UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
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x
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Annual
report pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
fiscal year ended December 31, 2007.
|
|
¨
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Transition
report pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
transition period from
to .
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Commission
file number: 001-32834
United
States Oil Fund,
LP
(Exact
name of registrant as
specified in its charter)
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Delaware
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|
20-2830691
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|
(State
or other jurisdiction of
incorporation
or
organization)
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|
(I.R.S.
Employer
Identification
No.)
|
1320
Harbor Bay Parkway, Suite
145
Alameda,
California
94502
(Address
of principal executive
offices) (Zip Code)
(510)
522-3336
(Registrant’s
telephone number,
including area code)
Securities
registered pursuant to
Section 12(b) of the Act:
Units American
Stock
Exchange
(Title
of class)
(Name of exchange on which
registered)
Securities
registered pursuant to
Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act.
¨
Yes x
No
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
¨
Yes x
No
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
x
Yes ¨
No
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405) is not contained herein, and will not be contained, to
the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company.
See definitions of “large accelerated filer," "accelerated filer” and
"smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one.)
Large
accelerated filer ¨ Accelerated
filer x Non-accelerated
filer ¨
Smaller reporting company ¨
(Do
not check if a smaller reporting company)
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act.).
¨
Yes x
No
The
aggregate market value of the registrant’s units held by non-affiliates of the
registrant as of June
30,
2007 was: $673,000,000.
The
registrant had 4,100,000 outstanding units as of March
12, 2008.
DOCUMENTS
INCORPORATED BY
REFERENCE:
None.
|
Business.
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What
is USOF?
United
States Oil Fund, LP ("USOF") is a Delaware limited partnership
organized on May 12, 2005. USOF maintains its main business office at 1320
Harbor Bay Parkway, Suite 145, Alameda, California 94502. USOF is a commodity
pool that issues limited partnership interests ("units") traded on the American
Stock Exchange (the "AMEX"). It operates pursuant to the terms of the Fourth
Amended and Restated Agreement of Limited Partnership dated as of November
13, 2007 (the "LP Agreement"), which grants full management control to the
General Partner.
Who
is the General
Partner?
USOF's
sole general partner is Victoria Bay Asset Management, LLC (the "General
Partner"), a single member limited liability company that was formed in the
state of Delaware on May 10, 2005. It maintains its main business office
at 1320
Harbor Bay Parkway, Suite 145, Alameda, California 94502. The General Partner
is
a wholly-owned subsidiary of Wainwright Holdings, Inc., a Delaware corporation
(“Wainwright”). Mr. Nicholas Gerber (discussed below) controls Wainwright
by virtue of his ownership of Wainwright’s shares. Wainwright is a holding
company that also owns an insurance company organized under Bermuda law and
a
registered investment adviser firm named Ameristock Corporation. The General
Partner is a member of the National Futures Association (the "NFA") and was
registered with the Commodity Futures Trading Commission (the "CFTC") as
of
December 1, 2005. The General Partner’s registration as a Commodity Pool
Operator ("CPO") was approved on December 1, 2005.
On
September 8, 2006, the General Partner formed the United States Natural Gas
Fund, LP ("USNG"), another limited partnership that is a commodity pool
and issues units traded on the AMEX. The investment objective of
USNG is for the changes in percentage terms of the units' net asset value
("NAV") to reflect the changes in percentage terms of the price of natural
gas
delivered at the Henry Hub, Louisiana, as measured by the changes in the
price
of the futures contract on natural gas traded on the New York Mercantile
Exchange (the "NYMEX"), less USNG’s expenses. USNG began trading on April 18,
2007. The General Partner is the general partner of USNG and is responsible
for
the management of USNG. Wainwright was the initial limited partner of USNG.
Investors in USOF who wish to receive additional information concerning the
United States Natural Gas Fund, LP, may do so by calling 1-800-920-0259,
or
going on-line to www.unitedstatesnaturalgasfund.com.
