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Why Is USO -- the Oil ETF -- Outperforming the Price of Oil?

NEW YORK (TheStreet) -- Things are looking good for United States Oil Fund (USO). The security closed Thursday with a 1.4% gain to $37.83 per share, mainly due to the jump in oil prices to $103.08. Developments in the oil futures markets have also benefited investors in oil ETFs.

But why?

Progress in the price of oil has led to "backwardation" in the futures markets -- a situation in which long-term contracts are priced lower than short-term contracts. This situation has also benefited investors in oil ETFs such as USO, because when the ETF rolls its positions in near-term contracts, it purchases next-month futures contract at a lower price than the near-term contract.

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This scenario leads to a gap between the price of West Texas Intermediate crude oil and the price of the USO ETF, as indicated in the chart below.

Source of data: Google finance and U.S. Energy Information Administration

The chart shows the normalized prices of oil and the USO ETF to the end of March. As the chart shows, the gap between USO and the price of oil remained wide.

This means that investors in USO during this time frame recorded a 4% gain, while investors in WTI oil lost nearly 1.5% of their investment.

Today's gains in the oil market are likely to be a short-term gain, partly due to the tensions in the Middle East. The gains don't have much to do with a fundamental change in market outlook. These short-term gains could only widen the backwardation, and investors in USO may benefit from this turn of events.

Conversely, if the price of oil resumes its downward trend, this could close the gap between the short-term futures contracts and long-term contracts. In such a case, USO will continue to come down and close the gap with oil prices.

Despite the recent recovery in the price of oil, it wasn't enough to pull up shares of leading oil producers such as Chevron (CVX), which slightly declined today by 0.62% to $130.08 per share at the close.

Today's plunge in natural gas prices by over 4% may have crowded out the positive effect oil prices have on oil companies' stocks.

For more from Lior Cohen, see "How Will the Brent-WTI Spread Impact Oil Refiners?"

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

TheStreet Ratings team rates CHEVRON CORP as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:

"We rate CHEVRON CORP (CVX) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its largely solid financial position with reasonable debt levels by most measures, attractive valuation levels, good cash flow from operations and increase in stock price during the past year. We feel these strengths outweigh the fact that the company has had somewhat weak growth in earnings per share."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • CVX's debt-to-equity ratio is very low at 0.15 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Along with the favorable debt-to-equity ratio, the company maintains an adequate quick ratio of 1.02, which illustrates the ability to avoid short-term cash problems.
  • Net operating cash flow has increased to $8,417.00 million or 47.30% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of 17.51%.
  • Compared to where it was 12 months ago, the stock is up, but it has so far lagged the appreciation in the S&P 500. Turning our attention to the future direction of the stock, it goes without saying that even the best stocks can fall in an overall down market. However, in any other environment, this stock still has good upside potential despite the fact that it has already risen in the past year.
  • CVX, with its decline in revenue, slightly underperformed the industry average of 3.2%. Since the same quarter one year prior, revenues slightly dropped by 6.2%. Weakness in the company's revenue seems to have hurt the bottom line, decreasing earnings per share.

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