USOF may also invest in futures contracts for other types of crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the NYMEX, ICE Futures or other U.S. and foreign exchanges (collectively, “Oil Futures Contracts”) and other oil interests such as cash-settled options on Oil Futures Contracts, forward contracts for oil and over-the-counter transactions that are based on the price of crude oil, other petroleum-based fuels, Oil Futures Contracts and indices based on the foregoing (collectively, “Other Oil Interests”). For convenience and unless otherwise specified, Oil Futures Contracts and Other Oil Interests collectively are referred to as “Oil Interests” in this quarterly report on Form 10-Q.
The NAV of USOF units is calculated once each trading day as of the earlier of the close of the New York Stock Exchange (the “NYSE”) or 4:00 p.m. New York time. The NAV for a particular trading day is released after 4:15 p.m. New York time. Trading on the NYSE typically closes at 4:00 p.m. New York time. USOF uses the NYMEX closing price (determined at the earlier of the close of the NYMEX or 2:30 p.m. New York time) for the contracts held on the NYMEX, but calculates or determines the value of all other USOF investments, including ICE Futures contracts or other futures contracts, as of the earlier of the close of the NYSE or 4:00 p.m. New York time.
More units may have been issued by USOF than are outstanding due to the redemption of units. Unlike funds that are registered under the Investment Company Act of 1940, as amended, units that have been redeemed by USOF cannot be resold by USOF. As a result, USOF contemplates that additional offerings of its units will be registered with the SEC in the future in anticipation of additional issuances and redemptions.
During the ninethree month period ended September 30, 2008,March 31, 2009, the daily average total net assets of USOF were $810,780,060. During the nine month period ended September 30, 2008, the total net assets of USOF did exceed $1 billion.$3,223,209,553. The management fee paid by USOF during the period amounted to $2,805,644.$3,576,438. Management fees as a percentage of total net assets averaged 0.46%0.45% over the course of this ninethree month period. By comparison, forduring the ninethree month period ended September 30, 2007,March 31, 2008, the daily average daily total net assets of USOF were $815,003,993.$427,078,224. During the ninethree month period ended September 30, 2007,March 31, 2008, the total net assets of USOF did not exceed $1 billion on a number of days.any day. The management fee paid by USOF for this ninethree month period amounted to $3,007,089,$530,931, which was calculated at the 0.50% rate for total net assets up to and including $1 billion and at the rate of 0.20% on average net assets over $1 billion, and accrued daily. Management fees as a percentage of averagetotal net assets averaged 0.50% over the course of this ninethree month period. Beginning January 1,Management fees as a percentage of total net assets were lower for the three months ended March 31, 2009 compared to the management fee paid by USOF will be calculated atthree months ended March 31, 2008 due to the rate of 0.45% forreduced expense ratio schedule and due to the period ended March 31, 2008 having no days in which total net assets exceeded $1 billion and therefore all total net assets and accrue daily.during that period were charged the higher daily rate of 0.50%.
In addition to the management fee, USOF pays for all brokerage fees, taxes and other expenses, including certain tax reporting costs, licensing fees for the use of intellectual property, ongoing registration or other fees paid to the SEC, the Financial Industry Regulatory Authority (“FINRA”) and any other regulatory agency in connection with offers and sales of its units subsequent to the initial offering and all legal, accounting, printing and other expenses associated therewith. The total of these fees, taxes and expenses for the three months ended March 31, 2009 was $2,790,047, as compared to $814,852 for the three months ended March 31, 2008. The increase in expenses from the three months ended March 31, 2008 to the three months ended March 31, 2009 was primarily due to the relative size of USOF and activity that resulted from its increased size, including the registration and the offering of additional units, increased brokerage fees, increased licensing fees and increased tax reporting costs due to the greater number of unit holders during the period. For the nine month periodthree months ended September 30,March 31, 2009, USOF incurred $453,200 in fees and other expenses relating to the registration and offering of additional units. By comparison, for the three months ended March 31, 2008, USOF incurred $393,787$105,629 in ongoing registration fees and other expenses relating to the registration and offering expenses. of additional units.
USOF is responsible for paying for its portion of the fees and expenses, including directors’ and officers’ liability insurance of the General Partner and the fees and expenses of the independent directors of the General Partner who are also its audit committee members. USOF shares these fees with USNG, US12OF, USGthe United States Natural Gas Fund, LP (“USNG”), the United States 12 Month Oil Fund, LP (“US12OF”), the United States Gasoline Fund, LP (“UGA”) and USHOthe United States Heating Oil Fund, LP (“USHO”) based on the relative assets of each fund computed on a daily basis. These fees for calendar year 20082009 are estimated to be a total of $286,000$477,000 for all five funds. By comparison, for the nine month periodyear ended September 30, 2007, USOF incurred $384,058December 31, 2008, these fees amounted to a total of $282,000 for all funds, and USOF’s portion of such fees was $145,602. Directors’ expenses are expected to increase in ongoing registration fees2009 due to payment for directors’ and other offering expenses. In addition, USOF agreedofficers’ liability insurance and an increase in the compensation awarded to paythe independent directors. Effective as of March 3, 2009, the General Partner has obtained directors’ and officers’ liability insurance covering all of the directors and officers of the General Partner. Previously, the General Partner did not have liability insurance for its directors and officers; instead, the independent directors $184,000 to cover their expensesreceived a payment in lieu of directors’ and pay for their services for 2007.officers’ insurance coverage.
USOF also incurs commissions to brokers for the purchase and sale of Oil Futures Contracts, Other Oil Interests or short-term obligations of the United States of two years or less (“Treasuries”). During the ninethree month period ended September 30,March 31, 2009, total commissions paid to brokers amounted to $1,793,482. By comparison, during the three month period ended March 31, 2008, total commissions paid to brokers amounted to $891,642. Prior$238,589. The increase in the total commissions paid to brokers was primarily a function of increased brokerage fees due to a higher number of futures contracts being held and traded as a result of the initial offering of its units, USOF had estimated that its annual level of such commissions was expected to be 0.35% ofincrease in USOF’s average total net assets.assets, the decrease in the price of Oil Futures Contracts and the increase in redemptions and creations of units during the period. The increase in assets required USOF to purchase a greater number of Oil Futures Contracts and incur a larger amount of commissions. As an annualized percentage of averagetotal net assets, the figure for the nine month periodthree months ended September 30, 2008 representedMarch 31, 2009 represents approximately 0.15%0.23% of averagetotal net assets. By comparison, for the nine month period ended September 30, 2007, total commissions paid amounted to $951,049. As an annualized percentage of average net assets, the figure for the nine month periodthree months ended September 30, 2007March 31, 2008 represented approximately 0.16%0.22% of averagetotal net assets. However, there can be no assurance that commission costs and portfolio turnover will not cause commission expenses to rise in future quarters.