On
June
27, 2007, the General Partner formed the United States 12 Month Oil Fund,
LP
(“US12OF”), also a limited partnership that is a commodity pool and issues units
traded on the AMEX. The investment objective of US12OF is for changes
in percentage terms of its units’ NAV to reflect the changes in percentage terms
of the price of light, sweet crude oil delivered to Cushing, Oklahoma,
as
measured by the changes in the average of the prices of 12 futures contracts
on
crude oil traded on the NYMEX, less US12OF's expenses. US12OF
began trading on December 6, 2007. The General Partner is the general partner
of
US12OF and is responsible for the management
of US12OF. Wainwright was the initial limited partner of US12OF.
Investors in USOF who wish to receive additional information concerning
the
United States 12 Month Oil Fund, LP, may do so by calling 1-800-920-0259,
or
going on-line to www.unitedstates12monthoilfund.com.
On
April
12, 2007, the General Partner formed the United States Gasoline Fund,
LP
(“USG”), also a limited partnership that is a commodity pool and issues units
traded on the AMEX. The investment objective of USG is for
the changes in percentage terms of its units’ NAV to reflect the changes in
percentage terms of the price of unleaded gasoline delivered to the New
York
harbor, as measured by the changes in the price of the futures contract
on
gasoline traded on the NYMEX, less USG's expenses. USG began trading
on February 26, 2008. The General Partner is the general partner of
USG and is responsible for the management of USG. Wainwright was the
initial limited partner of USG. Investors in USOF who wish to receive
additional information concerning the United States Gasoline Fund, LP,
may do so
by calling 1-800-920-0259, or going on-line to
www.unitedstatesgasolinefund.com.
The
General Partner is currently in the process of registering two other exchange
traded security funds, the United States Heating Oil Fund, LP (“USHO) and the
United States 12 Month Natural Gas Fund, LP (“US12NG”). USHO will be
a publicly traded limited partnership which seeks to have the changes in
percentage terms of its units’ NAV track the changes in percentage terms of the
price of heating oil (also known as No. 2 fuel) delivered to the New York
harbor. US12NG will be a publicly traded limited partnership which
will seek to have the changes in percentage terms of its units’ NAV reflect the
changes in percentage terms of the price of natural gas delivered at the
Henry
Hub, Louisiana, as measured by the changes in the average of the prices
of 12
futures contracts on natural gas traded on the NYMEX.
1
The
General Partner is required to evaluate the credit risk for USOF to
the futures
commission merchant, oversee the purchase and sale of USOF’s units by certain
authorized purchasers ("Authorized Purchasers"), review daily positions
and
margin requirements of USOF and manage USOF’s investments. The General Partner
also pays the fees of ALPS Distributors, Inc. (the "Marketing Agent")
and Brown
Brothers Harriman & Co. ("BBH&Co."), which acts as the administrator
(the "Administrator") and the custodian (the "Custodian") for
USOF.
Limited
partners have no right to elect the General Partner on an annual or
any other
continuing basis. If the General Partner voluntarily withdraws, however,
the
holders of a majority of USOF's outstanding units (excluding for purposes
of
such determination units owned, if any, by the withdrawing General Partner
and its affiliates) may elect its successor. The General Partner may
not be
removed as general partner except upon approval by the affirmative
vote of the
holders of at least 66 and 2/3 percent of USOF's outstanding units
(excluding
units owned, if any, by the General Partner and its affiliates), subject to
the satisfaction of certain conditions set forth in the LP
Agreement.
The
business and affairs of the General Partner are managed by a board
of directors,
which is comprised of four management directors, some of whom are also
its
executive officers (the “Management Directors”) and three independent directors
who meet the independent director requirements established by the AMEX
and the
Sarbanes-Oxley Act of 2002. Notwithstanding the foregoing, the Management
Directors have the authority to manage the General Partner pursuant
to its Third
Amended and Restated Limited Liability Company Agreement. The board
of directors
of the General Partner has an audit committee which is made up of the
three
independent directors (Peter M. Robinson, Gordon L. Ellis and Malcolm
R. Fobes
III). The audit committee is governed by an audit committee charter
that is
posted on USOF’s website, http://www.unitedstatesoilfund.com. Mr. Fobes and
Mr. Ellis meet the financial sophistication requirements of the AMEX and
the audit committee charter. Through its Management Directors, the
General
Partner manages the day-to-day operations of USOF.
