The following discussion should be read in conjunction with the condensed
financial statements and the notes thereto of the
Forward-Looking Information
This quarterly report on Form 10-Q, including this "Management's Discussion and Analysis of Financial Condition and Results of Operations," contains forward-looking statements regarding the plans and objectives of management for future operations. This information may involve known and unknown risks, uncertainties and other factors that may causeUSO's actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by any forward-looking statements.USO believes these factors include, but are not limited to, the following: changes in inflation inthe United States ; movements inU.S. and foreign currencies; market volatility in the crude oil markets and futures markets, in part attributable to the COVID-19 pandemic, disputes among oil-producing countries over the potential limits on the production of crude oil, changes in demand for crude oil and storage for crude oil; uncertainties associated with the impact from the coronavirus (COVID-19) pandemic, including: its impact on the global andU.S. capital markets and the global andU.S. economy, the length and duration of the COVID-19 outbreak inthe United States as well as worldwide and the magnitude of the economic impact of that outbreak, the effect of the COVID-19 pandemic onUSO's business prospects, including its ability to achieve its objectives, and the effect of the disruptions caused by the COVID-19 pandemic on our ability to continue to effectively manage our business. Forward-looking statements, which involve assumptions and describeUSO's future plans, strategies and expectations, are generally identifiable by use of the words "may," "will," "should," "expect," "anticipate," "estimate," "believe," "intend" or "project," the negative of these words, other variations on these words or comparable terminology. These forward-looking statements are based on assumptions that may be incorrect, andUSO cannot assure investors that the projections included in these forward-looking statements will come to pass.USO's actual results could differ materially from those expressed or implied by the forward-looking statements as a result of various factors.USO has based the forward-looking statements included in this quarterly report on Form 10-Q on information available to it on the date of this quarterly report on Form 10-Q, andUSO assumes no obligation to update any such forward-looking statements. AlthoughUSO undertakes no obligation to revise or update any forward-looking statements, whether as a result of new information, future events or otherwise, investors are advised to consult any additional disclosures thatUSO may make directly to them or through reports thatUSO files in the future with theSecurities and Exchange Commission (the "SEC"), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K.
Introduction
USO , aDelaware limited partnership, is a commodity pool that issues shares that may be purchased and sold on the NYSE Arca. The investment objective ofUSO is for the daily changes in percentage terms of its shares' per share NAV to reflect the daily changes in percentage terms of the spot price of light, sweet crude oil delivered toCushing, Oklahoma , as measured by the daily changes in the price of the futures contract for light, sweet crude oil traded on the NYMEX that is the near month contract to expire, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contract that is the next month contract to expire (the "Benchmark Oil Futures Contract"), plus interest earned onUSO's collateral holdings, lessUSO's expenses. "Near month contract" means the next contract traded on the NYMEX due to expire. "Next month contract" means the first contract traded on the NYMEX due to expire after the near month contract.USO seeks to achieve its investment objective by investing so that the average daily percentage change inUSO's NAV for any period of 30 successive valuation days will be within plus/minus ten percent (10%) of the average daily percentage change in the price of the Benchmark Oil Futures Contract over the same period. As described below,USO is currently unable to pursue its investment objective with the same high degree of success that it has in the past due to its limited ability to invest in the Benchmark Oil Futures Contract and certain other Oil Futures Contracts, as defined below, to the same extent it was able to before the market conditions and regulatory limitations imposed onUSO occurred in Spring of 2020, and risk mitigation measures taken byUSO's FCMs as a result, as described herein, arose. As a result of such market conditions, the regulatory conditions that were and could again be imposed, and the risk mitigation measures imposed by its FCMs, there is still uncertainty as to whetherUSO will be able to achieve its investment objective within as narrow a percentage change difference in its NAV for any period of 30 successive valuation days and the average daily percentage change in the price of the Benchmark Oil Futures Contract as it typically had prior to the Spring of 2020 due to the foregoing factors. 18
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USO's investment objective is not for its NAV or market price of shares to equal, in dollar terms, the spot price of light, sweet crude oil or any particular futures contract based on light, sweet crude oil, nor isUSO's investment objective for the percentage change in its NAV to reflect the percentage change of the price of any particular futures contract as measured over a time period greater than one day. The general partner ofUSO ,United States Commodity Funds, LLC ("USCF"), believes that it is not practical to manage the portfolio to achieve such an investment goal when investing in Oil Futures Contracts and Other Oil-Related Investments.USO invests primarily in futures contracts for light, sweet crude oil, other types of crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the NYMEX, ICE Futures or otherU.S. and foreign exchanges (collectively, "Oil Futures Contracts") and to a lesser extent, in order to comply with regulatory requirements, risk mitigation measures, liquidity requirements, or in view of market conditions, other oil-related investments such as cash-settled options on Oil Futures Contracts, forward contracts for oil, cleared swap contracts and OTC swaps that are based on the price of oil, other petroleum-based fuels, Oil Futures Contracts and indices based on the foregoing (collectively, "Other Oil-Related Investments"). For convenience and unless otherwise specified, Oil Futures Contracts and Other Oil-Related Investments collectively are referred to as "Oil Interests" in this quarterly report on Form 10-Q. USCF believes that market arbitrage opportunities will cause daily changes inUSO's share price on the NYSE Arca on a percentage basis to closely track daily changes inUSO's per share NAV on a percentage basis but there can be no assurance of that. USCF further believes that daily changes in prices of the Benchmark Oil Futures Contract have historically closely tracked the daily changes in spot prices of light, sweet crude oil. USCF believes that the net effect of these relationships will be that the daily changes in the price ofUSO's shares on the NYSE Arca on a percentage basis will closely track the daily changes in the spot price of a barrel of light, sweet crude oil on a percentage basis, plus interest earned onUSO's collateral holdings, lessUSO's expenses. As noted above,USO seeks to achieve its investment objective by investing so that the average daily percentage change inUSO's NAV for any period of 30 successive valuation days will be within plus/minus ten percent (10%) of the average daily percentage change in the price of the Benchmark Oil Futures Contract over the same period. Historically,USO has achieved its investment objective by primarily investing in the Benchmark Futures Contract and Oil Futures Contracts for light, sweet crude oil traded on NYMEX and ICE Futures with the same maturity month as the Benchmark Futures Contract Certain circumstances could cause and have caused, as discussed below,USO to invest in Oil Futures Contracts other than the Benchmark Oil Futures Contract and may causeUSO to invest in Other Oil-Related Investments. Such circumstances include: the need to comply with regulatory requirements (including, but not limited to, exchange accountability levels and position limits imposed by NYMEX discussed below); market conditions (including but not limited to those allowingUSO to obtain greater liquidity or to execute transactions with more favorable pricing); and risk mitigation measures taken byUSO's FCM,RBC Capital , and other FCMs that limitUSO and other market participants from investing in particular crude oil futures contracts. As a result of market and regulatory conditions, including significant market volatility, large numbers ofUSO shares purchased during a short period of time, and applicable regulatory accountability levels and position limits on oil futures contracts that were imposed onUSO in 2020, including as a result of the COVID-19 pandemic and the state of crude oil markets,USO has invested in Oil Futures Contracts (as defined below) in months other than the Benchmark Oil Futures Contract. The foregoing has impacted the performance ofUSO and its ability meet its investment objective within as narrow a percentage difference between the average daily percentage change inUSO's NAV for any period of 30 successive valuation days and the average daily percentage change in the price of the Benchmark Oil Futures Contract as it typically has in prior to the Spring of 2020.USO's investment in Oil Futures Contracts in months other than the Benchmark Oil Futures Contract, other Oil Futures Contracts and Other-Oil Related Interests (as defined below), is intended to be temporary but may continue indefinitely if the aforementioned market and regulatory conditions do not abate. Until such time asUSO is able to return to investing in the Benchmark Oil Futures Contract, its performance and ability to meet its investment objective will
continue to be impacted. 19 Table of Contents
The following chart shows, for the period ending
*PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS [[Image Removed: Graphic]] In 2020, significant market volatility occurred in the crude oil markets and the oil futures markets. Such volatility was attributable to the COVID-19 pandemic, disputes among oil-producing countries over the potential limits on the production of crude oil, a corresponding collapse in demand for crude oil and a lack of on-land storage for crude oil. These conditions together with the prospect that such conditions could reoccur, severely limited and continue to significantly limitUSO's ability to have a substantial portion of its assets invested in the Benchmark Oil Futures Contract and certain other Oil Futures Contracts of the same month, such as cash-settled, but substantially similar, oil futures contracts traded on ICE Futures (the "ICE WTI Contract"). Specifically:
In 2020, NYMEX and ICE Futures imposed accountability levels and position
limits on
WTI Contract, respectively. As described in more detail below, the NYMEX
ordered USCF,
assume a position in the light sweet crude oil futures contract for
in excess of 15,000 long futures contracts, for
long futures contracts, for
contracts, and for
While these limits no longer apply, NYMEX's current accountability levels for
? any one month in the Benchmark Oil Futures Contract is 10,000 contracts, and an
accountability level for all months of 20,000 net futures contracts for light
sweet crude oil, do apply. In addition, the ICE WTI Contract was in 2020 and,
currently, is subject to spot month and all-months-combined position limits
established under the
Directive, as implemented by the
Kingdom. ICE Futures also imposes accountability levels and position limits on
the ICE WTI Contract. Investors should note that the foregoing accountability
levels and position are subject to change and could change the amount and type
of permitted investments in which
Position Limits and Position Limits and Price Fluctuation Limits" below. 20 Table of Contents
In 2020, RBC imposed risk mitigation measures that constrained
invest in the Benchmark Oil Futures Contract and other Oil Futures Contracts.
RBC, which at the time was
not hold positions in the June Benchmark Oil Futures Contract expiring on May
19, 2020. At the time it imposed this restriction, RBC continued to trade and
clear other Oil Futures Contracts for
and rebalances of its portfolio. RBC also advised
? forward, it may only purchase additional Benchmark Oil Futures Contracts and
other Oil Futures Contracts through RBC for rolls and rebalances of
portfolio and not as investments for the proceeds of new Creation Baskets. The
limits on positions imposed by RBC on holdings in
regardless of whether the Oil Futures Contracts purchased would be within the
accountability levels and position limits permitted by NYMEX and ICE. RBC has
since informed
investment of the proceeds from Creation Baskets.
