For the world’s largest oil fund, the situation changes by the day—sometimes, by the hour.
Yesterday, several new developments occurred for the $5 billion United States Oil Fund LP (USO), including another portfolio overhaul, the emergence of sky-high trading premiums and an announced reverse share split.
Falling Oil Prices, Rising USO Demand
It’s all connected to the continued troubles in the crude oil market. As pandemic-related lockdowns remain in force, oil demand has crashed and excess storage capacity has run thin, pushing crude prices to record lows.
Yesterday, the June 2020 WTI crude oil contract fell 43% to close at $11.57/barrel—only one day after the expiring May 2020 WTI contract settled at -$37.63/barrel. (Read: “Stunningly, Oil Prices Crash Below Zero.“)
Falling prices have tanked USO’s returns, even as the fund sees record inflows from investors looking to play a potential oil rebound. Year to date, USO has taken in $4.9 billion in new net investment assets, though the fund itself is down more than 70%.
USO’s Holdings Change Again
Cratering oil futures prices and record investment demand have forced USO’s issuer, US Commodity Funds, to take a series of unusual steps in recent days.
Last Friday, we reported that USO would be shifting its portfolio from front-month oil futures to an 80%/20% blend of front-month and second-month futures (and second-month/third-month, in the short period between roll and expiry). (Read: “Biggest Oil ETF Shakes Up Structure.“)
However, yesterday, USO announced another, even more significant, portfolio change. Instead of the 80%/20% blend as described last week, USO will now begin investing in NYMEX and ICE crude oil futures “in any month available or in varying percentages,” or in noncrude oil futures investments, “without further disclosure.”
Functionally, this turns USO into an actively managed oil ETF that can invest in any crude oil futures contract across the curve, as well as contracts for other petroleum-based fuels, derivatives on those futures contracts, and related indexes and their derivatives.
USO Changes Due To Position Limits, Super Contango
As of yesterday’s close, USO had invested 40% of its portfolio in NYMEX and ICE June 2020 WTI Crude Oil futures contracts, roughly 55% of its portfolio in July 2020 crude oil contracts, and 5% of its portfolio in August contracts.
The language of the announcement implied that USO plans to hold this configuration until at least the next roll period—though, as stated above, the managers have the discretion to change the portfolio as needed.
The portfolio change was a necessary move for an ETF that kept brushing up against position limits for individual contracts. Friday’s portfolio change had been implemented in part to avoid exceeding the CFTC’s 25% position limit in the deliverable supply of any single given contract (in this case, the NYMEX June 2020 crude contract).
While the change offered momentary relief, as investor money continued to flow into the fund, USO was forced to buy more futures and therefore once again ended up brushing up against the position limit by the end of Monday’s trading session.
In its filing, USCF also cited “super contango” as a motivator for the portfolio change. Contango is a condition in which futures contracts that are slated to expire soon are cheaper to buy than those with later expiry dates, implying the expectation of future price rises.
“Super contango” is essentially contango in overdrive, and it emerges when the storage capacity for the underlying commodity is on the verge of running out—exactly what experts warn is happening right now in crude oil.
Massive Premiums Emerge For USO
Yesterday, USO also suspended creations, pending approval from the SEC to raise its outstanding shares to 4 billion. (Read: “Biggest Oil ETF Halts Creations.“)
Shortly thereafter, a 36.41% trading premium to net asset value (NAV) developed in the fund—the second-highest such premium ever recorded:
Source: Bloomberg; Data as of April 22, 2020
Trading premiums often develop in ETFs that have halted creations, because the arbitrage mechanism that usually keeps a fund’s price in line with its underlying NAV can no longer work. Thus, as investors chase a limited amount of shares, they drive up the fund’s trading price relative to its fair value.
It is unclear when the SEC will approve new shares for USO, or how long it will take the fund to reopen to creations afterward. For example, when the iShares Gold Trust (IAU) registered for an additional 300 million shares in 2016, the approval was granted and its creations restarted in five days.
But when the United States Natural Gas Fund LP (UNG) had to halt creations in 2009 for conditions similar to what’s happening for USO now, it took two months for USCF to secure approval for new shares—and another two months to reopen the fund for creations.
USO Announces 1-for-8 Reverse Split
As if all this weren’t enough excitement, this morning USO announced a 1-for-8 reverse share split that will become effective after the close of markets on April 28.
When an ETF reverse splits its shares, the number of outstanding shares falls while the price rises by some set factor. In a 1-for-8 split, the number of outstanding ETF shares would be reduced by eight, while its share price would be multiplied by eight. (Any shares that can’t be evenly divisible by eight would be paid out in cash at fair value.)
Nothing about the fair value of the ETF or the securities inside its portfolio is impacted by a reverse share split. But issuers have used reverse share splits, especially lately, to prop up prices of ETFs that have fallen sharply. (Read: “What It Means When ETFs Reverse Split.“)
Despite its massive inflows, USO’s price has fallen precipitously, driven lower by the plummeting oil market that it tracks. More than a month ago, on March 18, USO closed below $5/share—its listing exchange’s minimum allowable trading price—and hasn’t risen above that threshold since.
Yesterday the ETF closed at $3.75, though the fund had fallen even lower in after-hours trading.
That said, USO isn’t in danger of delisting just yet: The NYSE Arca’s listing standard requires a fund to hold at $5/share or above for a majority of days over a six-month period; meaning, the exchange won’t delist USO over one bad month or two.
Still, sub-$5/share isn’t a trading price that USO’s managers find desirable, and it might not take more than a few more weeks of trading there for the fund to bump up against that listing standard.
That’s why USO is doing the reverse share split. In fact, USO’s prospectus gives its managers the discretion to adjust the price via share splits at any time “to maintain convenient trading ranges for investors.”
What’s Next For USO?
The situation for USO changes by the day, and investors should continue to trade USO with extreme caution (if at all).
USO’s high premiums to NAV are likely to persist for some time, at least while creations are halted. It’s also highly likely that bid/ask spreads for the fund will continue to widen; USO’s 60-day average spread is now 0.17% and climbing higher.
In addition, the fund’s impending reverse share split will void all open trade orders, such as limit orders, stop orders and so on. Options on USO will be impacted too. Therefore, after the reverse split occurs, investors should make sure to review their orders and replace any that have been canceled.
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