How
Does USOF
Operate?
The
net
assets of USOF consist primarily of investments in futures contracts
for light, sweet crude oil, but may also consist of other types of crude
oil, heating oil, gasoline, natural gas and other petroleum-based fuels
that are
traded on the NYMEX, ICE Futures or other U.S. and foreign exchanges
(collectively, “Oil Futures Contracts”). USOF may also invest in other
oil-related investments such as cash-settled options on Oil Futures Contracts,
forward contracts for oil, and over-the-counter transactions that are based
on
the price of crude oil, other petroleum-based fuels, Oil Futures Contracts
and
indices based on the foregoing (collectively, “Other Oil Interests”). For
convenience and unless otherwise specified, Oil Futures Contracts and Other
Oil
Interests collectively are referred to as “oil interests” in this annual report
on Form 10-K.
USOF
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
Interests. In pursuing this objective, the primary focus of the General
Partner
is the investment in Oil Futures Contracts and the management of its investments
in short-term obligations of the United States of two years or less
(“Treasuries”), cash and/or cash equivalents for margining purposes and as
collateral.
The
investment objective of USOF is to have the changes in percentage terms
of the
units’ NAV reflect the changes in percentage terms of the spot price
of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by
the changes in the price of the futures contract on light, sweet crude
oil as
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 the
futures
contract will be the next month contract to expire, less USOF's expenses.
It
is not
the intent of USOF to be operated in a fashion such that its NAV will equal,
in
dollar terms, the spot price of light, sweet crude oil or any particular
futures
contract based on light, sweet crude oil.
2
USOF
seeks to achieve its investment objective by investing in a mix of Oil Futures
Contracts and Other Oil Interests such that changes in USOF’s NAV will closely
track the changes in the price of a specified Oil Futures Contract (the
“Benchmark Oil Futures Contract”). The General Partner believes changes in the
price of the Benchmark Oil Futures Contract have historically exhibited a
close
correlation with the changes in the spot price of light, sweet crude oil.
On any valuation day (a valuation day is any day as of which USOF calculates
its
NAV), the Benchmark Oil Futures Contract is the near month contract
for light, sweet crude oil traded on the NYMEX unless the near month
contract will expire within two weeks of the valuation day, in which case
the
Benchmark Oil Futures Contract is the next month contract for light, sweet
crude
oil traded on the NYMEX.
As
a
specific benchmark, the General Partner endeavors to place USOF’s trades in Oil
Futures Contracts and Other Oil Interests and otherwise manage USOF’s
investments so that A will be within plus/minus 10 percent of B,
where:
|
·
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A
is the average daily change in USOF’s NAV for any period of 30 successive
valuation days; i.e.,
any day as of
which USOF calculates its NAV, and
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|
·
|
B
is the average daily change in the price of the Benchmark Oil
Futures
Contract over the same
period.
|
The General Partner believes that market arbitrage opportunities cause daily changes in USOF’s unit price on the AMEX to closely track daily changes in USOF’s NAV. The General Partner further believes that the daily changes in prices of the Benchmark Oil Futures Contract have historically closely tracked the daily changes in the spot price of light, sweet crude oil. The General Partner believes that the net effect of these two relationships and the expected relationship described above between USOF’s NAV and the Benchmark Oil Futures Contract will be that the daily changes in the price of USOF’s units on the AMEX will continue to closely track the daily changes in the spot price of a barrel of light, sweet crude oil, less USOF’s expenses. The following graph demonstrates the correlation between the daily changes in the NAV of USOF and the daily changes in the Benchmark Oil Futures Contract during the last thirty valuation days ended December 31, 2007.
An
investment in the units allows both retail and institutional investors to easily
gain exposure to the crude oil market in a cost-effective manner. In addition,
the units also provide additional means for diversifying an investor’s
investments or hedging exposure to changes in oil prices.