Subsequent to RBC's imposition of risk mitigation measures in 2020,
into an agreements with RCG, MCM and MFUSA to become additional FCMs for
These FCMs have not precluded
proceeds from the purchases of Creation Baskets in Oil Futures Contracts,
including the Benchmark Oil Futures Contract. However, limits could be imposed
by any FCM that, coupled with the risk measures already taken by RBC, would
? continue to limit
invested in the Benchmark Oil Futures Contract.
certainty when and whether RBC will remove its limitations on holding certain
positions in Oil Future Contracts, or whether, or to what extent, any such
limits may be imposed by any other FCM in the future.
agreements with other FCMs and it cannot predict whether or when it will enter
into such agreements.
? A large number of
time in March and
These events significantly limitedUSO's current ability to have a substantial portion of its assets invested in the Benchmark Oil Futures Contract and, during the Spring of 2020, in other Oil Futures Contracts. Accordingly, and because such factors have continued to evolve,USO has invested in other permitted Oil Futures Contracts and had to more frequently rebalance and adjust the types of holdings in its portfolio than it has in the past. In addition, the limitations imposed by the exchanges and FCMs, especially during the Spring of 2020 limitedUSO's ability to invest in certain Oil Futures Contracts. As a result,USO was and will be limited in its ability to invest in Oil Futures Contracts, including the Benchmark Oil Futures Contract, and may be required to invest in other permitted investments including Other Oil-Related Interests, and may hold larger amounts of Treasuries, cash and cash equivalents, which will further impairUSO's ability to meet its investment objective.USO has had the ability to invest in Oil Futures Contracts beyond the Benchmark Oil Futures Contract and in Other Oil-Related Investments but, until recently,USO's need to exercise its discretion in making such investments has been limited. Certain circumstances, including market conditions, applicable regulatory requirements and risk mitigation measures imposed by FCMs, counterparties or other market participants, requireUSO to exercise greater discretion in investing than in the past.USO has established parameters for the decision-making regarding the permitted investmentsUSO will hold and the intended order of priority it will consider in selecting investments to be held inUSO's portfolio as set forth and discussed in greater detail below. The application of the below parameters requiresUSO to exercise its discretion. If, due to regulatory requirements, risk mitigation measures, market conditions, liquidity requirements or other factors,USO is not able to invest in accordance with such parameters and the intended order of priority, such methodology may change. Accordingly, for the foreseeable future, to address and comply with the market conditions, regulatory requirements or other factors that have influenced, and may continue to influence, its investment decisions,USO intends to buy or sell the following permitted investments taking into account the order, or waterfall, set forth below whenUSO increases or decreases either its portfolio overall or its holdings of particular investments:
The current or front month ("first month") Oil Futures Contracts based on the
price of the light, sweet crude oil known as West Texas Intermediate ("WTI")
1. or, which are priced off of the oil futures contracts based on WTI as traded
on the NYMEX including the Benchmark Oil Futures Contracts and the ICE WTI
Contract ("WTI Oil Futures Contracts"); then
The first month, the next or following month ("second month", with months
2. thereafter 2. being numerically designated, i.e., the third month, the fourth
month, the fifth month, etc.) and the third month WTI Oil Futures Contracts;
then
The first through the sixth month WTI Oil Futures Contracts, plus the next
3. nearest June WTI Oil Futures Contracts or the next nearest December WTI Oil
Futures Contracts that is not included in the first through sixth months; then
21 Table of Contents
4. The first through the twelfth month WTI Oil Futures Contracts; then
The first through the twelfth month WTI Oil Futures Contracts plus the second
5. through thirteenth month Oil Futures Contracts based on Brent Crude Oil traded
on ICE Futures ("Brent Oil Futures Contracts"); then
The first through the twelfth month WTI Oil Futures Contracts Months plus the
second through thirteenth month Brent Oil Futures Contracts plus the first
6. through the twelfth month Oil Futures Contracts based on Ultra Low Sulfur
Diesel Oil Futures Contract traded on NYMEX ("USDL Oil Futures Contract");
then
The first through the twelfth month WTI Oil Futures Contracts plus the second
through thirteenth month Brent Oil Futures Contracts plus the first through
7. the twelfth month USDL Oil Futures Contracts plus the first through the
twelfth month RBOB Gasoline Oil Futures Contracts ("Gasoline Futures Contract"); then
Contacts or other types of crude oil traded on the
8.
liquidity to meaningfully contribute to
addition to the foregoing investments; then, finally,
9. Other Oil-Related Investments, in addition to the foregoing investments.
If, due to regulatory requirements, risk mitigation measures, market conditions, liquidity requirements or other factors,USO is not able to invest in a particular month contract described above, then it will adjust the methodology incrementally beginning from the nearest month contract available to it that it is reasonable or feasible to hold in light of such factors. IfUSO uses OTC swaps or other instruments, those OTC swaps or instruments would also provide exposure to one or more of the same above-described permitted investments in varying months or contracts.USO also anticipates that to the extent it invests in Oil Futures Contracts other than WTI Oil Futures Contacts) and Other Oil- Related Investments, it may enter into various non-exchange-traded derivative contracts to hedge the short-term price movements of such Oil Futures Contracts and Other Oil-Related Investments against the current Benchmark Oil Futures Contract. The progression from one stage of permitted investments described in the above waterfall to the next stage, including the specific target weights for the particular portfolio investments to be held byUSO , will take into account, to the extent applicable, the relative levels of open interest, position limits, and other factors. The specific permitted investments and the identified target weights for such investments, consistent with progression from one stage of the above described waterfall to the next stage, will be published on the website the day before the start of (i) any monthly roll/rebalance period for the end of such roll/rebalance period, and (ii) any rebalancing to be done outside of the monthly roll period due to market conditions, regulatory requirements or other factors described herein. In extreme circumstances, changes may need to be made intraday. In such circumstances, the changes will be published on the website at the end of the day.USO will attempt to execute rebalances required over several days to minimize market impact. However, it may be necessary to execute these risk measures rapidly and with minimal notice. Published portfolio changes will be implemented byUSO over the course of the roll/rebalance period as indicated on the website or over the course of another day or period with respect to a particular change outside of the roll.USO will progress through the stages of the above describe waterfall of permitted investments as it approaches regulatory or other limits or as necessary to address market conditions, or other factors, including additional investments inUSO , requiring consideration of particular levels of the waterfall. Generally,USO will invest in each stage of the waterfall in the order described above. However,USO , in its sole discretion, may proceed to invest in a further stage of the waterfall (i.e., skipping over a particular stage) if it determines it may exceed position limits in the immediately following stage of the above waterfall within the next month. The investment intention announced byUSO could change as a result of any or all of the following: evolving market conditions, a change in regulator accountability levels and position limits imposed onUSO with respect to its investment in Oil Futures Contracts, additional or different risk mitigation measures taken by market participants, generally, includingUSO , with respect toUSO acquiring additional Oil Futures contracts, orUSO selling additional sharesUSO's ability to invest in the Benchmark Oil Futures Contract could be limited by any of these occurrences. In addition, while determining the appropriate investments forUSO's portfolio in accordance with its current intention, or to address the foregoing changes in market conditions, regulatory requirements or risk mitigation measures,USO may need to hold significant portions of its portfolio in cash beyond what it has historically held in order to satisfy potential margin requirements. 22
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USCF may not be able to fully investUSO's assets in Benchmark Oil Futures Contracts having an aggregate notional amount exactly equal toUSO's NAV. For example, as standardized contracts, the Benchmark Oil Futures Contracts are for a specified amount of a particular commodity, andUSO's NAV and the proceeds from the sale of a Creation Basket are unlikely to be an exact multiple of the amounts of those contracts. As a result, in such circumstances,USO may be better able to achieve the exact amount of exposure to changes in price of the Benchmark Oil Futures Contract through the use of Other Oil-Related Investments, such as OTC contracts that have better correlation with changes in price of the Benchmark Oil Futures Contract. USCF does not anticipate lettingUSO's Oil Futures Contracts expire and taking delivery of the underlying commodity. Instead, USCF will close existing positions, e.g., when it changes the Benchmark Oil Futures Contracts or Other Oil-Related Investments or it otherwise determines it would be appropriate to do so and reinvests the proceeds in new Oil Futures Contracts or Other Oil-Related Investments. Positions may also be closed out to meet orders for Redemption Baskets and in such case proceeds for such baskets will not be reinvested. While it isUSO's expectation that at some point in the future it will be able to return to primarily investing in the Benchmark Oil Futures Contract, there can be no guarantee of when, if ever, that will occur. In addition, because of the limitations imposed onUSO , for example, by its regulators and its FCMs,USO may be limited in investing in other Oil futures Contracts in addition to the Benchmark Oil Futures Contract. Limitations onUSO may negatively impact the ability ofUSO (i) to reallocate its investments to more favorably meet its investment objective or (ii) in connection with the purchase of Creation Baskets, to invest the proceeds of such purchases in Oil Futures Contracts. As a result, investors inUSO should expectUSO's ability to invest in the Benchmark Oil Futures Contract and other Oil Futures Contracts will continue to be limited andUSO may be required to invest in Other Oil-Related Interests. As a result, there may be continued wider deviations between the performance ofUSO's investments and the Benchmark Oil Futures Contract, than prior to the Spring of 2020, and that changes inUSO's share price may not be able to track changes in the price of the Benchmark Oil Futures Contract within as narrow a percentage change difference for any period of 30 successive valuation days as it typically had prior to Spring of 2020. The inability to closely track the Benchmark Oil Futures Contract and, as described in this quarterly report on Form 10-Q, the changes in its portfolio of investments and the impact of higher levels of contango, will impact the performance ofUSO and the value of its shares.USO has not leveraged, and does not intend to leverage, its assets through borrowings or otherwise, and makes its investments accordingly. Consistent with the foregoing,USO's announced investment intentions, and any changes thereto, will take into account the need forUSO to make permitted investments that also allow it to maintain adequate liquidity to meet its margin and collateral requirements and to avoid, to the extent reasonably possible,USO becoming leveraged. If market conditions require it, these risk reduction procedures may occur on short notice if they occur other than during a roll or rebalance period.