Interest Income. USOF seeks to invest its assets such that it holds Oil Futures Contracts and Other Oil Interests in an amount equal to the total net assets of the portfolio. Typically, such investments do not require USOF to pay the full amount of the contract value at the time of purchase, but rather require USOF to post an amount as a margin deposit against the eventual settlement of the contract. As a result, USOF retains an amount that is approximately equal to its total net assets, which USOF invests in Treasuries, cash and/or cash equivalents. This includes both the amount on deposit with the futures commission merchant as margin, as well as unrestricted cash and cash equivalents held with USOF’s custodian bank. The Treasuries, cash and/or cash equivalents earn interest that accrues on a daily basis. For the ninethree month period ended September 30, 2008,March 31, 2009, USOF earned $12,213,272$1,839,120 in interest income on such cash holdings. Based on USOF’s average daily total net assets, during this time period, this iswas equivalent to an annualized yield of 2.01%0.23%. USOF did not purchase Treasuries during the ninethree month period ended September 30, 2008March 31, 2009 and held all of its funds in cash and/or cash equivalents during this time period. By comparison, for the ninethree month period ended September 30, 2007,March 31, 2008, USOF earned $30,175,872$2,895,300 in interest income on such cash holdings. Based on USOF’s average daily total net assets, during this time period, this is equivalent to an annualized yield of 4.95%2.73%. USOF did not purchase Treasuries during the three month period ended March 31, 2008 and held all of its funds in cash and/or cash equivalents during this time period. Interest rates on short-term investments in the United States, including cash, cash equivalents, and short-term Treasuries, were sharply lower during the three month period ended March 31, 2009 compared to the same time period in 2008. As a result, the amount of interest earned by USOF as a percentage of total net assets was lower during the three month period ended March 31, 2009.
Tracking USOF’s Benchmark. USOF seeks to manage its portfolio such that changes in its average daily NAV, on a percentage basis, closely track changes in the average of the daily price of the Benchmark Oil Futures Contract, also on a percentage basis. Specifically, USOF seeks to manage the portfolio such that over any rolling period of 30 valuation days, the average daily change in the NAV is within a range of 90% to 110% (0.9 to 1.1) of the average daily change in the price of the Benchmark Oil Futures Contract. As an example, if the average daily movement of the Benchmark Oil Futures Contract for a particular 30-day time period was 0.5% per day, USOF management would attempt to manage the portfolio such that the average daily movement of the NAV during that same time period fell between 0.45% and 0.55% (i.ei.e., between 0.9 and 1.1 of the benchmark’s results). USOF’s portfolio management goals do not include trying to make the nominal price of USOF’s NAV equal to the nominal price of the current Benchmark Oil Futures Contract or the spot price for crude oil. Management believes that it is not practical to manage the portfolio to achieve such an investment goal when investing in listed Oil Futures Contracts.
For the 30 valuation days ended September 30, 2008,March 31, 2009, the simple average daily change in the Benchmark Oil Futures Contract was (0.323)%-0.030%, while the simple average daily change in the NAV of USOF over the same time period was (0.319)%-0.032%. The average daily difference was 0.004%-0.002% (or 0.4-0.2 basis points, where 1 basis point equals 1/100 of 1%). As a percentage of the daily movement of the Benchmark Oil Futures Contract, the average error in daily tracking by the NAV was 0.8%-0.619%, meaning that over this time period USOF’s tracking error was within the plus or minus 10% range established as its benchmark tracking goal. The first chart below shows the daily movement of USOF’s NAV versus the daily movement of the Benchmark Oil Futures Contract for the 30-day period ended March 31, 2009.
*PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
USOF Monthly Total Return vs Benchmark Futures Contracts*
(monthly since inception to March 31, 2009)
*PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Since the offering of USOF units to the public on April 10, 2006 to September 30, 2008,March 31, 2009, the simple average daily change in the Benchmark Oil Futures Contract was 0.041%- -0.080%, while the simple average daily change in the NAV of USOF over the same time period was 0.050%-0.073%. The average daily difference was 0.009%0.007% (or 0.90.7 basis points, where 1 basis point equals 1/100 of 1%). As a percentage of the daily movement of the Benchmark Oil Futures Contract, the average error in daily tracking by the NAV was 2.432%2.148%, meaning that over this time period USOF’s tracking error was within the plus or minus 10% range established as its benchmark tracking goal.
An alternative tracking measurement of the return performance of USOF versus the return of its Benchmark Oil Futures Contract can be calculated by comparing the actual return of USOF, measured by changes in its NAV, versus the expectedexpected changes in its NAV under the assumption that USOF’s returns had been exactly the same as the daily changes in its Benchmark Oil Futures Contract.
For the ninethree month period ended September 30, 2008,March 31, 2009, the actual total return of USOF as measured by changes in its NAV was 7.07%-14.43%. This is based on an initial NAV of $75.82$34.31 on December 31, 20072008 and an ending NAV as of September 30, 2008March 31, 2009 of $81.18.$29.36. During this time period, USOF made no distributions to its unitholders. However, if USOF’s daily changes in its NAV had instead exactly tracked the changes in the daily return of the Benchmark Oil Futures Contract, USOF would have ended the thirdfirst quarter of 20082009 with an estimated NAV of $80.46,$29.40, for a total return over the relevant time period of 6.13%-14.30%. The difference between the actual NAV total return of USOF of 7.07%-14.43% and the expected total return based on the Benchmark Oil Futures Contract of 6.13%-14.30% was an error over the time period of 0.94%-0.13%, which is to say that USOF’s actual total return trailed the benchmark result by that percentage. Management believes that a portion of the difference between the actual return and the expected benchmark return can be attributed to the net impact of the expenses and the interest that USOF collects on its cash and cash equivalent holdings. During the three month period ended March 31, 2009, USOF received interest income of $1,839,120, which is equivalent to a weighted average interest rate of 0.23% for the three month period ended March 31, 2009. In addition, during the three month period ended March 31, 2009, USOF also collected $156,000 from brokerage firms creating or redeeming baskets of units. This income also contributed to USOF’s actual return. However, if the total assets of USOF continue to increase, management believes that the impact on total returns of these fees from creations and redemptions will diminish as a percentage of the total return. During the three month period ended March 31, 2009, USOF incurred total expenses of $6,366,485. Income from interest and brokerage collections net of expenses was $(4,371,365) which is equivalent to a weighted average net interest rate of - -0.55% for the three month period ended March 31, 2009.
By comparison, for the three month period ended March 31, 2008, the actual total return of USOF as measured by changes in its NAV was 7.27%. This was based on an initial NAV of $75.82 on December 31, 2007 and an ending NAV as of March 31, 2008 of $81.33. During this time period, USOF made no distributions to its unitholders. However, if USOF’s daily changes in its NAV had instead exactly tracked the changes in the daily return of the Benchmark Oil Futures Contract, USOF would have ended the first quarter of 2008 with an estimated NAV of $81.01, for a total return over the relevant time period of 6.86%. The difference between the actual NAV total return of USOF of 7.27% and the expected total return based on the Benchmark Oil Futures Contract of 6.86% was an error over the time period of 0.41%, which is to say that USOF’s actual total return exceeded the benchmark result by that percentage. Management believes that a portion of the difference between the actual return and the expected benchmark return can be attributed to the impact of the interest that USOF collects on its cash and cash equivalent holdings. During the three month period ended March 31, 2008, USOF received interest income of $2,895,300, which is equivalent to a weighted average interest rate of 2.73% for the three month period ended March 31, 2009. In addition, during the ninethree month period ended September 30,March 31, 2008, USOF also collected fees$89,000 from brokerage firms creating or redeeming baskets of units. This income also contributed to USOF’s actual return exceedingDuring the benchmark results. However, if the total assets of USOF continue to increase, management believes that the impact on total returns of these fees from creations and redemptions will diminish as a percentage of the total return.