3
The
Benchmark Oil Futures Contract will be changed or “rolled” from the near month
contract to expire to the next month to expire during one day.
These
relationships are illustrated in the following diagram:
The
Price of USOF’s Units Is Expected
to Correlate Closely
With
USOF’S NAV
USOF’s
units are traded on the AMEX. The price of
units
fluctuates in response to USOF’s NAV and the supply and demand
pressures
of the AMEX. Because of certain arbitrage opportunities, the
General
Partner believes the price of USOF’s units traded on the
AMEX
will
correlate closely with USOF’s NAV.
Daily
Changes in USOF’s NAV Are
Expected to Correlate Closely With
Daily
Changes in the Price of the
Benchmark Oil
Futures
Contract
The
General Partner endeavors to invest USOF’s assets as fully as
possible
in Oil Futures Contracts and Other Oil Interests so that the
changes
in the NAV closely correlate with changes in the price of the
Benchmark
Oil Futures Contract.
Daily
Changes in the Price of the
Benchmark Oil Futures
Contract
Are Expected to Correlate
Closely With Daily Changes
in
the Spot Price of Light,
Sweet Crude Oil
The
General Partner believes that changes in the price of the Benchmark
Oil
Futures Contract will closely correlate with changes in the cash or
spot
price of light, sweet crude oil
4
The
General Partner employs a “neutral” investment strategy in order to track
changes in the price of the Benchmark Oil Futures Contract regardless
of whether
the price goes up or goes down. USOF’s “neutral” investment strategy is designed
to permit investors generally to purchase and sell USOF’s units for the purpose
of investing indirectly in oil in a cost-effective manner, and/or to
permit
participants in the oil or other industries to hedge the risk of losses
in their
crude oil-related transactions. Accordingly,
depending on the investment objective of an individual investor, the
risks
generally associated with investing in crude oil and/or the risks involved
in
hedging may exist. In addition, an investment in USOF involves the risk
that the
changes in the price of USOF’s units will not accurately track the changes in
the Benchmark Oil Futures Contract.
USOF’s
total portfolio composition is disclosed each business day that the AMEX
is open
for trading on USOF’s website and through the AMEX’s website at
http://www.amex.com. The website disclosure of portfolio holdings is made
daily
and includes, as applicable, the name and value of each oil interest, the
specific types of Other Oil Interests and characteristics of such Other
Oil
Interests, Treasuries, and amount of the cash and/or cash equivalents held
in
USOF’s portfolio. USOF’s website is publicly accessible at no charge. USOF’s
assets are held in segregation pursuant to the Commodity Exchange Act (the
"CEA") and CFTC regulations.
The
units issued by USOF may be purchased
only by Authorized Purchasers only in blocks of 100,000 units called
Creation
Baskets. The amount of the purchase payment for a Creation Basket is
equal to
the aggregate NAV of units in the Creation Basket. Similarly, Authorized
Purchasers may redeem units only in blocks of 100,000 units called Redemption
Baskets. The amount of the redemption proceeds for a Redemption Basket
is equal
to the aggregate NAV of units in the Redemption Basket. The purchase
price for
Creation Baskets and the redemption price for Redemption Baskets is the
actual
NAV calculated at the end of the business day when notice for a purchase
or
redemption is received by USOF. The AMEX publishes an approximate intra-day
NAV based on the prior day’s NAV and the current price of Benchmark Oil
Futures Contracts, but the basket price is determined based on the actual
NAV at
the end of the day.
While
USOF issues units only in Creation Baskets, units may also be
purchased and sold in much smaller increments on the AMEX. These
transactions, however, are effected at the bid and ask prices established
by specialist firm(s). Like any listed security, units can be purchased
and sold
at any time a secondary market is open.
5
What
is USOF’s Investment
Strategy?
In
managing USOF’s assets, the General Partner does not use a technical trading
system that issues buy and sell orders. The General Partner instead employs
a
quantitative methodology whereby each time a Creation Basket is sold, the
General Partner purchases oil interests, such as an Oil Futures Contract
for
light, sweet crude oil traded on the NYMEX, that have an aggregate face
amount
that approximates the amount of Treasuries and/or cash received upon the
issuance of the Creation Basket.