Regulatory Disclosure
Accountability Levels, Position Limits and Price Fluctuation Limits. Designated contract markets ("DCMs"), such as the NYMEX and ICE Futures, have established accountability levels and position limits on the maximum net long or net short futures contracts in commodity interests that any person or group of persons under common trading control (other than as a hedge, which an investment byUSO is not) may hold, own or control. These levels and position limits apply to the futures contracts thatUSO invests in to meet its investment objective. In addition to accountability levels and position limits, the NYMEX and ICE Futures also set daily price fluctuation limits on futures contracts. The daily price fluctuation limit establishes the maximum amount that the price of a futures contract may vary either up or down from the previous day's settlement price. Once the daily price fluctuation limit has been reached in a particular futures contract, no trades may be made at a price beyond that limit. 23
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The accountability levels for the Benchmark Oil Futures Contract and other Oil Futures Contracts traded onU.S. -based futures exchanges, such as the NYMEX, are not a fixed ceiling, but rather a threshold above which the NYMEX may exercise greater scrutiny and control over an investor's positions. The current accountability level for investments for any one month in the Benchmark Oil Futures Contract is 10,000 contracts. In addition, the NYMEX imposes an accountability level for all months of 20,000 net futures contracts for light, sweet crude oil. In addition, the ICE Futures maintains the same accountability levels, position limits and monitoring authority for its light, sweet crude oil contract as the NYMEX. IfUSO and the Related Public Funds exceed these accountability levels for investments in the futures contracts for light, sweet crude oil, the NYMEX and ICE Futures will monitor such exposure and may ask for further information on their activities including the total size of all positions, investment and trading strategy, and the extent of liquidity resources ofUSO and the Related Public Funds. If deemed necessary by the NYMEX and/or ICE Futures,USO could be ordered to reduce its Crude Oil Futures CL contracts to below the 10,000 single month and/or 20,000 all month accountability level. USCF received letters from the CME on behalf of theNYMEX Market Regulation Department onApril 16, 2020 (the "April 16 CME Letter") and onApril 23, 2020 (the "April 23 CME Letter", and together with theApril 16 CME Letter, the "CME Letters"). The CME Letters ordered USCF,USO and the Related Public Funds not to exceed accountability levels in specified light, sweet crude oil futures contracts and not to assume any positions in the specified light, sweet crude oil futures contract in excess of the exchange established position limits. The accountability levels and position limits set forth in theApril 23 CME Letter superseded theApril 16 CME Letter. TheApril 23 CME Letter ordered USCF,USO and the Related Public Funds not to exceed accountability levels in excess of 10,000 futures contracts in the light, sweet crude oil futures contract forJune 2020 . While these limits no longer apply, NYMEX's current accountability levels for any one month in the Benchmark Oil Futures Contract is 10,000 contracts, and an accountability level for all months of 20,000 net futures contracts for light sweet crude oil, do apply. As ofJune 30, 2021 ,USO held 43,145 NYMEX WTI Crude Oil Futures CL contracts and did not hold any ICE WTI Crude Oil Futures contracts.USO exceeded accountability levels of the NYMEX during the six months endedJune 30, 2021 , including when it held a maximum of 73,956 Crude Oil Futures CL contracts, on the NYMEX, exceeding the "any" month limit. Position limits differ from accountability levels in that they represent fixed limits on the maximum number of futures contracts that any person may hold and cannot allow such limits to be exceeded without express CFTC authority to do so. In addition to accountability levels and position limits that may apply at any time, the NYMEX and ICE Futures impose position limits on contracts held in the last few days of trading in the near month contract to expire. Commencing with the monthly roll that occurred inMay 2020 ,USO's positions in Oil Futures Contracts and Other Oil Related Investments roll over a ten-day period, whereas previouslyUSO's positions would roll over a four-day period. As ofMay 1, 2020 , the type and percentages of investments to be held byUSO at the end of the monthly roll period as well as going forward, including for any rebalances, is published on its website www.uscfinvestments.com. For the six months endedJune 30, 2021 ,USO did not exceed any position limits imposed by the NYMEX and ICE Futures. TheApril 23 CME Letter, discussed above, ordered USCF,USO and the Related Public Funds not to assume a position in the light, sweet crude oil futures contract forJune 2020 in excess of 15,000 long futures contracts, forJuly 2020 in 78,000 long futures contracts, forAugust 2020 in 50,000 long futures contracts, forSeptember 2020 in 35,000 long futures contracts. The foregoing accountability levels and position limits are subject to change. Due to evolving market conditions, a change in regulator accountability levels and position limits imposed onUSO with respect to its investment in Oil Futures Contracts as discussed in the CME Letters, remaining within relevant accountability levels and position limits, and additional or different risk mitigation measures taken byUSO's FCM with respect toUSO acquiring additional Oil Futures contracts,USO has invested and intends to invest in other permitted investments, beyond the Benchmark Oil Futures Contract. The regulation of commodity interest trading inthe United States and other countries is an evolving area of the law. The various statements made in this summary are subject to modification by legislative action and changes in the rules and regulations of theSEC ,Financial Industry Regulatory Authority ("FINRA"), the CFTC, the NFA, the futures exchanges, clearing organizations and other regulatory bodies. Pending final resolution of all applicable regulatory requirements, some examples of how new rules and regulations could impactUSO are discussed in "Item 1. Business" and "Item 1A. Risk Factors" in this quarterly report on Form 10-Q.
Futures Contracts and Position Limits
The CFTC is generally prohibited by statute from regulating trading on non-U.S. futures exchanges and markets. The CFTC, however, has adopted regulations relating to the marketing of non-U.S. futures contracts inthe United States . These regulations permit certain contracts on non-U.S. exchanges to be offered and sold inthe United States . 24
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OnOctober 15, 2020 , the CFTC approved the Position Limits Rule. The Position Limits Rule establishes federal position limits for 25 core referenced futures contracts (comprised of agricultural, energy and metals futures contracts), futures and options linked to the core referenced futures contracts, and swaps that are economically equivalent to the core referenced futures contracts. The Position Limits Rule sets position limits for the spot month and non-spot month; however, the non-spot month limits only apply in respect of the agricultural futures contracts that are currently subject to position limits under Part 150 of the CFTC regulations (the "legacy agricultural contracts"). With respect to regulatory oversight, the Position Limits Rule delegates authority to designated contract markets and swap execution facilities to oversee certain aspects of the position limits framework. In addition to setting the federal position limits, the Position Limits Rule also provides several exemptions from such position limits, including an expanded list of enumerated bona fide hedge exemptions and certain spread exemptions. Further, the Position Limits Rule sets forth two alternative processes for pursuing an exemption for non-enumerated hedge positions. Other than for the legacy agricultural contracts, compliance with the limits imposed by the Position Limits Rule will not be required until 2022, except that economically equivalent swaps need not comply with the Position Limits Rule until 2023. The Benchmark Futures Contract will be subject to position limits under the Position Limits Rule, andUSO's trading does not qualify as an enumerated bona fide hedge. Accordingly, the Position Limits Rule could negatively impact the ability ofUSO to meet its investment objective by inhibiting USCF's ability to effectively invest the proceeds from sales of Creation Baskets ofUSO in particular amounts and types of its permitted investments. Until such time as compliance with the Position Limits Rule is required, the regulatory architecture in effect prior to the adoption of the Position Limit Rules will govern transactions in commodities and related derivatives. Under that system, the CFTC enforces federal limits on speculation in the nine legacy agricultural contracts, while futures exchanges establish and enforce position limits and accountability levels for other agricultural products and certain energy products (e.g., oil and natural gas). Under existing CFTC regulations and the Position Limits Rule, for the purpose of position limits, a market participant is generally required, subject to certain narrow exceptions, to aggregate all positions for which that participant controls the trading decisions with all positions for which that participant has a 10 percent or greater ownership interest in an account or position, as well as the positions of two or more persons acting pursuant to an express or implied agreement or understanding with that market participant (the "Aggregation Rules").
OTC Swaps
InOctober 2015 , theOffice of the Comptroller of the Currency , theBoard of Governors of theFederal Reserve System , theFDIC , theFarm Credit Administration , and theFederal Housing Finance Agency (each an "Agency" and, collectively, the "Agencies") jointly adopted final rules to establish minimum margin and capital requirements for registered swap dealers, major swap participants, security-based swap dealers, and major security-based swap participants ("Swap Entities") that are subject to the jurisdiction of one of the Agencies (such entities, "Covered Swap Entities", and the joint final rules, the "Final Margin Rules"). The Final Margin Rules will subject non-cleared swaps and non-cleared security-based swaps between Covered Swap Entities and Swap Entities, and between Covered Swap Entities and financial end users that have material swaps exposure (i.e., an average daily aggregate notional of$8 billion or more in non-cleared swaps calculated in accordance with the Final Margin Rules), to a mandatory two-way minimum initial margin requirement. The minimum amount of the initial margin required to be posted or collected would be either the amount calculated by the Covered Swap Entity using a standardized schedule set forth as an appendix to the Final Margin Rules, which provides the gross initial margin (as a percentage of total notional exposure) for certain asset classes, or an internal margin model of the Covered Swap Entity conforming to the requirements of the Final Margin Rules that is approved by the Agency having jurisdiction over the particular Covered Swap Entity. The Final Margin Rules specify the types of collateral that may be posted or collected as initial margin for non-cleared swaps and non-cleared security-based swaps with financial end users (generally cash, certain government, government-sponsored enterprise securities, certain liquid debt, certain equity securities, certain eligible publicly traded debt, and gold); and sets forth haircuts for certain collateral asset classes. The Final Margin Rules require minimum variation margin to be exchanged daily for non-cleared swaps and non-cleared security-based swaps between Covered Swap Entities and Swap Entities and between Covered Swap Entities and all financial end-users (without regard to the swaps exposure of the particular financial end-user). The minimum variation margin amount is the daily mark-to-market change in the value of the swap to the Covered Swap Entity, taking into account variation margin previously posted or collected. For non-cleared swaps and security-based swaps between Covered Swap Entities and financial end-users, variation margin may be posted or collected in cash or non-cash collateral that is considered eligible for initial margin purposes. Variation margin is not subject to segregation with an independent, third-party custodian, and may, if permitted by contract, be rehypothecated. 25
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The initial margin requirements of the Final Margin Rules are being phased in over time, and the variation margin requirements of the Final Margin Rules are currently in effect.USO is not a Covered Swap Entity under the Final Margin Rules, but it is a financial end-user. Accordingly,USO is currently subject to the variation margin requirements of the Final Margin Rules. However,USO does not have material swaps exposure and, accordingly,USO will not be subject to the initial margin requirements of the Final Margin Rules. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") required the CFTC and theSEC to adopt their own margin rules to apply to a limited number of registered swap dealers, security-based swap dealers, major swap participants, and major security-based swap participants that are not subject to the jurisdiction of one of the Agencies. OnDecember 16, 2015 the CFTC finalized its margin rules, which are substantially the same as the Final Margin Rules and have the same implementation timeline. TheSEC adopted margin rules for security-based swap dealers and major security-based swap participants onJune 21, 2019 . TheSEC's margin rules are generally aligned with the Final Margin Rules and the CFTC's margin rules, but they differ in a few key respects relating to timing for compliance and the manner in which initial margin must be segregated.USO does not currently engage in security-based swap transactions and, therefore, theSEC's margin rules are not expected to apply toUSO .
