Oil ETFs: Tread Carefully

NEW YORK (TheStreet) -- As oil prices surge, popular oil-tracking ETFs like United States Oil(USO Quote) could face regulatory difficulties.

In the wake of the restructuring of the United States Natural Gas(UNG Quote) (UNG) (ETFs Reshaped Ahead of Regulation and PowerShares DB Commodity(DBC Quote) ETFs, investors should be cautious about dipping into futures-backed oil funds.

New position limits handed down by the Commodities Futures Trading Commission have caused multiple halts in ETF share creation, the mercy killing of PowerShares DB Crude Oil Double Long ETN(DXO Quote), and the restructuring of several large, popular funds like UNG that track futures.

USO, iPath's S&P GSCI Crude Oil Total Return Index(OIL Quote), Powershares' DB Oil and the United States 12 Month Oil Fund(USL Quote) all track a basket of futures contracts in order to provide investors with exposure to crude oil prices.

In the past, the biggest problems facing these funds were contango and an influx of ill-suited investors. Contango and backwardation, two phenomenons which occur when fund managers have to sell one month's futures contracts and buy another's, had long caused discrepancies between the market value and underlying value of futures-backed oil funds.

Buyers of USO and OIL are particularly vulnerable to the contango problem, while the underlying methodologies of DBO and USL attempt to mitigate the effects of rolling the contracts.

As investors get excited once again about the climbing price of oil, greater challenges could face futures-backed oil ETFs. While most of the funds have not yet reached the size to draw accusations of "speculation" and "market manipulation" from regulators, an increased interest in tracking oil prices could bring these funds to critical mass.