By comparison, for the ninethree month period ended September 30, 2007, the actualMarch 31, 2008, USOF incurred total returnexpenses of USOF as measured by changes in its NAV$1,345,783. Income from interest and brokerage collections net of expenses was 20.80%. This was based on an initial NAV of $51.87 on January 1, 2007 and an ending NAV as of September 30, 2007 of $62.66. During this time period, USOF made no distributions to its unitholders. However, if USOF’s daily changes in its NAV had instead exactly tracked the changes in the daily return of the Benchmark Oil Futures Contract, USOF would have ended the third quarter of 2007 with an estimated NAV of $60.76, for a total return over the relevant time period of 17.14%. The difference between the actual NAV total return of USOF of 20.80% and the expected total return based on the Benchmark Oil Futures Contract of 17.14% was an error over the time period of 3.66%,$1,638,517, which is equivalent to say that USOF’s actual total return exceededa weighted average net interest rate of 1.54% for the benchmark result by that percentage. Management believes that a portion of the difference between the actual return and the expected benchmark return can be attributed to the impact of the interest that USOF collects on its cash and cash equivalent holdings. In addition, during the ninethree month period ended September 30, 2007, USOF also collected fees from brokerage firms creating or redeeming baskets of units.March 31, 2008. This income also contributed to USOF’s actual return exceeding the benchmark results.
There are currently three factors that have impacted during the latest period, or are most likely to impact USOF’s ability to accurately track its Benchmark Oil Futures Contract.
First, USOF may buy or sell its holdings in the then current Benchmark Oil Futures Contract at a price other than the closing settlement price of that contract on the day induring which USOF executes the trade. In that case, USOF may getpay a price that is higher, or lower, than that of the Benchmark Oil Futures Contract, which could cause the changes in the daily NAV of USOF to either be too high or too low relative to the changes in the daily benchmark.Benchmark Oil Futures Contract. During the ninethree month period ended September 30, 2008,March 31, 2009, management attempted to minimize the effect of these transactions by seeking to execute its purchasespurchase or salessale of the Benchmark Oil Futures ContractsContract at, or as close as possible to, the end of the day settlement price. However, it may not always be possible for USOF to obtain the closing settlement price and there is no assurance that failure to obtain the closing settlement price in the future will not adversely impact USOF’s attempt to track its benchmarkthe Benchmark Oil Futures Contract over time.
Second, USOF earns interest on its cash, cash equivalents and Treasury holdings. USOF is not required to distribute any portion of its income to its unitholders and did not make any distributions to unitholders during the ninethree month period ended September 30, 2008.March 31, 2009. Interest payments, and any other income, were retained within the portfolio and added to USOF’s NAV. When this income exceeds the level of USOF’s expenses for its management fee, brokerage commissions and other expenses (including ongoing registration fees, licensing fees and the fees and expenses of the independent directors of the General Partner), USOF will realize a net yield that will tend to cause daily changes in the NAV of USOF to track slightly higher than daily changes in the Benchmark Oil Futures Contract. During the ninethree month period ended September 30, 2008,March 31, 2009, USOF earned, on an annualized basis, approximately 2.01%0.23% on its cash holdings. It also incurred cash expenses on an annualized basis of 0.46%0.45% for management fees and approximately 0.15%0.23% in brokerage commission costs related to the purchase and sale of futures contracts, and 0.30%0.12% for other expenses. The foregoing fees and expenses resulted in a net yield on an annualized basis of approximately 1.10%-0.57% and affected USOF’s ability to track its benchmark. If short-term interest rates rise above the current levels, the level of deviation created by the yield would increase. Conversely, if short-term interest rates were to decline, the amount of error created by the yield would decrease. IfWhen short-term yields drop to a level lower than the combined expenses of the management fee and the brokerage commissions, then the tracking error would becomebecomes a negative number and would tend to cause the daily returns of the NAV to underperform the daily returns of the Benchmark Oil Futures Contract.
Third, USOF may hold Other Oil Interests in its portfolio that may fail to closely track the Benchmark Oil Futures Contract’s total return movements. In that case, the error in tracking the benchmarkBenchmark Oil Futures Contract could result in daily changes in the NAV of USOF that are either too high, or too low, relative to the daily changes in the benchmark.Benchmark Oil Futures Contract. During the ninethree month period ended September 30, 2008,March 31, 2009, USOF did not hold any Other Oil Interests. However, there can be no assurance that in the future quarters USOF will not make use of such Other Oil Interests.
During the nine month period ended September 30, 2008, the prices of front month Benchmark Oil Futures Contracts rose from near the $96.00 level to approximately the $100.60 level. The prices of front month contracts were also higher than the prices of second month contracts for most of the first quarter of 2008 and the first half of the second quarter of 2008. The price of the front month contract was less than the second month contract for the balance of the second quarter of 2008 and most of the third quarter of 2008, although the front month price finished the end of the third quarter of 2008 higher than the second month contract.
Term Structure of Crude Oil Futures Prices and the Impact on Total Returns. Several factors determine the total return from investing in a futures contract position. One factor that impacts the total return that will result from investing in near month crude oil futures contracts and “rolling” those contracts forward each month is the price relationship between the current near month contract and the later month contracts. For example, if the price of the near month contract is higher than the next month contract (a situation referred to as “backwardation” in the futures market), then absent any other change there is a tendency for the price of a next month contract to rise in value as it becomes the near month contract and approaches expiration. Conversely, if the price of a near month contract is lower than the next month contract (a situation referred to as “contango” in the futures market), then absent any other change there is a tendency for the price of a next month contract to decline in value as it becomes the near month contract and approaches expiration.
As an example, assume that the price of crude oil for immediate delivery (the “spot” price), was $50 per barrel, and the value of a position in the near month futures contract was also $50. Over time, the price of the barrel of crude oil will fluctuate based on a number of market factors, including demand for oil relative to its supply. The value of the near month contract will likewise fluctuate in reaction to a number of market factors. If investors seek to maintain their position in a near month contract and not take delivery of the oil, every month they must sell their current near month contract as it approaches expiration and invest in the next month contract.