Mandatory Trading and Clearing of Swaps
CFTC regulations require that certain swap transactions be executed on organized exchanges or "swap execution facilities" and cleared through regulated clearing organizations ("derivative clearing organizations" ("DCOs")), if the CFTC mandates the central clearing of a particular class of swap and such swap is "made available to trade" on a swap execution facility. Currently, swap dealers, major swap participants, commodity pools, certain private funds and entities predominantly engaged in activities that are financial in nature are required to execute on a swap execution facility, and clear, certain interest rate swaps and index-based credit default swaps. As a result, ifUSO enters into an interest rate or index-based credit default swap that is subject to these requirements, such swap will be required to be executed on a swap execution facility and centrally cleared. Mandatory clearing and "made available to trade" determinations with respect to additional types of swaps may be issued in the future, and, when finalized, could requireUSO to electronically execute and centrally clear certain OTC instruments presently entered into and settled on a bi-lateral basis. If a swap is required to be cleared, initial and variation margin requirements are set by the relevant clearing organization, subject to certain regulatory requirements and guidelines. Additional margin may be required and held byUSO's FCM.
Other Requirements for Swaps
In addition to the margin requirements described above, swaps that are not required to be cleared and executed on a SEF but that are executed bilaterally are also subject to various requirements pursuant to CFTC regulations, including, among other things, reporting and recordkeeping requirements and, depending on the status of the counterparties, trading documentation requirements and dispute resolution requirements.
Derivatives Regulations in Non-
In addition toU.S. laws and regulations,USO may be subject to non-U.S. derivatives laws and regulations if it engages in futures and/or swap transactions with non-U.S. persons. For example,USO may be impacted by European laws and regulations to the extent that it engages in futures transactions on European exchanges or derivatives transactions with European entities. Other jurisdictions impose requirements applicable to futures and derivatives that are similar to those imposed by theU.S. , including position limits, margin, clearing and trade execution requirements.
Money Market Funds
TheSEC adopted amendments to Rule 2a-7 under the Investment Company Act of 1940, as amended ("1940 Act") which became effective in 2016, to reform money market funds ("MMFs"). While the rule applies only to MMFs, it may indirectly affect institutional investors such asUSO . A portion ofUSO's assets that are not used for margin or collateral in the Futures Contracts currently are invested in government MMFs.USO does not hold any non-government MMFs and does not anticipate investing in any non-government MMFs. However, ifUSO invests in other types of MMFs besides government MMFs in the future,USO could be negatively impacted by investing in an MMF that does not maintain a stable$1.00 NAV or that has the potential to impose redemption fees and gates (temporary suspension of redemptions). 26
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Although such government MMFs seek to preserve the value of an investment at$1.00 per share, there is no guarantee that they will be able to do so andUSO may lose money by investing in a government MMF. An investment in a government MMF is not insured or guaranteed by theFederal Deposit Insurance Corporation , referred to herein as theFDIC , or any other government agency. The share price of a government MMF can fall below the$1.00 share price.USO cannot rely on or expect a government MMF's adviser or its affiliates to enter into support agreements or take other actions to maintain the government MMF's$1.00 share price. The credit quality of a government MMF's holdings can change rapidly in certain markets, and the default of a single holding could have an adverse impact on the government MMF's share price. Due to fluctuations in interest rates, the market value of securities held by a government MMF may vary. A government MMF's share price can also be negatively affected during periods of high redemption pressures and/or illiquid markets.
Price Movements
Crude oil futures prices were volatile during the six months endedJune 30, 2021 . The price of the Benchmark Oil Futures Contract started the period at$48.52 per barrel. The high of the period was onJune 25, 2021 when the price reached$74.05 per barrel. The low of the period was onJanuary 4, 2021 when the price dropped to$47.62 per barrel. The period ended with the Benchmark Oil Futures Contract at$73.47 per barrel, an increase of approximately 51.42% over the period.USO's per share NAV began the period at$33.07 and ended the period at$49.87 onJune 30, 2021 , an increase of approximately 50.80% over the period. The Benchmark Oil Futures Contract prices listed above began with the February contracts and ended with the August contracts. The increase of approximately 51.42% on the Benchmark Oil Futures Contract listed above is a hypothetical return only and could not actually be achieved by an investor holding Oil Futures Contracts. An investment in Oil Futures Contracts would need to be rolled forward during the time period described in order to simulate such a result. Furthermore, the change in the nominal price of these differing Oil Futures Contracts, measured from the start of the period to the end of the period, does not represent the actual benchmark results thatUSO seeks to track, which are more fully described below in the section titled "Tracking USO's Benchmark." During the six months endedJune 30, 2021 , the crude oil futures market alternated between conditions of contango and backwardation. On days when the market was in contango the price of the near month crude Oil Futures Contract is lower than the price of the next month crude Oil Futures Contract, or contracts further away from expiration. On days when the market is in backwardation, the price of the near month crude Oil Futures Contract is higher than the price of the next month crude Oil Futures Contract or contracts further away from expiration. For a discussion of the impact of backwardation and contango on total returns, see "Term Structure of Crude Oil Prices and the Impact on Total Returns" below.
Valuation of Oil Futures Contracts and the Computation of the Per Share NAV The per share NAV ofUSO's shares is calculated once each NYSE Arca trading day. The per share NAV for a particular trading day is released after4:00 p.m. New York time. Trading during the core trading session on the NYSE Arca typically closes at4:00 p.m. New York time.USO's Administrator uses the settlement price determined by NYMEX at2:30 p.m. Eastern time for the Oil Futures Contracts held on the NYMEX and the settlement price determined by ICE Futures at2:30 p.m. Eastern time for the Oil Futures Contracts held on ICE Futures, but calculates or determines the value of all otherUSO investments, other futures contracts, as of the earlier of the close of the NYSE Arca or4:00 p.m. New York time.
