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.