If the futures market is in backwardation, e.g.e.g., when the expected price of crude oil in the future would be less, the investor would be buying a next month contract for a lower price than the current near month contract. Hypothetically, and assuming no other changes to either prevailing crude oil prices or the price relationship between the spot price, the near month contract and the next month contract (and ignoring the impact of commission costs and the interest earned on Treasuries, cash and/or cash equivalents), the value of the next month contract would rise as it approaches expiration and becomes the new near month contract. In this example, the value of the $50 investment would tend to rise faster than the spot price of crude oil, or fall slower. As a result, it would be possible in this hypothetical example for the price of spot crude oil to have risen to $60 after some period of time, while the value of the investment in the futures contract would have risen to $65, assuming backwardation is large enough or enough time has elapsed. Similarly, the spot price of crude oil could have fallen to $40 while the value of an investment in the futures contract could have fallen to only $45. Over time, if backwardation remained constant, the difference would continue to increase.
If the futures market is in contango, the investor would be buying a next month contract for a higher price than the current near month contract. Hypothetically, and assuming no other changes to either prevailing crude oil prices or the price relationship between the spot price, the near month contract and the next month contract (and ignoring the impact of commission costs and the interest earned on cash), the value of the next month contract would fall as it approaches expiration and becomes the new near month contract. In this example, it would mean that the value of the $50 investment would tend to rise slower than the spot price of crude oil, or fall faster. As a result, it would be possible in this hypothetical example for the spot price of crude oil to have risen to $60 after some period of time, while the value of the investment in the futures contract will have risen to only $55, assuming contango is large enough or enough time has elapsed. Similarly, the spot price of crude oil could have fallen to $45 while the value of an investment in the futures contract could have fallen to $40. Over time, if contango remained constant, the difference would continue to increase.
The chart below compares the price of the near month contract to the average price of the firstnear 12 months over the last 10 years (1998-2007)(1999-2008). When the price of the near month contract is higher than the average price of the frontnear 12 month contracts, the market would be described as being in backwardation. When the price of the near month contract is lower than the average price of the frontnear 12 month contracts, the market would be described as being in contango. Although the prices of the near month contract and the average price of the frontnear 12 month contracts do tend to move up or down together, it can be seen that at times the near month prices are clearly higher than the average price of the near 12 month contracts (backwardation), and other times they are below the average price of the frontnear 12 month contracts (contango).
20
*PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
An alternative way to view the same data is to subtract the dollar price of the average dollar price of the near 12 month contracts from the dollar price of the near month contract the average dollar price of the front 12 month contracts.contract. If the resulting number is a positive number, then the near month price is higher than the average price of the frontnear 12 months and the market could be described as being in backwardation. If the resulting number is a negative number, then the near month price is lower than the average price of the frontnear 12 months and the market could be described as being in contango. The chart below shows the results from subtracting the average dollar price of the near 12 month contracts from the near month price the average price of the front 12 month contracts for the 10 year period between 19981999 and 2007.2008.
21
*PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
An investment in a portfolio that involved owning only the near month contract would likely produce a different result than an investment in a portfolio that owned an equal number of each of the frontnear 12 months’ worth of contracts. Generally speaking, when the crude oil futures market is in backwardation, the near month only portfolio would tend to have a higher total return than the 12 month portfolio. Conversely, if the crude oil futures market was in contango, the portfolio containing 12 months’ worth of contracts would tend to outperform the near month only portfolio. The chart below shows the annual results of owning a portfolio consisting of the near month contract versusand a portfolio containing the frontnear 12 months’ worth of contracts. In addition, the chart shows the annual change in the spot price of light sweet crude oil. In this example, each month, the near month only portfolio would sell the near month contract at expiration and buy the next month out contract. The portfolio holding an equal number of the frontnear 12 months’ worth of contracts would sell the near month contract at expiration and replace it with the contract that becomes the new twelfth month contract.
Historical Data of Owning and Rolling the Near Month Light, Sweet Oil Contract
versus the Near 12 Month Contracts and versus the Annual Change in the Spot Price Of Crude Oil *
*PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
As seen in the chart above, there have been periods of both positive and negative annual total returns for both hypothetical portfolios over the last 10 years. In addition, there have been periods during which the near month only approach had higher returns, and periods where the 12 month approach had higher total returns. The above chart does not represent the performance history of USOF or any affiliated funds.
Historically, the crude oil futures markets have experienced periods of contango and backwardation, with backwardation being in place more often than contango. During the previous two years, including 2006 and the first half of 2007, these markets have experienced contango. However, starting early in the third quarter of 2007, the crude oil futures market moved into backwardation. The crude oil markets remained in backwardation until late in the second quarter of 2008 when they moved into contango. The crude oil markets remained in contango until late in the third quarter of 2008, when the markets moved into backwardation. While the investment objective of USOF is not to have the market price of its units match, dollar for dollar, changesEarly in the spot price of oil, contango and backwardation have impacted the total return on an investment in USOF units during the past year relative to a hypothetical direct investment in crude oil. For example, an investment made in USOF units made during the secondfourth quarter of 2007, a period of contango in2008, the crude oil markets, decreased by -0.71%, whilemarket moved back into contango and remained in contango for the spot pricebalance of crude oil for immediate delivery during2008. During the same period increased by 7.30%. Conversely, an investment made in USOF units during the thirdfirst quarter of 2007, a period in which2009, the crude oil futures market remained in contango. During parts of January and February of 2009, the level of contango was mostly in backwardation, increased by 17.82% while the spot price of crude oil increased by 15.53% (note: these comparisons ignore the potential costs associated with physically owning and storing crude oil which could be substantial).unusually steep.
Periods of contango or backwardation do not meaningfullymaterially impact USOF’s investment objective of having percentage changes in its per unit NAV track percentage changes in the price of the Benchmark Oil Futures Contract since the impact of backwardation and contango tended to equally impact the percentage changes in price of both USOF’s units and the Benchmark Oil Futures Contract. It is impossible to predict with any degree of certainty whether backwardation or contango will occur in the future. It is likely that both conditions will occur during different periods.
Crude Oil Market.Market. During the ninethree month period ended September 30, 2008,March 31, 2009, crude oil prices were impacted by several factors. On the consumption side, demand remained strongweak inside and outside the United States as continued global economic growth, especially inincluding emerging economies such as China and India, remained brisk. Additionally,weak to negative for the U.S. dollar, the currency in which crude oil is traded globally, continued to fall, effectively making crude oil cheaper for most non-U.S. dollar economies. Crude oil prices reached an all time high in July 2008 when the front month contract price reached approximately $145 a barrel.
However, concerns about a weakening U.S. economy leading to reduced demand for oil products became a major factor late in the thirdfirst quarter of 2008.the year. On the supply side, efforts to reduce production remained steady despite concerns about violence impactingby the Organization of the Petroleum Exporting Countries to more closely match global consumption were only partially successful. This divergence between production and comsumption has led to large build-ups in Iraqcrude oil inventories and Nigeria. Political tensions between Iran and the United States also contributed to market concerns about interruptions in production. At the same time, a concern remained about the ability of majorweak oil producing countries to continue to raise their production to accommodate increasing demand.prices. However, crude oil prices reversed their upward trend and fell sharply late indid finish the thirdfirst quarter of 2008 as a slowing U.S. economy, and flat demand growth outside2009 approximately 11% higher than at the beginning of the U.S., was enough to improve the global supply and demand balance. The front month futures contract ended the third quarter of 2008 at approximately $100, down 31% from its July highs.quarter.
