vulnerable to a sell-off. Combine this with the fact that USO holds 20% of the June WTI contract positions and the sell-off could be intensified on May 5 when the roll begins.
  • There are far more alternatives to bet on a rise in oil price, but none of them are perfect.
  • Looking for a helping hand in the market? Members of HFI Research get exclusive ideas and guidance to navigate any climate. Get started today »

Welcome to the USO edition of Oil Markets Daily!

This has garnered a lot of attention over the past week, so we thought it's an important topic for an oil market fundamentals report. If you don't want to read the explanation below, the punchline is that NYSEARCA:USO is not the vehicle to bet on higher oil prices, at least not in the current market environment.

USO suffers/benefits from something called the roll yield.

First, you need to understand what a futures curve is.

In the picture above, you can see the WTI forward curve at the moment, one year ago and up to five years ago. What you will notice is that the WTI curve one and two years ago was downward sloping. This is what you call ackwardation. In a backwardation market, supply is less than demand, causing the prompt or current prices to be higher than future prices.

In a contango market, which is what the current curve is showing (shaping upward), supply is greater than demand, causing prompt prices to be lower than future prices.

Source: CME

Now the issue you run into with USO is that betting on oil price rising or falling is an imperfect science. Because of the nature of futures trading, there are contract expirations that the speculators have to contend with. There's no continuous oil instrument you can keep betting on to see whether prices rise or not (more on this later).

As for USO, on the seventh of every month and for the next four business trading days, it will start selling the current prompt month and buy into the next month. You can see the anticipated roll period on the USO sponsor website.

Source: USCF

This is where the problem of a super contango market kicks in. USO already is in

We are now entering one of the craziest periods in the energy sector. Valuations have gotten so out of hand that we believe this is the final washout. We are now offering a 2-week free trial and if you wish to read our WCTWs this week, please see here.

This article was written by

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in USO over 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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