Results of Operations and the Crude Oil Market
Results of Operations. OnApril 10, 2006 ,USO listed its shares on the AMEX under the ticker symbol "USO ." On that day,USO established its initial offering price at$67.39 per share and issued 200,000 shares to the initial Authorized Participant,KV Execution Services, LLC , in exchange for$13,479,000 in cash. As a result of the acquisition of the AMEX by NYSE Euronext,USO's shares ceased trading on the AMEX and commenced trading on the NYSE Arca onNovember 25 ,
2008. 27 Table of Contents As ofJune 30, 2021 ,USO had issued 4,653,000,000 shares, 61,623,603 of which were outstanding. As ofJune 30, 2021 , there were 974,000,000 shares registered but not yet issued.USO has registered 5,627,000,000 shares since inception. OnApril 28, 2020 , after the close of trading on the NYSE Arca,USO effected a 1-for-8 reverse share split and post-split shares ofUSO began trading onApril 29, 2020 . As a result of the reverse share split, every eight pre-split shares ofUSO were automatically exchanged for one post-split share. Immediately prior to the reverse split, there were 1,482,900,000 shares ofUSO issued and outstanding, representing a per share NAV of$2.04 . Immediately after the effect of the reverse share split, the number of issued and outstanding shares ofUSO decreased to 185,362,500, not accounting for fractional shares, and the per share NAV increased to$16.35 . In connection with the reverse share split, the CUSIP number forUSO's shares changed to 91232N207.USO's ticker symbol, "USO ," remains the same. The accompanying unaudited condensed financial statements have been adjusted to reflect the effect of the reverse share split on a retroactive basis. More shares may have been issued byUSO than are outstanding due to the redemption of shares. Unlike funds that are registered under the 1940 Act, shares that have been redeemed byUSO cannot be resold byUSO . As a result,USO contemplates that additional offerings of its shares will be registered with theSEC in the future in anticipation of additional issuances and redemptions. As ofJune 30, 2021 ,USO had the following Authorized Participants: ABN Amro,BNP Paribas Securities Corp. ,Citadel Securities LLC ,Citigroup Global Markets Inc. ,Credit Suisse Securities USA LLC ,Goldman Sachs & Company ,JP Morgan Securities Inc. ,Merrill Lynch Professional Clearing Corp. ,Morgan Stanley & Company Inc. ,RBC Capital Markets LLC ,SG Americas Securities LLC ,UBS Securities LLC andVirtu Financial BD LLC . For the Six Months EndedJune 30, 2021 Compared to the Six Months EndedJune 30, 2020 Six months Six months ended endedJune 30, 2021 June 30, 2020
Average daily total net assets$ 3,255,866,404 $
2,811,778,572
Dividend and interest income earned on Treasuries, cash and/or cash equivalents
$ 714,910 $
8,552,898
Annualized yield based on average daily total net assets 0.04 % 0.61 % Management fee$ 7,265,487 $
6,291,930
Total fees and other expenses excluding management fees$ 5,947,751 $
7,385,149
Fees and expenses related to the registration or offering of additional shares$ 1,260,041 $
1,478,714
Total commissions accrued to brokers$ 655,585 $
4,679,525
Total commissions as annualized percentage of average total net assets 0.04 % 0.33 % Commissions accrued as a result of rebalancing$ 511,882 $
3,863,377
Percentage of commissions accrued as a result of rebalancing 78.08 % 82.56 % Commissions accrued as a result of creation and redemption activity$ 143,703 $
816,148
Percentage of commissions accrued as a result of creation and redemption activity 21.92 %
17.44 % Portfolio Expenses.USO's expenses consist of investment management fees, brokerage fees and commissions, certain offering costs, licensing fees, registration fees, the fees and expenses of the independent directors of USCF and expenses relating to tax accounting and reporting requirements. The management fee thatUSO pays to USCF is calculated as a percentage of the total net assets ofUSO . The fee is accrued daily and paid monthly. Average interest rates earned on short-term investments held byUSO , including cash, cash equivalents and Treasuries, were lower during the six months endedJune 30, 2021 , compared to the six months endedJune 30, 2020 . As a result, the amount of income earned byUSO as a percentage of average daily total net assets was lower during the six months endedJune 30, 2021 , compared to the six months endedJune 30, 2020 . To the degree that the aggregate yield is lower, the net expense ratio, inclusive of income, will be higher. The decrease in total fees and other expenses excluding management fees for the six months endedJune 30, 2021 , compared to the six months endedJune 30, 2020 , was due primarily to a decrease in total commissions accrued to brokers and directors' fees and insurance. 28
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The decrease in total commissions accrued to brokers for the six months endedJune 30, 2021 , compared to the six months endedJune 30, 2020 , was due primarily to a lower number of Oil Futures Contracts being held and traded. For the Three Months EndedJune 30, 2021 Compared to the Three Months EndedJune 30, 2020 Three months Three months ended endedJune 30, 2021 June 30, 2020
Average daily total net assets$ 3,076,784,006 $
4,140,398,737
Dividend and interest income earned on Treasuries, cash and/or cash equivalents
$ 326,103 $
3,152,052
Annualized yield based on average daily total net assets 0.04 % 0.31 % Management fee$ 3,451,899 $
4,632,495
Total fees and other expenses excluding management fees$ 3,316,710 $
5,705,718
Fees and expenses related to the registration or offering of additional shares$ 315,041 $
1,211,000
Total commissions accrued to brokers$ 350,906 $
3,706,371
Total commissions as annualized percentage of average total net assets 0.05 % 0.36 % Commissions accrued as a result of rebalancing$ 301,685 $
3,303,396
Percentage of commissions accrued as a result of rebalancing 85.97 % 89.13 % Commissions accrued as a result of creation and redemption activity$ 49,221 $
402,975
Percentage of commissions accrued as a result of creation and redemption activity 14.03 %
10.87 % Portfolio Expenses.USO's expenses consist of investment management fees, brokerage fees and commissions, certain offering costs, licensing fees, registration fees, the fees and expenses of the independent directors of USCF and expenses relating to tax accounting and reporting requirements. The management fee thatUSO pays to USCF is calculated as a percentage of the total net assets ofUSO . The fee is accrued daily and paid monthly. Average interest rates earned on short-term investments held byUSO , including cash, cash equivalents and Treasuries, were lower during the three months endedJune 30, 2021 , compared to the three months endedJune 30, 2020 . As a result, the amount of income earned byUSO as a percentage of average daily total net assets was lower during the three months endedJune 30, 2021 , compared to the three months endedJune 30, 2020 . The decrease in total fees and other expenses excluding management fees for the three months endedJune 30, 2021 , compared to the three months endedJune 30, 2020 , was due primarily to a decrease in total commissions accrued to brokers and expenses related to the decrease in total net assets.
The decrease in total commissions accrued to brokers for the three months ended
Tracking
USCF seeks to manageUSO's portfolio such that changes in its average daily per share NAV, on a percentage basis, closely track the daily changes in the average price of the Benchmark Oil Futures Contract, also on a percentage basis. Specifically, USCF seeks to manage the portfolio such that over any rolling period of 30-valuation days, the average daily change inUSO's per share 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 price of the Benchmark Oil Futures Contract for a particular 30-valuation day time period was 0.50% per day, USCF would attempt to manage the portfolio such that the average daily movement of the per share NAV during that same time period fell between 0.45% and 0.55% (i.e., between 0.9 and 1.1 of the benchmark's results).USO's portfolio management goals do not include trying to make the nominal price ofUSO's per share NAV equal to the nominal price of the current Benchmark Oil Futures Contract or the spot price for light, sweet crude oil. USCF believes that it is not practical to manage the portfolio to achieve such an investment goal when investing in Oil Futures Contracts and Other Oil-Related Investments. 29 Table of Contents
For the 30-valuation days endedJune 30, 2021 , the average daily change in the Benchmark Oil Futures Contract was 0.404%, while the average daily change in the per share NAV ofUSO over the same time period was 0.363%. The average daily difference was (0.041)% (or (4.1) basis points, where 1 basis point equals 1/100 of 1%), meaning that over this time periodUSO's NAV performed within the plus or minus 10% range established as its benchmark tracking goal. Since the commencement of the offering ofUSO's shares to the public onApril 10, 2006 toJune 30, 2021 , the average daily change in the Benchmark Oil Futures Contract was (0.010)%, while the average daily change in the per share NAV ofUSO over the same time period was (0.029)%. The average daily difference was (0.019)% (or (1.9) basis points, where 1 basis point equals 1/100 of 1%), meaning that over this time periodUSO's NAV performed within the plus or minus 10% range established as its benchmark tracking goal. The following two graphs demonstrate the correlation between the changes inUSO's NAV and the changes in the Benchmark Oil Futures Contract. The first graph exhibits the daily changes in the last 30 valuation days endedJune 30, 2021 . The second graph measures monthly changes sinceJune 30, 2016 throughJune 30, 2021 . *PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS [[Image Removed: Graphic]] 30 Table of Contents *PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS [[Image Removed: Graphic]]
An alternative tracking measurement of the return performance ofUSO versus the return of its Benchmark Oil Futures Contract can be calculated by comparing the actual return ofUSO , measured by changes in its per share NAV, versus the expected changes in its per share NAV under the assumption thatUSO's returns had been exactly the same as the daily changes in its Benchmark Oil Futures Contract. For the six months endedJune 30, 2021 , the actual total return ofUSO as measured by changes in its per share NAV was 50.80%. This is based on an initial per share NAV of$33.07 as ofDecember 31, 2020 and an ending per share NAV as ofJune 30, 2021 of$49.87 . During this time period,USO made no distributions to its shareholders. However, ifUSO's daily changes in its per share NAV had instead exactly tracked the changes in the daily total return of the Benchmark Oil Futures Contract,USO would have had an estimated per share NAV of$50.36 as ofJune 30, 2021 , for a total return over the relevant time period of 52.28%. The difference between the actual per share NAV total return ofUSO of 50.80% and the expected total return based on the Benchmark Oil Futures Contract of 52.28% was a tracking difference over the time period of (1.48)%, which is to say thatUSO's actual total return underperformed its benchmark by that percentage.USO incurs expenses primarily composed of the management fee, brokerage commissions for the buying and selling of futures contracts, and other expenses. The impact of these expenses, offset by interest and dividend income, and net of positive or negative execution, tended to cause daily changes in the per share NAV ofUSO to track slightly lower or higher than daily changes in the price of the Benchmark Oil Futures Contract. 31
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By comparison, for the six months endedJune 30, 2020 , the actual total return ofUSO as measured by changes in its per share NAV was (72.60)%. This is based on an initial per share NAV of$102.27 * as ofDecember 31, 2019 and an ending per share NAV as ofJune 30, 2020 of$28.02 . During this time period,USO made no distributions to its shareholders. However, ifUSO's daily changes in its per share NAV had instead exactly tracked the changes in the daily total return of the Benchmark Oil Futures Contract,USO would have had an estimated per share NAV of$49.03 as ofJune 30, 2020 , for a total return over the relevant time period of (52.06)%. The difference between the actual per share NAV total return ofUSO of (72.60)% and the expected total return based on the Benchmark Oil Futures Contract of (52.06)% was a difference over the time period of (20.54)%, which is to say thatUSO's actual total return underperformed its benchmark.USO incurs expenses primarily composed of the management fee, brokerage commissions for the buying and selling of futures contracts, and other expenses. The impact of these expenses, offset by interest and dividend income, and net of positive or negative execution, tended to cause daily changes in the per share NAV ofUSO to track slightly lower higher than daily changes in the price of the Benchmark Oil Futures Contract.
* Adjusted to give effect to the reverse share split of 1-for-8 executed on
As a result of market conditions and the regulatory response that occurred inMarch 2020 and thereafter, large numbers ofUSO shares that were purchased during a short period of time, and regulatory accountability levels and position limits on oil futures contracts that were imposed onUSO , and risk mitigation measures imposed by its FCMs,USO invested in Oil Futures Contracts in months other than the Benchmark Oil Futures Contracts. The foregoing impacted the performance ofUSO and made it difficult forUSO to meet its investment objective, which is for the daily percentage changes in the NAV per share to reflect the daily percentage changes of the spot price of light, sweet crude oil, as measured by the daily percentage changes in the price of Benchmark Oil Futures Contract, plus interest earned onUSO's collateral holdings, lessUSO's expenses, with the same level of success as before in meeting its investment objective. While it isUSO's expectation that at some point in the future it will return to primarily investing in the Benchmark Futures Contract and related ICE Futures contracts or other similar futures contracts of the same tenor based on light, sweet crude oil, there can be no guarantee of when, if ever, that will occur. As a result, investors inUSO should expect that there will be continued wider deviations between the performance ofUSO's investments and the Benchmark Futures Contract than prior to the Spring of 2020, and changes inUSO's share price may not be able to track changes in the price of Benchmark Futures Contract within as narrow a percentage change difference for any period of successive valuation days as it typically has prior to the Spring of 2020. That said, in the second quarter of 2021 the average daily difference between the return ofUSO's NAV and the Benchmark Futures Contract was (0.015)% (or (1.5) basis points).