Crude Oil Price Movements in Comparison to other Energy Commodities and Investment Categories. The General Partner believes that investors frequently measure the degree to which prices or total returns of one investment or asset class move up or down in value in concert with another investment or asset class. Statistically, such a measure is usually done by measuring the correlation of the price movements of the two different investments or asset classes over some period of time. The correlation is scaled between 1 and -1, where 1 indicates that the two investment options move up or down in price or value together, known as “positive correlation,” and -1 indicating that they move in completely opposite directions, known as “negative correlation.” A correlation of 0 would mean that the movements of the two are neither positively or negatively correlated, known as “non-correlation.” That is, the investment options sometimes move up and down together and other times move in opposite directions.
For the ten year time period between 19971998 and 2007,2008, the chart below compares the monthly movements of crude oil versus the monthly movements of several other energy commodities, such as natural gas, heating oil, and unleaded gasoline, as well as several major non-commodity investment asset classes, such as large cap U.S. equities, U.S. government bonds and global equities. It can be seen that over this particular time period, the movement of crude oil on a monthly basis was NOT strongly correlated, positively or negatively, with the movements of large cap U.S. equities, U.S. government bonds or global equities. However, movements in crude oil had a strong positive correlation to movements in heating oil and unleaded gasoline. Finally, crude oil had a positive, but weaker, correlation with natural gas.
10 Year Correlation Matrix 1997-2007 | | Large Cap US Equities (S&P 500) | | U.S. Govt. Bonds (EFFAS U.S. Government Bond Index) | | Global Equities (FTSE World Index) | | Unleaded Gasoline | | Natural Gas | | Heating Oil | | Crude Oil | | |
10 Year Correlation Matrix 1998-2008 | | | Large Cap U.S. Equities (S&P 500) | | | U.S. Govt. Bonds (EFFAS U.S. Government Bond Index) | | | Global Equities (FTSE World Index) | | | Unleaded Gasoline | | | Natural Gas | | | Heating Oil | | | Crude Oil | |
Large Cap U.S. Equities (S&P 500) | | | 1 | | -0.237 | | 0.949 | | -0.087 | | -0.008 | | -0.065 | | -0.037 | | | | 1.000 | | | | -0.223 | | | | 0.936 | | | | 0.266 | | | | 0.045 | | | | 0.003 | | | | 0.063 | |
US Govt. Bonds (EFFAS U.S. Government Bond Index) | | | | | 1 | | -0.259 | | -0.175 | | 0.197 | | 0.065 | | 0.033 | | |
U.S. Govt. Bonds (EFFAS U.S. Government Bond Index) | | | | | | | 1.000 | | | | -0.214 | | | | -0.134 | | | | 0.054 | | | | 0.037 | | | | -0.29 | |
Global Equities (FTSE World Index) | | | | | | | 1 | | 0.124 | | 0.029 | | -0.003 | | 0.040 | | | | | | | | | | | 1.000 | | | | 0.384 | | | | 0.072 | | | | 0.084 | | | | 0.155 | |
Gasoline | | | | | | | | | 1 | | 0.267 | | 0.663 | | 0.634 | | |
Unleaded Gasoline | | | | | | | | | | | | | | | 1.000 | | | | 0.254 | | | | 0.787 | | | | 0.747 | |
Natural Gas | | | | | | | | | | | 1 | | 0.480 | | 0.344 | | | | | | | | | | | | | | | | | | | 1.000 | | | | 0.394 | | | | 0.292 | |
Heating Oil | | | | | | | | | | | | | 1 | | 0.802 | | | | | | | | | | | | | | | | | | | | | | | 1.000 | | | | 0.738 | |
Crude Oil | | | | | | | | | | | | | | | 1 | | | | | | | | | | | | | | | | | | | | | | | | | | | 1.000 | |
source: Bloomberg, NYMEX | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
The chart below covers a more recent, but much shorter, range of dates than the above chart. Over the one year period ended March 31, 2009, crude oil continued to have a strong positive correlation with heating oil and unleaded gasoline. During this period, it also had a stronger correlation with the movements of natural gas than it had displayed over the ten year period ended December 31, 2008. Notably, the correlation between crude oil and both large cap U.S. equities and global equities, which had been essentially non-correlated over the ten year period ended December 31, 2008, displayed results that indicated that they had a mildly positive correlation over this shorter time period, particularly due to the recent downturn in the U.S. economy. Finally, the results showed that crude oil and U.S. government bonds, which had essentially been non-correlated for the ten year period ended December 31, 2008, were weakly negatively correlated over this more recent time period.
Correlation Matrix – 12 months ended March 31, 2009 | | Large Cap U.S. Equities (S&P 500) | | | U.S. Govt. Bonds (EFFAS U.S. Government Bond Index) | | | Global Equities (FTSE World Index) | | | Unleaded Gasoline | | | Natural Gas | | | Heating Oil | | | Crude Oil | |
Large Cap U.S. Equities (S&P 500) | | | 1.000 | | | | 0.234 | | | | 0.980 | | | | 0.504 | | | | 0.564 | | | | 0.014 | | | | 0.527 | |
U.S. Govt. Bonds (EFFAS U.S. Government Bond Index) | | | | | | | 1.000 | | | | 0.296 | | | | -0.399 | | | | -0.296 | | | | 0.067 | | | | -0.220 | |
Global Equities (FTSE World Index) | | | | | | | | | | | 1.000 | | | | 0.525 | | | | 0.562 | | | | 0.067 | | | | 0.541 | |
Unleaded Gasoline | | | | | | | | | | | | | | | 1.000 | | | | 0.883 | | | | 0.189 | | | | 0.811 | |
Natural Gas | | | | | | | | | | | | | | | | | | | 1.000 | | | | 0.444 | | | | 0.871 | |
Heating Oil | | | | | | | | | | | | | | | | | | | | | | | 1.000 | | | | 0.513 | |
Crude Oil | | | | | | | | | | | | | | | | | | | | | | | | | | | 1.000 | |
Source: Bloomberg, NYMEX | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Investors are cautioned that the historical price relationships between crude oil and various other energy commodities, as well as other investment asset classes, as measured by correlation may not be reliable predictors of future price movements and correlation results. The results pictured above would have been different if a different range of dates had been selected. The General Partner believes that crude oil has historically not demonstrated a strong correlation with equities or bonds over long periods of time. However, the General Partner also believes that in the future it is possible that crude oil could have long term correlation results that indicate prices of crude oil more closely track the movements of equities or bonds. In addition, the General Partner believes that, when measured over time periods shorter than ten years, there will always be some periods where the correlation of crude oil to equities and bonds will be either more strongly positively correlated or more strongly negatively correlated than the long term historical results suggest.