As
an
example, assume that a Creation Basket purchase order is placed on January
2,
2007. If one were to assume USOF’s closing NAV per unit for January 2 is $63.76,
USOF would receive $6,376,000 for the Creation Basket ($63.76 NAV per unit
times
100,000 units, and ignoring the Creation Basket fee of $1,000). Assume
that the
price of an Oil Futures Contract for light, sweet crude oil on January 3,
2007 is $63,770. Because the price of oil reflected in these near month
futures
contracts on January 3, 2007 is different (in this case, higher) than the
price
of oil reflected in USOF’s NAV calculated as of January 2, 2007 (the day the
corresponding Creation Basket was sold), USOF cannot invest the entire
purchase
amount corresponding to the Creation Basket in futures contracts — i.e., it can
only invest in 99 Oil Futures Contracts with an aggregate value of $6,313,230
($63,770 per contract times 99 contracts). Assuming a margin equal to 10%
of the value of the Oil Futures Contracts which would require $631,323
in
Treasuries to be deposited as margin with the futures commission merchant
through which the contract was purchased, the remainder of the purchase
price
for the Creation Basket, $5,744,677, would remain invested in Treasuries,
cash and/or cash equivalents as determined by the General Partner from time
to time based on factors such as potential calls for margin or anticipated
redemptions.
6
The
specific Oil Futures Contracts purchased depend on various factors, including
a
judgment by the General Partner as to the appropriate diversification of
USOF’s
investments in futures contracts with respect to the month of expiration,
and
the prevailing price volatility of particular contracts. While the General
Partner has made significant investments in NYMEX Oil Futures Contracts,
as USOF
reaches certain position limits on the NYMEX, or for other
reasons, it has also and may continue to invest in Oil Futures Contracts
traded
on other exchanges or invest in Other Oil Interests such as contracts in
the
“over-the-counter” market.
The
General Partner does not anticipate letting its Oil Futures Contracts expire
and
taking delivery of the underlying oil. Instead, the General Partner will
close
existing positions when it is determined appropriate to do so and reinvest
the
proceeds in new Oil Futures Contracts. Positions may also be closed out
to meet
orders for Redemption Baskets.
By
remaining invested as fully as possible in Oil Futures Contracts or Other
Oil
Interests, the General Partner believes that the changes in percentage
terms in
USOF’s NAV will continue to closely track the changes in percentage terms
in the prices of the futures contracts in which USOF invests. The General
Partner believes that certain arbitrage opportunities result in the price
of the
units traded on the AMEX closely tracking the NAV of USOF. Additionally,
as
discussed above, the General Partner has conducted research that indicates
that
oil futures contracts traded on the NYMEX have closely tracked the spot
price of
the underlying oil. Based on these expected interrelationships, the General
Partner believes that the changes in the price of USOF’s units as traded on the
AMEX will continue to closely track the changes in the spot price of light,
sweet crude oil.
What
are Oil Futures
Contracts?
Oil
Futures Contracts are agreements between two parties. One party agrees
to buy
oil from the other party at a later date at a price and quantity agreed
upon
when the contract is made. Oil Futures Contracts are traded on futures
exchanges, including the NYMEX. For example, the Benchmark Oil Futures
Contract
is traded on the NYMEX in units of 1,000 barrels. The price of crude
oil futures contracts traded on the NYMEX are priced by floor brokers and
other
exchange members both through an “open outcry” of offers to purchase or sell the
contracts and through an electronic, screen-based system that determines
the
price by matching electronically offers to purchase and sell.
Certain
typical and significant characteristics of Oil Futures Contracts are discussed
below. Additional risks of investing in Oil Futures Contracts are included
in
“What are the Risk Factors Involved with an Investment in USOF?”
Impact
of Accountability Levels,
Position Limits and Price Fluctuation Limits.