There are three factors that typically have impacted or are most likely to
impact
First,USO may buy or sell its holdings in the then current Benchmark Oil Futures Contract at a price other than the settlement price of that contract on the day during whichUSO executes the trade. In that case,USO may pay a price that is higher, or lower, than the closing settlement price of the Benchmark Oil Futures Contract, which could cause the changes in the daily per share NAV ofUSO to either be too high or too low relative to the daily changes in the Benchmark Oil Futures Contract. During the six months endedJune 30, 2021 , USCF attempted to minimize the effect of these transactions by seeking to execute its purchase or sale of Oil Futures Contracts at, or as close as possible to, the end of the day settlement price. However, it may not always be possible forUSO to obtain the settlement price and there is no assurance that failure to obtain the closing settlement price in the future will not adversely impactUSO's attempt to track the Benchmark Oil Futures Contract. 32
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Second,USO incurs expenses primarily composed of the management fee, brokerage commissions for the buying and selling of futures contracts, and other expenses. The impact of these expenses tends to cause daily changes in the per share NAV ofUSO to track slightly lower than daily changes in the price of the Benchmark Oil Futures Contract. At the same time,USO earns dividend and interest income on its cash, cash equivalents and Treasuries.USO is not required to distribute any portion of its income to its shareholders and did not make any distributions to shareholders during the six months endedJune 30, 2021 . Interest payments, and any other income, were retained within the portfolio and added toUSO's NAV. When this income exceeds the level ofUSO'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 USCF),USO will realize a net yield that will tend to cause daily changes in the per share NAV ofUSO to track slightly higher than daily changes in the Benchmark Oil Futures Contract. If short-term interest rates rise above these 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. When short-term yields drop to a level lower than the combined expenses of the management fee and the brokerage commissions, then the tracking error becomes a negative number and would tend to cause the daily returns of the per share NAV to underperform the daily returns of the Benchmark Oil Futures Contract. USCF anticipates that interest rates may continue to stagnate over the near future near historical lows. It is anticipated that fees and expenses paid byUSO may continue to be higher than interest earned byUSO . As such, USCF anticipates thatUSO could possibly underperform its benchmark so long as interest earned is less than the fees and expenses paid byUSO . Third,USO may hold Other Oil-Related Investments 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 Benchmark Oil Futures Contract could result in daily changes in the per share NAV ofUSO that are either too high, or too low, relative to the daily changes in the Benchmark Oil Futures Contract. During the six months endedJune 30, 2021 ,USO did not hold any Other Oil-Related Investments. IfUSO increases in size, and due to its obligations to comply with market conditions, regulatory limits, and risk mitigation measures imposed by its FCMs,USO may invest in Other Oil-Related Investments which may have the effect of increasing transaction related expenses and may result in increased tracking error. Term Structure of Crude Oil Futures Prices and the Impact on Total Returns. Several factors determine the total return from investing in futures contracts. One factor arises from "rolling" futures contracts that will expire at the end of the current month (the "near" or "front" month contract) forward each month prior to expiration. For a strategy that entails holding the near month contract, the price relationship between that futures contract and the next month futures contract will impact returns. For example, if the price of the near month futures contract is higher than the next futures month contract (a situation referred to as "backwardation"), then absent any other change, the price of a next month futures contract tends to rise in value as it becomes the near month futures contract and approaches expiration. Conversely, if the price of a near month futures contract is lower than the next month futures contract (a situation referred to as "contango"), then absent any other change, the price of a next month futures contract tends to decline in value as it becomes the near month futures contract and approaches expiration. As an example, assume that the price of crude oil for immediate delivery, is$50 per barrel, and the value of a position in the near month futures contract is also$50 . Over time, the price of crude oil will fluctuate based on a number of market factors, including demand for oil relative to supply. The value of the near month futures contract will likewise fluctuate in reaction to a number of market factors. If an investor seeks to maintain a position in a near month futures contract and not take delivery of physical barrels of crude oil, the investor must sell the current near month futures contract as it approaches expiration and invest in the next month futures contract. In order to continue holding a position in the current near month futures contract, this "roll" forward of the futures contract must be executed every month. Contango and backwardation are natural market forces that have impacted the total return on an investment inUSO's shares during the past year relative to a hypothetical direct investment in crude oil. In the future, it is likely that the relationship between the market price ofUSO's shares and changes in the spot prices of light, sweet crude oil will continue to be impacted by contango and backwardation. It is important to note that this comparison ignores the potential costs associated with physically owning and storing crude oil, which could be substantial. 33 Table of Contents
If the futures market is in backwardation, e.g., when the price of the near month futures contract is higher than the price of the next month futures contract, the investor would buy a next month futures contract for a lower price than the current near month futures contract. Assuming the price of the next month futures contract was$49 per barrel, or 2% cheaper than the$50 near month futures contract, then, hypothetically, and assuming no other changes (e.g., 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 income earned on cash and/or cash equivalents), the value of the$49 next month futures contract would rise to$50 as it approaches expiration. In this example, the value of an investment in the next month futures contract would tend to outperform the spot price of crude oil. As a result, it would be possible for the new near month futures contract to rise 12% while the spot price of crude oil may have risen a lower amount, e.g., only 10%. Similarly, the spot price of crude oil could have fallen 10% while the value of an investment in the futures contract might have fallen another amount, e.g., only 8%. Over time, if backwardation remained constant, this difference between the spot price and the futures contract price would continue to increase. If the futures market is in contango, an investor would be buying a next month futures contract for a higher price than the current near month futures contract. Again, assuming the near month futures contract is$50 per barrel, the price of the next month futures contract might be$51 per barrel, or 2% more expensive than the front month futures contract. Hypothetically, and assuming no other changes, the value of the$51 next month futures contract would fall to$50 as it approaches expiration. In this example, the value of an investment in the second month would tend to underperform the spot price of crude oil. As a result, it would be possible for the new near month futures contract to rise only 10% while the spot price of crude oil may have risen a higher amount, e.g., 12%. Similarly, the spot price of crude oil could have fallen 10% while the value of an investment in the second month futures contract might have fallen another amount, e.g., 12%. Over time, if contango remained constant, this difference between the spot price and the futures contract price would continue to increase. The chart below compares the daily price of the near month crude oil futures contract to the price of 13th month crude oil futures contract (i.e., a contract one year forward) over the last 10 years. When the price of the near month futures contract is higher than the price of the 13th month futures contract, the market would be described as being in backwardation. When the price of the near month futures contract is lower than the 13th month futures contract, the market would be described as being in contango. Although the price of the near month futures contract and the price of the 13th month futures contract tend to move together, it can be seen that at times the near month futures contract prices are higher than the 13th month futures contract prices (backwardation) and, at other times, the near month futures contract prices are lower than the 13th month futures contract prices (contango). 34 Table of Contents *PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS [[Image Removed: Graphic]]
An alternative way to view the same data is to subtract the dollar price of the 13th month crude oil futures contract from the dollar price of the near month crude oil futures contract, as shown in the chart below. When the difference is positive, the market is in backwardation. When the difference is negative, the market is in contango. The crude oil market spent time in both backwardation and contango during the last ten years. 35 Table of Contents *PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS [[Image Removed: Graphic]] An investment in a portfolio that owned only the near month crude oil futures contract would likely produce a different result than an investment in a portfolio that owned an equal number of each of the near 12 months' of crude oil futures contracts. Generally speaking, when the crude oil futures market is in backwardation, a portfolio of only the near month crude oil futures contract may tend to have a higher total return than a portfolio of 12 months' of the crude oil futures contract. Conversely, if the crude oil futures market was in contango, the portfolio containing only 12 months' of crude oil futures contracts may tend to outperform the portfolio holding only the near month
crude oil futures contract. 36 Table of Contents Historically, the crude oil futures markets have experienced periods of contango and backwardation, with backwardation being in place somewhat less often than contango since oil futures trading started in 1983. Following the global financial crisis in the fourth quarter of 2008, the crude oil market moved into contango and remained in contango for a period of several years. During parts of 2009, the level of contango was unusually steep as a combination of slackU.S. and global demand for crude oil and issues involving the physical transportation and storage of crude oil atCushing, Oklahoma , the primary pricing point for oil traded in theU.S. , led to unusually high inventories of crude oil. A combination of improved transportation and storage capacity, along with growing demand for crude oil globally, moderated the inventory build-up and led to reduced levels of contango by 2011. However, at the end ofNovember 2014 , global crude oil inventories grew rapidly afterOPEC voted to defend its market share againstU.S. shale-oil producers, resulting in another period during which the crude oil market remained primarily in contango. This period of contango continued throughDecember 31, 2017 . Declining global crude oil inventories caused the market to flip into backwardation at the beginning of 2018 through lateOctober 2018 , at which point ongoing supply growth in theU.S. , combined with increasedOPEC production, once again led market participants to fear another global glut of crude oil. The crude oil market was primarily in contango the first half of 2019 and in backwardation during the second half of 2019.