The chart below covers a more recent, but much shorter, range of dates than the above chart. Over the nine months ended September 30, 2008,correlations between crude oil, continued to have a strong positive correlation withnatural gas, heating oil and gasoline. During this period it also had a stronger correlationgasoline are relevant because the General Partner endeavors to invest USOF’s assets in Oil Futures Contracts and Other Crude Oil-Related Investments so that daily changes in USOF’s NAV correlate as closely as possible with daily changes in the price of the Benchmark Oil Futures Contract. If certain other fuel-based commodity futures contracts do not closely correlate with the movements of natural gas than it had displayed overOil Futures Contract, then their use could lead to greater tracking error. As noted, the prior ten year period. Notably,General Partner also believes that the correlation between crude oil and both large cap U.S. equities and global equities, which had been essentially non-correlated over the prior ten years, displayed results that indicated that they had a weak but positive correlation over this shorter time period, particularly due to the recent downturnchanges in the U.S. economy. Finally,price of the results showed thatBenchmark Oil Futures Contract will closely correlate with changes in the spot price of light, sweet crude oil and U.S. government bonds, which had essentially been non-correlated for the prior ten year period, were weakly negatively correlated over this more recent time period.oil.
Correlation Matrix 2008 YTD (9 months) | | Large Cap US Equities (S&P 500) | | U.S. Govt. Bonds (EFFAS U.S. Government Bond Index) | | Global Equities (FTSE World Index) | | Unleaded Gasoline | | Natural Gas | | Heating Oil | | Crude Oil | |
Large Cap U.S. Equities (S&P 500) | | | 1 | | | -0.641 | | | 0.920 | | | 0.565 | | | -0.152 | | | 0.214 | | | 0.289 | |
US Govt. Bonds (EFFAS U.S. Government Bond Index) | | | | | | 1 | | | -0.682 | | | -0.581 | | | -0.045 | | | -0.414 | | | -0.507 | |
Global Equities (FTSE World Index) | | | | | | | | | 1 | | | 0.760 | | | 0.108 | | | 0.496 | | | 0.575 | |
Gasoline | | | | | | | | | | | | 1 | | | 0.650 | | | 0.900 | | | 0.923 | |
Natural Gas | | | | | | | | | | | | | | | 1 | | | 0.805 | | | 0.771 | |
Heating Oil | | | | | | | | | | | | | | | | | | 1 | | | 0.914 | |
Crude Oil | | | | | | | | | | | | | | | | | | | | | 1 | |
source: Bloomberg, NYMEX | | | | | | | | | | | | | | | | | | | | | | |
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Critical Accounting Policies
Preparation of the condensed financial statements and related disclosures in compliance with accounting principles generally accepted in the United States of America requires the application of appropriate accounting rules and guidance, as well as the use of estimates. USOF’s application of these policies involves judgments and actual results may differ from the estimates used.
The General Partner has evaluated the nature and types of estimates that it makes in preparing USOF’s condensed financial statements and related disclosures and has determined that the valuation of its investments which are not traded on a United States or internationally recognized futures exchange (such as forward contracts and over-the-counter contracts) involves a critical accounting policy. The values which are used by USOF for its forward contracts are provided by its commodity broker who uses market prices when available, while over-the-counter contracts are valued based on the present value of estimated future cash flows that would be received from or paid to a third party in settlement of these derivative contracts prior to their delivery date and valued on a daily basis. In addition, USOF estimates interest income on a daily basis using prevailing interest rates earned on its cash and cash equivalents. These estimates are adjusted to the actual amount received on a monthly basis and the difference, if any, is not considered material.
Liquidity and Capital Resources
USOF has not made, and does not anticipate making, use of borrowings or other lines of credit to meet its obligations. USOF has met, and it is anticipated that USOF will continue to meet, its liquidity needs in the normal course of business from the proceeds of the sale of its investments or from the Treasuries, cash and/or cash equivalents that it intends to hold at all times. USOF’s liquidity needs include: redeeming units, providing margin deposits for its existing Oil Futures Contracts or the purchase of additional Oil Futures Contracts and posting collateral for its over-the-counter contracts and payment of its expenses, summarized below under “Contractual Obligations.”
USOF currently generates cash primarily from (i) the sale of baskets consisting of 100,000 units (“Creation BasketsBaskets”) and (ii) interest earned on Treasuries, cash and/or cash equivalents. USOF has allocated substantially all of its net assets to trading in Oil Interests. USOF invests in Oil Interests to the fullest extent possible without being leveraged or unable to satisfy its current or potential margin or collateral obligations with respect to its investments in Oil Futures Contracts and Other Oil Interests. A significant portion of the NAV is held in cash and cash equivalents that are used as margin and as collateral for USOF’s trading in Oil Interests. The percentage that Treasuries will bear to the total net assets will vary from period to period as the market values of the Oil Interests change. The balance of the net assets is held in USOF’s Oil Futures Contracts and Other Oil Interests trading account.account at its custodian bank. Interest earned on USOF’s interest-bearing funds is paid to USOF.
In prior periods, the amount of cash earned by USOF from the sale of Creation Baskets and from interest has exceeded the amount of cash required to pay USOF’s expenses. However, there can be no assurance that the amount of cash earned will do so in a period of very low short-term interest rates. In that event, USOF may not be able to rely on its income to cover cash expenses, which could cause a drop in USOF’s NAV over time. USOF’s investment in Oil Interests may be subject to periods of illiquidity because of market conditions, regulatory considerations and other reasons. For example, most commodity exchanges limit the fluctuations in Oil Futures Contracts prices during a single day by regulations referred to as “daily limits.” During a single day, no trades may be executed at prices beyond the daily limit. Once the price of an Oil Futures Contract has increased or decreased by an amount equal to the daily limit, positions in the contracts can neither be taken nor liquidated unless the traders are willing to effect trades at or within the specified daily limit. Such market conditions could prevent USOF from promptly liquidating its positions in Oil Futures Contracts. During the ninethree month period ended September 30, 2008,March 31, 2009, USOF was not forced to purchase or liquidate any of its positions while daily limits were in effect; however, USOF cannot predict whether such an event may occur in the future.
Prior toSince March 23, 2007, all paymentsUSOF has been responsible for expenses relating to (i) investment management fees, (ii) brokerage fees and commissions, (iii) licensing fees for the use of intellectual property, (iv) ongoing registration expenses in connection with respectoffers and sales of its units subsequent to USOF’sthe initial offering, (v) taxes and other expenses, including certain tax reporting costs, (vi) fees and expenses of the independent directors of the General Partner’sPartner and (vii) other extraordinary expenses were paid by their affiliates. Neither USOF nornot in the ordinary course of business, while the General Partner has any obligation or intentionbeen responsible for expenses relating to refund such payments by their affiliates. These affiliates are under no obligation to paythe fees of USOF’s or the General Partner’s current or future expenses.marketing agent, administrator and custodian. If the General Partner and USOF are unsuccessful in raising sufficient funds to cover USOF’sthese respective expenses or in locating any other source of funding, USOF will terminate and investors may lose all or part of their investment.
