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Is USO Going Back To $100? Not Likely

Readers are wondering if oil fund prices will go up as quickly as they went down. Unfortunately, it's very unlikely.

Ever since the price of oil and oil funds collapsed in April, I've received a bunch of questions asking where prices go from here. I've written extensively on the United States Oil Fund (USO) and the ProShares Ultra Bloomberg Crude Oil Fund (UCO) lately, so questions were related specifically to those products.

Questions like this:

I’m a newbie in shares & stocks. I just invested in UCO at $12 per share. Do you think there’s a chance it may go back in the $100-$200 range once things start opening back up?

When the ETFs recover how high do you think they’ll go? UCO has dropped insane amounts. From near $300/share just 3 months ago to what it’s at now. I’m wondering if it has any chance of returning to those numbers in the next 6 months.

I can sort of understand the optimism here. USO started the year at a split-adjusted $100. UCO started the year at more than $500. If they cratered this year in just a few months when oil prices plunged, can't they just return to their former levels when oil prices rebound?


The quick answer to both questions is it's possible, of course, but highly unlikely.

There's two ways to approach this question - from an economic standpoint and a structural standpoint.

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Economically, a return to $100 on USO would require at least a return to oil's former levels. In this case, that would equate to roughly $60/barrel. Needless to say, oil prices crashed for a reason in 2020. The coronavirus has ground the U.S. and global economies to a halt and we still have no idea when things are going to come fully back online. Manufacturing and services activity have plummeted to all-time lows. The unemployment rate is probably around 20%. Many consumers are hoarding what cash they have and spending only on essentials. In a lot of cases, even that's not enough to make ends meet.

That also means that virtually all demand for crude oil has gone away. Air travel is essentially non-existent. Vacations are cancelled. Even simple trips to work have been minimized since so many people are working from home now.

Supplies are already maxed out. That's a big reason why oil last month fell to -$40 barrel. Lots of crude production but no place to put it. Producers were PAYING people to take it off their hands.

With states starting to reopen, the supply/demand imbalance will slowly start to work itself out but that could take months, if not years. And the basic demand for crude could take months, if not years, to return as well.

Is that a recipe for oil prices to go from $10/barrel back to $60? Definitely not.

If that weren't enough, the structural changes that USO made to its strategy might be an even stronger headwind preventing a return to $100.

USO used to invest solely in near-term oil contracts with expirations of around one month or less. That changed when the May contract went to $0. USO made its first change to target contracts with expirations up to three months out instead of one to spread out some risk. Then, it dumped the one-month contracts altogether. Then, it changed again to target contracts up to 12 months out. Then, it decided to allow for the purchase of contracts in gasoline, diesel, natural gas and other non-petroleum products.

In other words, USO is no longer a play on oil prices. It's become a play on commodities prices in general.

That's been good from a pure structural standpoint, but not for the fund's ability to rebound sharply. The moves that were made diversify a good chunk of the risk that was present in USO previously, but that comes at the expense of returns.

Longer-term oil contract prices are less volatile than shorter-term ones and less risk means less return potential. Even if oil returned to $60, USO would experience much less of a bounce than before.

But that's not it.

Oil funds aren't like regular ETFs or mutual funds where you simply buy and hold stocks, bonds or whatever. Instead, they invest in monthly oil futures contracts. Previously, when USO invested in one-month futures contracts, the fund needed to sell them just prior to expiration and reinvest the proceeds into the next month's contract. And they need to do that over and over every month. That trading, or roll, comes at a cost and that hurts USO's share price.

Take a look at what just happened in April.


When USO invested in near-term contracts, it tracked the price of oil pretty closely. But then it started rotating out of short-term contracts and into long-term contracts. I've highlighted the section of the chart where that took place and you can see what those roll costs did to the price. Oil was up 10% but USO dropped 7%. That all came from the cost of rolling over oil futures contracts.

When you add the economic and structural risks together, I don't think there's any way it gets even near $100.

I made the case in a prior article for USO returning to $32. That's pretty much a best case scenario where the economic reopening works well, consumers begin returning en masse to shopping centers and resume traveling, there's no new spike in coronavirus cases and OPEC countries agree not to overproduce again.

But that's far from a guarantee and we shouldn't assume that USO will even rise into the double digits from here. In my opinion, oil and oil funds, like USO and UCO, are still poor risk/reward tradeoffs.

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