Crude oil flipped back into contango in
InMarch 2020 , contango dramatically increased and reached historic levels during the economic crisis arising from the COVID-19 pandemic and disputes among oil producing nations regarding limits on oil production levels. This level of contango was due to significant market volatility that occurred in crude oil markets as well as oil futures markets. Crude oil prices collapsed in the wake of the COVID-19 demand shock, which reduced global petroleum consumption, and the price war launched bySaudi Arabia at the beginning ofMarch 2020 in response toRussia's unwillingness to participate in extending previously agreed upon supply cuts. An estimated twenty million barrels a day of crude demand evaporated as a result of quarantines and massive drops in industrial and manufacturing activity. Eventually,the United States ,OPEC ,Russia , and other oil producers around the world agreed to a historic 9.7 million barrel per day cut to crude supply. The supply cut along with the partial reopening of economies during the third quarter of 2020 reduced some of the unprecedented volatility oil markets experienced in the spring of 2020. Likewise, contango returned to moderate levels inMay 2020 . During the six months endedJune 30, 2021 , the crude oil futures market was primarily in a state of backwardation as measured by the difference between the front month and the second month contract. As a result of market and regulatory conditions, including significant market volatility, large numbers ofUSO shares purchased during a short period of time, applicable regulatory accountability levels and position limits on oil futures contracts, and FCM risk mitigation measures that were imposed onUSO , in 2020,USO invested in Oil Futures Contracts in months other than the Benchmark Oil Futures Contracts and was limited in its investments in the Benchmark Oil Futures Contract. In order to continue to meet its investment objective,USO has chosen from its permitted investments types and amounts of Oil Futures Contracts allowed by its current regulatory requirements and under the risk mitigation efforts of its FCMs and other market participants, including those Oil Futures Contracts with expiration dates for months later than that of the Benchmark Futures Contract. Continued holdings in these later month contracts may allowUSO to experience lesser effects from contango than would be the case ifUSO's holdings were primarily in Oil Futures Contracts in the first month or second month. Likewise, continued holdings in these later month contracts also could causeUSO to experience lesser effects from backwardation than would be the case ifUSO's holdings were primarily in Oil Futures Contracts in the first month or second month. WhileUSO continues to invest in later month contracts, there is no assurance that this will continue and ifUSO returns to primarily investing in the Benchmark Oil Futures Contract it will be subject to greater effects of contango and backwardation. Crude Oil Market. During the six months endedJune 30, 2021 , crude oil prices traded in a range between$47.62 to$74.05 . Crude oil rose 51.42% from the end of 2020 throughJune 30, 2021 finishing the quarter at$73.47 . The simultaneous demand and supply shocks from the COVID-19 pandemic and Saudi-Russia price war precipitated unparalleled risk and volatility in crude oil markets during the first half of 2020. Global demand for crude oil plummeted by as much as 30% in the spring of 2020 as workers around the world stopped driving, airlines cut flight schedules, and companies suspended operations. Meanwhile,U.S. crude oil supply reached 13 million barrels per day (mbd), capping a period of almost continuous growth since 2016. To offset the seemingly unstoppableU.S. production juggernaut, OPEC+ (a loose coalition betweenOPEC and non-member nations such asRussia andMexico ) had maintained an uneasy series of agreements to curtail their crude oil output in order to support crude oil prices. However, in early March of 2020,Russia refusedSaudi Arabia's proposal to extend cuts in response to the COVID-19 demand shock. The kingdom retaliated with a massive production increase, launching an all-out price war in the middle of a pandemic. Although the members of OPEC+ reached a record-shattering agreement in mid-April of 2020, the implementation of new supply cuts came too late to prevent crude oil prices from plummeting to historic lows, culminating in a drop into negative territory for the May WTI crude oil futures contract onApril 20, 2020 . 37
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During the second quarter of 2020, theInternational Energy Agency (IEA) reported that crude oil demand fell an average of 16.4 mbd while global crude oil supply declined by an average of 13.7 mbd. Demand evaporated as a result of quarantines and massive drops in industrial and manufacturing activity. Supply declined largely due to the historic agreement in April of 2020 betweenthe United States ,OPEC ,Russia , and other oil producers. The bulk of the supply decline came from voluntary OPEC+ cuts while 2.8 mbd resulted from market driven cuts inthe United States . As ofJune 30, 2020 ,U.S. production had dropped over 15%, rapidly falling back to 11 mbd. Oil producing rigs inthe United States fell to 180 from over 670 at the start of the year, a massive decline that will likely seeU.S. supply fall further. Finally, in late June of 2020 storage in theU.S. spiked to 541 million barrels while global storage reached 3.351 billion barrels.
The unprecedented twin crises described above caused unparalleled effects on oil futures markets during 2020.
First, front month WTI Oil Futures Contract prices dipped below$20 for the first time since 2002 and hit an all-time closing low of$(37.63) . Multiple record-breaking returns occurred between March and May of 2020. The price of the front month WTI Oil Futures Contract averaged$28 during the second quarter of 2020 compared to$46 during the first quarter of 2020 and$57 during calendar year 2019. Second, crude oil price volatility went off-the-charts. For example, the 30-day annualized volatility of front month WTI crude oil futures prices reached 984% inMay 2020 after averaging 35% in 2019 and 25% in the first two months of 2020. (If May crude oil futures had not gone negative onApril 20, 2020 , volatility would "only" have reached 416%.) Third, futures curves, which can exhibit conditions known as "contango" and "backwardation" as discussed above, moved into a condition that some market experts referred to as "super contango." This was a result of extreme bearishness at the front of the futures curve due to rapidly filling storage facilities in theU.S. and around the world. Specifically, the price of the front month WTI Oil Futures Contract detached from the rest of the futures curve and fell to an extreme position relative to futures contracts with expiration dates in later months. On a percentage basis, the difference in price between the front month WTI Oil Futures Contract and the second month WTI Oil Futures Contract was more than double the previous record. This divergence caused the price of WTI Oil Futures Contracts with different expiration dates to move in different directions. For example, the price of the front month WTI Oil Futures Contract and second month WTI Oil Futures Contract typically move together (i.e., increase or decrease) about 99% of the time. However, in late April of 2020, the correlation of the price of the front and second month WTI Oil Futures Contracts was (24)%, meaning that these contracts were moving in opposite directions. Fourth,USO , among other market participants, diversified its portfolio away from the front of the futures curve in favor of deferred contract months, as discussed in this Form 10-Q. The move byUSO and other market participants to deferred contract months caused a historic change to relative levels of open interest among the different futures contracts. For example, open interest in the front month futures contract fell an average of 40% during April, May, and June of 2020 compared to the average level of open interest during those same calendar months during the previous five years. More recently, as economies reopened and OPEC+ supply cuts were absorbed by the market, WTI crude oil prices rose from all-time lows in the spring of 2020 to$48.52 per barrel onDecember 31, 2020 . Prices continued rising during the first half of 2021 to a high of$74.05 before finishing the second quarter at$73.47 . WTI crude oil inventories inthe United States fell from a modern record of 541 mb inJune 2020 to 445 mb by the end of the second quarter of 2021. Meanwhile, crude oil production inthe United States fell below 10 mbd during the second half of 2020 after peaking at over 13 mbd inMarch 2020 . Production topped 11.3 mbd by the end of June of 2021. Similarly,OPEC production declined from over 30 mbd pre-COVID-19 to a pandemic low of 22.5 mbd before gradually recovering to 26.5 mbd byJune 2021 . It's uncertain how quicklyOPEC ,Russia , or theU.S. will return to pre-pandemic 2019 production levels. It's similarly difficult to forecast when the recovery in demand will occur given the ongoing threat posed by COVID-19 variants. While some market participants expect the rise in crude oil prices to continue, several factors could impact the rise in prices. First, supply from both theU.S. andOPEC has been rebounding. Second, the majority of the demand recovery from the COVID-19 pandemic is now in the rearview mirror. Third, any increased supply fromIran would likely surprise the market as current expectations are for little to no progress in negotiations betweenIran and theU.S. On the other hand, inflation could continue to increase, which would likely be a catalyst for ongoing crude oil price increases. The full impact of the world's response to the COVID-19 pandemic still has not been determined. At this stage, it is impossible to predict whether crude oil prices will rise, fall, or remain stable. High risk remains in the oil markets until demand and supply are fully balanced and the full impact of past, current, and future COVID-19 pandemic mitigation measures is known. Crude Oil Price Movements in Comparison toOther Energy Commodities and Investment Categories. USCF 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 38 Table of Contents the two different investments or asset classes over some period of time. The correlation is scaled between1 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 indicates 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 nor 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 betweenJune 30, 2011 andJune 30, 2021 , the table below compares the monthly movements of crude oil prices versus the monthly movements of the prices of several other energy commodities, such as natural gas, diesel-heating oil, and unleaded gasoline, as well as several major non-commodity investment asset classes, such as large capU.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 exhibited strong correlation with unleaded gasoline and diesel-heating oil, moderate correlation with the movements of large capU.S. equities and global equities, no correlation with natural gas, and moderate negative correlation withU.S. government bonds. *PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Crude Oil - 10 Years Large US Global Cap US Gov't Equities Equities Bonds (FTSE (S&P (BEUSG4 World Unleaded Heating Natural Crude Correlation Matrix 10 Years 500) Index) Index) Gasoline Oil Gas OilLarge Cap US Equities (S&P 500) 1.000 (0.381) 0.967 0.546 0.366 0.161 0.471 US Gov't Bonds (BEUSG4 Index) 1.000 (0.368) (0.306) (0.340) (0.082) (0.330)Global Equities (FTSE World Index) 1.000 0.574 0.428 0.137 0.509 Unleaded Gasoline 1.000 0.678 0.081 0.740 Heating Oil 1.000 0.018 0.784 Natural Gas 1.000 0.010 Crude Oil 1.000
Source: Bloomberg, NYMEX
The table below covers a more recent, but much shorter, range of dates than the above table. Over the one year period endedJune 30, 2021 , movements of crude oil displayed strong correlation with unleaded gasoline, diesel- heating oil, large capU.S. equities and global equities , limited correlation with the movements ofU.S. Government bonds and limited negative correlation with movements of natural gas. *PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Crude Oil - 1 Year Large US Global Cap US Gov't Equities Equities Bonds (FTSE (S&P (BEUSG4 World Unleaded Heating Natural Crude Correlation Matrix 1 Year 500) Index) Index) Gasoline Oil Gas Oil Large Cap US Equities (S&P 500) 1.000 0.137 0.974 0.539 0.449 (0.081) 0.645 US Gov't Bonds (BEUSG4 Index) 1.000 0.182 (0.124) 0.184 (0.099) 0.156 Global Equities (FTSE World Index) 1.000
0.608 0.578 (0.215) 0.719 Unleaded Gasoline 1.000 0.845 (0.390) 0.881 Heating Oil 1.000 (0.485) 0.881 Natural Gas 1.000 (0.286) Crude Oil 1.000 Source: Bloomberg, NYMEX 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. USCF believes that crude oil has historically not demonstrated a strong correlation with equities or bonds over long periods of time. However, USCF 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, USCF believes that, when measured over time periods shorter than ten years, there will 39