Market Risk
Trading in Oil Futures Contracts and Other Oil Interests, such as forwards, involves USOF entering into contractual commitments to purchase or sell oil at a specified date in the future. The gross or face amountaggregate market value of the contracts will significantly exceed USOF’s future cash requirements since USOF intends to close out its open positions prior to settlement. As a result, USOF is generally only subject to the risk of loss arising from the change in value of the contracts. USOF considers the “fair value” of its derivative instruments to be the unrealized gain or loss on the contracts. The market risk associated with USOF’s commitments to purchase oil is limited to the gross face amountaggregate market value of the contracts held. However, should USOF enter into a contractual commitment to sell oil, it would be required to make delivery of the oil at the contract price, repurchase the contract at prevailing prices or settle in cash. Since there are no limits on the future price of oil, the market risk to USOF could be unlimited.
USOF’s exposure to market risk depends on a number of factors, including the markets for oil, the volatility of interest rates and foreign exchange rates, the liquidity of the Oil Futures Contracts and Other Oil Interests markets and the relationships among the contracts held by USOF. The limited experience that USOF has had in utilizing its model to trade in Oil Interests in a manner intended to track the changes in the spot price of crude oil as represented by the change in the near month crude oil futures contract, as well as drastic market occurrences, could ultimately lead to the loss of all or substantially all of an investor’s capital.
Credit Risk
When USOF enters into Oil Futures Contracts and Other Oil Interests, it is exposed to the credit risk that the counterparty will not be able to meet its obligations. The counterparty for the Oil Futures Contracts traded on the NYMEX and on most other foreign futures exchanges is the clearinghouse associated with the particular exchange. In general, clearinghouses are backed by their members who may be required to share in the financial burden resulting from the nonperformance of one of their members and, therefore, this additional member support should significantly reduce credit risk. Some foreign exchanges are not backed by their clearinghouse members but may be backed by a consortium of banks or other financial institutions. There can be no assurance that any counterparty, clearinghouse, or their members or their financial backers will satisfy their obligations to USOF in such circumstances.
The General Partner attempts to manage the credit risk of USOF by following various trading limitations and policies. In particular, USOF generally posts margin and/or holds liquid assets that are approximately equal to the face amountmarket value of its obligations to counterparties under the Oil Futures Contracts and Other Oil Interests it holds. The General Partner has implemented procedures that include, but are not limited to, executing and clearing trades only with creditworthy parties and/or requiring the posting of collateral or margin by such parties for the benefit of USOF to limit its credit exposure. UBS Securities LLC, USOF’s commodity broker, or any other broker that may be retained by USOF in the future, when acting as USOF’s futures commission merchant in accepting orders to purchase or sell Oil Futures Contracts on United States exchanges, is required by CFTC regulations to separately account for and segregate as belonging to USOF, all assets of USOF relating to domestic Oil Futures Contracts trading. These futures commission merchants are not allowed to commingle USOF’s assets with its other assets. In addition, the CFTC requires commodity brokers to hold in a secure account the USOF assets related to foreign Oil Futures Contracts trading.
During the three month period ended March 31, 2009, the only foreign exchange on which USOF made investments was the ICE Futures, which is a London based futures exchange. Those crude oil contracts are denominated in U.S. dollars. 26
In the future, USOF may purchase over-the-counter contracts. See “Item 3. Quantitative and Qualitative Disclosures About Market Risk” of this quarterly report on Form 10-Q for a discussion of over-the-counter contracts.As of September 30, 2008,March 31, 2009, USOF had deposits in domestic and foreign financial institutions, including cash investments in money market funds, in the amount of $1,701,783,696.$2,780,809,660. This amount is subject to loss should these institutions cease operations.
Off Balance Sheet Financing
As of September 30, 2008,March 31, 2009, USOF has no loan guarantee, credit support or other off-balance sheet arrangements of any kind other than agreements entered into in the normal course of business, which may include indemnification provisions relating to certain risks that service providers undertake in performing services which are in the best interests of USOF. While USOF’s exposure under these indemnification provisions cannot be estimated, they are not expected to have a material impact on USOF’s financial position.
Redemption Basket Obligation
In order to meet its investment objective and pay its contractual obligations described below, USOF requires liquidity to redeem units, which redemptions must be in blocks of 100,000 units called “Redemption Baskets”. USOF has to date satisfied this obligation by paying from the cash or cash equivalents it holds or through the sale of its Treasuries in an amount proportionate to the number of units being redeemed.
Contractual Obligations
USOF’s primary contractual obligations are with the General Partner. In return for its services, the General Partner is entitled to a management fee calculated as a fixed percentage of USOF’s NAV, currently 0.50% for a0.45% of NAV of $1 billion or less, and thereafter 0.20% for a NAV above $1 billion.on its average net assets.
The General Partner agreed to pay the start-up costs associated with the formation of USOF, primarily its legal, accounting and other costs in connection with the General Partner’s registration with the CFTC as a CPO and the registration and listing of USOF and its units with the SEC, FINRA and the AMEX, respectively. However, following USOF’s initial offering of units, offering costs incurred in connection with registering and listing additional units of USOF are directly borne on an ongoing basis by USOF, and not by the General Partner.
The General Partner pays the fees of USOF’s marketing agent, ALPS Distributors, Inc., and the fees of the custodian and transfer agent, Brown Brothers Harriman & Co. (“BBH&Co.”), as well as BBH&Co.’s fees for performing administrative services, including in connection with the preparation of USOF’s condensed financial statements and its SEC and CFTC reports. The General Partner and USOF have also entered into a licensing agreement with the NYMEX pursuant to which USOF and the affiliated funds managed by the General Partner pay a licensing fee to the NYMEX. The General PartnerUSOF also pays any fees for implementation of services and base service fees charged by the accounting firm responsible for preparing USOF’s tax reporting forms; however, USOF pays the fees and expenses associated with its tax accounting and reporting requirements.requirements with the exception of certain initial implementation service fees and base service fees which are paid by the General Partner.
In addition to the General Partner’s management fee, USOF pays its brokerage fees (including fees to a futures commission merchant), over-the-counter dealer spreads, any licensing fees for the use of intellectual property, and, subsequent to the initial offering, registration and other fees paid to the SEC, FINRA, or other regulatory agencies in connection with the offer and sale of units, as well as legal, printing, accounting and other expenses associated therewith, and extraordinary expenses. The latter are expenses not incurred in the ordinary course of USOF’s business, including expenses relating to the indemnification of any person against liabilities and obligations to the extent permitted by law and under the LP Agreement, the bringing or defending of actions in law or in equity or otherwise conducting litigation and incurring legal expenses and the settlement of claims and litigation. Commission payments to a futures commission merchant are on a contract-by-contract, or round turn, basis. USOF also pays a portion of the fees and expenses of the independent directors of the General Partner. See Note 3 to the Notes to Condensed Financial Statements (Unaudited).