Oil
Futures Contracts include typical and significant characteristics. Most
significantly, the CFTC and U.S. designated contract markets such as
the NYMEX
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 in USOF is not) may hold, own or control. The net position
is the
difference between an individual or firm’s open long contracts and open short
contracts in any one commodity. In addition, most U.S. futures exchanges,
such
as the NYMEX, limit the price fluctuation for Oil Futures
Contracts.
7
The
accountability levels for the Benchmark Oil Futures Contract and other
Oil
Futures Contracts traded on 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 at any
one time in the Benchmark Oil Futures Contract is 20,000 contracts. If USOF
exceeds this accountability level for investments in the Benchmark
Oil Futures
Contract, the NYMEX will monitor USOF’s exposure and ask for further information
on USOF’s activities, including the total size of all positions, investment
and
trading strategy, and the extent of USOF’s liquidity resources. If deemed
necessary by the NYMEX, it could also order USOF to reduce its position
back to
the accountability level. As of December 31, 2007, USOF held 4,754
Oil Futures
Contracts traded on the NYMEX and 300 Oil Futures Contracts traded
on the ICE
Futures.
If
the
NYMEX orders USOF to reduce its position back to the accountability level,
or to
an accountability level that the NYMEX deems appropriate for USOF, such
an
accountability level may impact the mix of investments in oil interests
made by
USOF. To illustrate, assume that the price of the Benchmark Oil Futures
Contract
and the unit price of USOF are each $10, and that the NYMEX has determined
that
USOF may not own more than 20,000 Benchmark Oil Futures Contracts. In such
case, USOF could invest up to $2 billion of its daily net assets in the
Benchmark Oil Futures Contract (i.e., $10 per contract multiplied by
1,000 (a
Benchmark Oil Futures Contract is a contract for 1,000 barrels of oil
multiplied
by 20,000 contracts)) before reaching the accountability level imposed
by the
NYMEX. Once the daily net assets of the portfolio exceed $2 billion in
the
Benchmark Oil Futures Contract, the portfolio may not be able
to make any further investments in the Benchmark Oil Futures Contract,
depending
on whether the NYMEX imposes limits. If the NYMEX does impose limits
at the $2
billion level (or another level), USOF anticipates that it will invest
the
majority of its assets above that level in a mix of other Oil Futures
Contracts
or Other Oil Interests.
In
addition to accountability levels, the NYMEX imposes position limits
on
contracts held in the last few days of trading in the near month contract
to
expire. It is unlikely that USOF will run up against such position limits
because USOF’s investment strategy is to change or "roll" from the near month
contract to expire to the next month contract during one day beginning
two weeks
from expiration of the contract.
U.S.
futures exchanges, including the NYMEX, also limit the amount of price
fluctuation for Oil Futures Contracts. For example, the NYMEX imposes
a $10.00
per barrel ($10,000 per contract) price fluctuation limit for Benchmark
Oil
Futures Contracts. This limit is initially based off the previous trading
day’s
settlement price. If any Benchmark Oil Futures Contract is traded, bid,
or
offered at the limit for five minutes, trading is halted for five minutes.
When
trading resumes, it begins at the point where the limit was imposed and
the
limit is reset to be $10.00 per barrel in either direction of that point.
If
another halt were triggered, the market would continue to be expanded
by $10.00
per barrel in either direction after each successive five-minute trading
halt.
There is no maximum price fluctuation limit during any one trading
session.
USOF
anticipates that to the extent it invests in Oil Futures Contracts other
than light, sweet crude oil contracts (such as futures contracts for Brent
crude oil, natural gas, heating oil, and gasoline) and Other Oil Interests,
it
will invest in various non-exchange-traded derivative contracts to hedge
the
short-term price movements of such Oil Futures Contracts and Other Oil
Interests
against the current Benchmark Oil Futures Contract.
|
Futures
Contract
|
Position
Accountability
Levels
and Limits
|
Maximum
Daily
Price
Fluctuation
|
||
|
NYMEX
Light, Sweet Crude Oil
|
Any
one month/all months: 20,000 net futures, but not to exceed
3,000
contracts in the last three days of trading in the spot
month.