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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 correlations between crude oil, natural gas, diesel-heating oil and gasoline are relevant because USCF endeavors to investUSO's assets in Oil Futures Contracts and Other Oil-Related Investments so that daily changes in percentage terms inUSO's per share NAV correlate as closely as possible with daily changes in percentage terms in the price of the Benchmark Oil Futures Contract. If certain other fuel-based commodity futures contracts do not closely correlate with the crude-oil futures contract, then their use could lead to greater tracking error. As noted above, USCF also believes that the changes in percentage terms in the price of the Benchmark Oil Futures Contract will closely correlate with changes in percentage terms in the spot price of light, sweet crude oil. Critical Accounting Policies Preparation of the condensed financial statements and related disclosures in compliance with accounting principles generally accepted inthe United States of America requires the application of appropriate accounting rules and guidance, as well as the use of estimates.USO's application of these policies involves judgments and actual results may differ from the estimates used. USCF has evaluated the nature and types of estimates that it makes in preparingUSO's condensed financial statements and related disclosures and has determined that the valuation of its investments, which are not traded on aUnited States or internationally recognized futures exchange (such as forward contracts and OTC swaps) involves a critical accounting policy. The values which are used byUSO for its Oil Futures Contracts are provided by its commodity broker who uses market prices when available, while OTC swaps 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,USO estimates interest and dividend income on a daily basis using prevailing 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
USO has not made, and does not anticipate making, use of borrowings or other lines of credit to meet its obligations.USO has met, and it is anticipated thatUSO 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.USO's liquidity needs include: redeeming shares, providing margin deposits for its existing Oil Futures Contracts or the purchase of additional Oil Futures Contracts and posting collateral for its OTC swaps, if applicable, and payment of its expenses, summarized below under "Contractual Obligations."USO currently generates cash primarily from: (i) the sale of baskets consisting of 100,000 shares ("Creation Baskets") and (ii) income earned on Treasuries, cash and/or cash equivalents.USO has allocated substantially all of its net assets to trading in Oil Interests.USO 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-Related Investments. A significant portion ofUSO's NAV is held in cash and cash equivalents that are used as margin and as collateral for its trading in Oil Interests. The balance of the assets is held inUSO's account at its custodian bank and in investments in money market funds and Treasuries at the FCMs. Income received fromUSO's investments in money market funds and Treasuries is paid toUSO . During the six months endedJune 30, 2021 ,USO's expenses exceeded the incomeUSO earned and the cash earned from the sale of Creation Baskets and the redemption of Redemption Baskets. During the six months endedJune 30, 2021 ,USO used other assets to pay expenses. To the extent expenses exceed income,USO's NAV will be negatively impacted. USCF endeavors to have the value ofUSO's Treasuries, cash and cash equivalents, whether held byUSO or posted as margin or other collateral, at all times approximate the aggregate market value of its obligations for its investments in Oil Interests. Commodity pools' trading positions in futures contracts or other related investments are typically required to be secured by the deposit of margin funds that represent only a small percentage of a futures contract's (or other commodity interest's) entire market value. While USCF has not and does not intend to leverageUSO's assets, it is not prohibited from doing so under the LP Agreement. Although permitted to do so under its LP Agreement,USO has not and does not intend to leverage its assets and makes its investments accordingly. Consistent with the foregoing,USO's investments will take into account the need forUSO to make permitted investments that also allow it to maintain adequate liquidity to meet its margin and collateral requirements and to avoid, to the extent reasonably possible,USO becoming leveraged. If market conditions require it, these risk reduction procedures may occur on short notice if they occur other than during a roll or rebalance period. 40
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USO's investments 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 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 a 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 preventUSO from promptly liquidating its positions in Futures Contracts. During the six months endedJune 30, 2021 ,USO did not purchase or liquidate any of its positions while daily limits were in effect; however,USO cannot predict whether such an event may occur in the future. SinceMarch 23, 2007 ,USO has been responsible for expenses relating to: (i) management fees, (ii) brokerage fees and commissions, (iii) licensing fees for the use of intellectual property, (iv) ongoing registration expenses in connection with offers and sales of its shares subsequent to the initial offering, (v) other expenses, including tax reporting costs, (vi) fees and expenses of the independent directors of USCF and (vii) other extraordinary expenses not in the ordinary course of business.USO may terminate at any time, regardless of whetherUSO has incurred losses, subject to the terms of the LP Agreement. In particular, unforeseen circumstances, but not limited to, (i) market conditions, regulatory requirements, risk mitigation measures taken byUSO or third parties or otherwise that would leadUSO to determine that it could no longer foreseeably meet its investment objective or thatUSO's aggregate net assets in relation to its operating expenses or its margin or collateral requirements make the continued operation ofUSO unreasonable or imprudent, or (ii) adjudication of incompetence, bankruptcy, dissolution, withdrawal or removal of USCF as the general partner ofUSO could causeUSO to terminate unless a majority interest of the limited partners within 90 days of the event elects to continue the partnership and appoints a successor general partner, or the affirmative vote of a majority in interest of the limited partners subject to certain conditions. However, no level of losses will requireUSO to terminateUSO .USO's termination would cause the liquidation and potential loss of an investor's investment. Termination could also negatively affect the overall maturity and timing of an investor's investment portfolio.
Market Risk
Trading in Oil Futures Contracts and Other Oil-Related Investments, such as forwards, involvesUSO entering into contractual commitments to purchase or sell oil at a specified date in the future. The aggregate market value of the contracts will significantly exceedUSO's future cash requirements sinceUSO intends to close out its open positions prior to settlement. As a result,USO is generally only subject to the risk of loss arising from the change in value of the contracts.USO considers the "fair value" of its derivative instruments to be the unrealized gain or loss on the contracts. The market risk associated withUSO's commitments to purchase oil is limited to the aggregate market value of the contracts held. However, shouldUSO 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 toUSO could be unlimited.USO'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-Related Investments markets and the relationships among the contracts held byUSO . Drastic market occurrences could ultimately lead to the loss of all or substantially all of an investor's capital. Credit Risk WhenUSO enters into Oil Futures Contracts and Other Oil-Related Investments, 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 futures exchanges is the clearinghouse associated with the particular exchange. In general, in addition to margin required to be posted by the clearinghouse in connection with cleared trades, 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.USO is not currently a member of any clearinghouse. 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 toUSO in such circumstances. 41
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USCF attempts to manage the credit risk ofUSO by following various trading limitations and policies. In particular,USO generally posts margin and/or holds liquid assets that are approximately equal to the market value of its obligations to counterparties under the Oil Futures Contracts and Other Oil-Related Investments it holds. USCF 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 ofUSO to limit its credit exposure. An FCM, when acting on behalf ofUSO in accepting orders to purchase or sell Oil Futures Contracts onUnited States exchanges, is required by CFTC regulations to separately account for and segregate as belonging toUSO , all assets ofUSO relating to domestic Oil Futures Contracts trading. These FCMs are not allowed to commingleUSO's assets with their other assets. In addition, the CFTC requires FCMs to hold in a secure accountUSO's assets related to foreign Oil Futures Contracts and, in some cases, to cleared swaps executed through the FCMs. Similarly, under its current OTC agreements,USO requires that collateral it posts or receives be posted with its custodian, and under agreements among the custodian,USO and its counterparties, such collateral is segregated.
In the future,
As ofJune 30, 2021 ,USO held cash deposits and investments in Treasuries and money market funds in the amount of$2,762,908,222 with the custodian and FCMs. Some or all of these amounts held by a custodian or an FCM, as applicable, may be subject to loss shouldUSO's custodian or FCMs, as applicable, cease operations.
Off Balance Sheet Financing
As ofJune 30, 2021 ,USO had 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 ofUSO . WhileUSO's exposure under these indemnification provisions cannot be estimated, they are not expected to have a material impact onUSO's financial position.
Redemption Basket Obligation
In order to meet its investment objective and pay its contractual obligations described below,USO requires liquidity to redeem shares, which redemptions must be in blocks of 100,000 shares called "Redemption Baskets."USO 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 shares being redeemed. Contractual ObligationsUSO's primary contractual obligations are with USCF. In return for its services, USCF is entitled to a management fee calculated daily and paid monthly as a fixed percentage ofUSO's NAV, currently 0.45% of NAV on its average daily total net assets. USCF agreed to pay the start-up costs associated with the formation ofUSO , primarily its legal, accounting and other costs in connection with USCF's registration with the CFTC as a CPO and the registration and listing ofUSO and its shares with theSEC ,FINRA and NYSE Arca (formerly, AMEX), respectively. However, sinceUSO's initial offering of shares, offering costs incurred in connection with registering and listing additional shares ofUSO have been directly borne on an ongoing basis byUSO , and not by USCF. USCF pays the fees of the Marketing Agent as well as BNY Mellon's fees for performing administrative, custodial, and transfer agency services. BNY Mellon's fees for performing administrative services include those in connection with the preparation ofUSO's condensed financial statements and itsSEC , NFA and CFTC reports. USCF andUSO have also entered into a licensing agreement with the NYMEX pursuant to whichUSO and the Related Public Funds, other than BNO, USCI and CPER, pay a licensing fee to the NYMEX.USO also pays the fees and expenses associated with its tax accounting and reporting requirements. USCF paid BBH&Co.'s fees for performing administrative services, including those in connection with the preparation ofUSO's condensed financial statements and itsSEC , NFA and CFTC reports throughMay 31, 2020 . 42
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In addition to USCF's management fee,USO pays its brokerage fees (including fees to FCMs), OTC dealer spreads, any licensing fees for the use of intellectual property, and, subsequent to the initial offering, registration and other fees paid to theSEC ,FINRA , or other regulatory agencies in connection with the offer and sale of shares, as well as legal, printing, accounting and other expenses associated therewith, and extraordinary expenses. The latter are expenses not incurred in the ordinary course ofUSO'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 FCMs are on a contract-by-contract, or round turn, basis.USO also pays a portion of the fees and expenses of the independent directors of USCF. See Note 3 to the Notes to Condensed Financial Statements (Unaudited) in Item 1 of this quarterly report on Form 10-Q. The parties cannot anticipate the amount of payments that will be required under these arrangements for future periods, asUSO's per share NAVs and trading levels to meet its investment objective 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 ofUSO's existence. Either party may terminate these agreements earlier for certain reasons described in the agreements.
As of
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