The parties cannot anticipate the amount of payments that will be required under these arrangements for future periods, as USOF’s NAVs and trading levels to meet its investment objectives will not be known until a future date. These agreements are effective for a specific term agreed upon by the parties with an option to renew, or, in some cases, are in effect for the duration of USOF’s existence. Either party may terminate these agreements earlier for certain reasons described in the agreements.
Item 3.Quantitative and Qualitative Disclosures About Market Risk.
Over-the-Counter Derivatives (Including Spreads and Straddles)
In the future, USOF may purchase over-the-counter contracts. Unlike most of the exchange-traded Oil Futures Contracts or exchange-traded options on such futures, each party to an over-the-counter contract bears the credit risk that the other party may not be able to perform its obligations under its contract.
Some crude oil-based derivatives transactions contain fairly generic terms and conditions and are available from a wide range of participants. Other crude oil-based derivatives have highly customized terms and conditions and are not as widely available. Many of these over-the-counter contracts are cash-settled forwards for the future delivery of crude oil- or petroleum-based fuels that have terms similar to the Oil Futures Contracts. Others take the form of “swaps” in which the two parties exchange cash flows based on pre-determined formulas tied to the spot price of crude oil, forward crude oil prices or crude oil futures prices. For example, USOF may enter into over-the-counter derivative contracts whose value will be tied to changes in the difference between the spot price of light, sweet crude oil, the price of Oil Futures Contracts traded on the NYMEX and the prices of other Oil Futures Contracts that may be invested in by USOF.
To protect itself from the credit risk that arises in connection with such contracts, USOF may enter into agreements with each counterparty that provide for the netting of its overall exposure to such counterparty, such as the agreements published by the International Swaps and Derivatives Association, Inc. USOF also may require that the counterparty be highly rated and/or provide collateral or other credit support to address USOF’s exposure to the counterparty. In addition, it is also possible for USOF and its counterparty to agree to clear their agreement through an established futures clearing houseclearinghouse such as those connected to the NYMEX or the ICE Futures. In that event, USOF would no longer have credit risk of its original counterparty, as the clearinghouse would now be USOF’s counterparty. USOF would still retain any price risk associated with its transaction.
The creditworthiness of each potential counterparty is assessed by the General Partner. The General Partner assesses or reviews, as appropriate, the creditworthiness of each potential or existing counterparty to an over-the-counter contract pursuant to guidelines approved by the General Partner’sPartner's board of directors.directors (the “Board”). Furthermore, the General Partner on behalf of USOF only enters into over-the-counter contracts with counterparties who are, or are affiliates of, (a) members of the Federal Reserve System or foreign banks with branchesregulated by a United States federal bank regulator, (b) broker-dealers regulated by the Federal Reserve Board; (b) primary dealersSEC, (c) insurance companies domiciled in U.S. government securities; (c) broker-dealers;the United States, and (d) commodity futures merchants;producers, users or (e) affiliatestraders of energy, whether or not regulated by the foregoing.CFTC. Any entity acting as a counterparty shall be regulated in either the United States or the United Kingdom unless otherwise approved by the Board after consultation with its legal counsel. Existing counterparties are also reviewed periodically by the General Partner.
USOF anticipates that the use of Other Oil Interests together with its investments in Oil Futures Contracts will produce price and total return results that closely track the investment goals of USOF.
USOF may employ spreads or straddles in its trading to mitigate the differences in its investment portfolio and its goal of tracking the price of the Benchmark Oil Futures Contract. USOF would use a spread when it chooses to take simultaneous long and short positions in futures written on the same underlying asset, but with different delivery months. The effect of holding such combined positions is to adjust the sensitivity of USOF to changes in the price relationship between futures contracts which will expire sooner and those that will expire later. USOF would use such a spread if the General Partner felt that taking such long and short positions, when combined with the rest of its holdings, would more closely track the investment goals of USOF, or if the General Partner felt it would lead to an overall lower cost of trading to achieve a given level of economic exposure to movements in oil prices. USOF would enter into a straddle when it chooses to take an option position consisting of a long (or short) position in both a call option and put option. The economic effect of holding certain combinations of put options and call options can be very similar to that of owning the underlying futures contracts. USOF would make use of such a straddle approach if, in the opinion of the General Partner, the resulting combination would more closely track the investment goals of USOF or if it would lead to an overall lower cost of trading to achieve a given level of economic exposure to movements in oil prices.
During the ninethree month period ended September 30, 2008,March 31, 2009, USOF did not employ any hedging methods such as those described above since all of its investments were made over an exchange. Therefore, USOF was not exposed to counterparty risk.
Disclosure Controls and Procedures
USOF maintains disclosure controls and procedures that are designed to ensure that material information required to be disclosed in USOF’s periodic reports filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms.
The duly appointed officers of the General Partner, including its chief executive officer and chief financial officer, who perform functions equivalent to those of a principal executive officer and principal financial officer of USOF if USOF had any officers, have evaluated the effectiveness of USOF’s disclosure controls and procedures and have concluded that the disclosure controls and procedures of USOF have been effective as of the end of the period covered by this quarterly report.report on Form 10-Q.
Change in Internal Control Over Financial Reporting
There were no changes in USOF’s internal control over financial reporting during USOF’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, USOF’s internal control over financial reporting.
Part II.OTHER INFORMATION
Item 1. Legal Proceedings.
Not applicable.
Item 1A. Risk Factors.
There has not been a material change from the risk factors previously disclosed in USOF's Annual Report on Form 10-K for the fiscal year ended December 31, 2007. 2008.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Not applicable.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 5.Other Information.
Monthly Account Statements
Pursuant to the requirement under partRule 4.22 ofunder the Commodity Exchange Act, each month USOF publishes an account statement for its unitholders, which includes a Statement of Income (Loss) and a Statement of Changes in NAV. The account statement is filed withfurnished to the SEC on a current report on Form 8-K pursuant to Section 13 or 15(d) of the Exchange Act and posted each month on USOF’s website at www.unitedstatesoilfund.com.
Item 6.Exhibits.
Listed below are the exhibits which are filed or furnished as part of this quarterly report on Form 10-Q (according to the number assigned to them in Item 601 of Regulation S-K):
Exhibit Number | | |
Number
| | Description of Document |
10.1*
| | Fifth Amended and Restated Agreement of Limited Partnership. |
31.1** | | Certification by Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2** | | Certification by Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1*** | | Certification by Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2*** | | Certification by Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
*Incorporated by reference to Registrant’s Current Report on Form 8-K filed on October 14, 2008
**Filed herewith
***Furnished herewith
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
United States Oil Fund, LP (Registrant)
By: United States Commodity Funds LLC, its general partner
|
By: | United States Commodity Funds LLC, its general partner |
| (formerly known as Victoria Bay Asset Management, LLC) |
| | |
By: | /s/ /s/ Nicholas D. Gerber
| | | | |
Nicholas D. Gerber |
Chief Executive Officer |
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Chief Executive Officer Date: November 10, 2008May 11, 2009 | | | | |
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By: | | | | | |
Howard Mah |
Chief Financial Officer |
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Chief Financial Officer Date: November 10, 2008May 11, 2009 | | | | |