|
$10.00
per barrel ($10,000 per contract) for all months. If any contract
is
traded, bid, or offered at the limit for five minutes, trading
is halted
for five minutes. When trading resumes, the limit is expanded
by $10.00
per barrel in either direction. If another halt were triggered,
the market
would continue to be expanded by $10.00 per barrel in either
direction
after each successive five-minute trading halt. There will
be no maximum
price fluctuation limits during any one trading
session.
|
||
|
ICE
Futures Brent Crude Futures
|
There
are no position limits.
|
There
is no maximum daily price fluctuation limit.
|
||
|
ICE
WTI Crude Futures
|
There
are no position limits.
|
There
is no maximum daily price fluctuation.
|
||
|
NYMEX
Heating Oil
|
Any
one month/all months: 7,000 net futures, but not to exceed
1,000 contracts
in the last three days of trading in the spot month
|
$0.25
per gallon ($10,500 per contract) for all months. If any contract
is
traded, bid, or offered at the limit for five minutes, trading
is halted
for five minutes. When trading resumes, the limit is expanded
by $0.25 per
gallon in either direction. If another halt were triggered,
the market
would continue to be expanded by $0.25 per gallon in either
direction
after each successive five-minute trading halt. There will
be no maximum
price fluctuation limits during any one trading
session.
|
||
|
NYMEX
Gasoline
|
Any
one month/all months: 7,000 net futures, but not to exceed
1,000 contracts
in the last three days of trading in the spot month.
|
$0.25
per gallon ($10,500 per contract) for all months. If any contract
is
traded, bid, or offered at the limit for five minutes, trading
is halted
for five minutes. When trading resumes, the limit is expanded
by $0.25 per
gallon in either direction. If another halt were triggered,
the market
would continue to be expanded by $0.25 per gallon in either
direction
after each successive five-minute trading halt. There will
be no maximum
price fluctuation limits during any one trading
session.
|
||
|
NYMEX
Natural Gas
|
Any
one month/all months: 12,000 net futures, but not to exceed
1,000
contracts in the last three days of trading in the spot
month.
|
$3.00
per mmBtu ($30,000 per contract) for all months. If any contract
is
traded, bid, or offered at the limit for five minutes, trading
is halted
for five minutes. When trading resumes, the limit is expanded
by $3.00 per
mmBtu in either direction. If another halt were triggered,
the market
would continue to be expanded by $3.00 per mmBtu in either
direction after
each successive five-minute trading halt. There will be no
maximum price
fluctuation limits during any one trading
session.
|
9
Price
Volatility. Despite
daily price limits, the price volatility of Oil Futures Contracts generally
has
been historically greater than that for traditional securities such as
stocks
and bonds. Price volatility often is greater day-to-day as opposed to intra-day.
Oil Futures Contracts tend to be more volatile than stocks and bonds because
price movements for crude oil are more currently and directly influenced
by
economic factors for which current data is available and are traded by
oil
futures traders throughout the day. These economic factors include; changes
in
interest rates; governmental, agricultural, trade, fiscal, monetary and
exchange
control programs and policies; weather and climate conditions; changing
supply
and demand relationships; changes in balances of payments and trade; U.S.
and
international rates of inflation; currency devaluations and revaluations;
U.S.
and international political and economic events; and changes in philosophies
and
emotions of market participants. Because USOF invests a significant portion
of
its assets in Oil Futures Contracts, the assets of USOF, and therefore
the
prices of USOF units, may be subject to greater volatility than traditional
securities.
Marking-to-Market
Futures
Positions. Oil Futures Contracts are marked to market at the end of each
trading day and the margin required with respect to such contracts is adjusted
accordingly. This process of marking-to-market is designed to prevent losses
from accumulating in any futures account. Therefore, if USOF’s futures positions
have declined in value, USOF may be required to post variation margin to
cover this decline. Alternatively, if USOF futures positions have increased
in
value, this increase will be credited to USOF’s account.
What
is the Crude Oil Market and the
Petroleum-Based Fuel Market?
USOF
may
purchase Oil Futures Contracts traded on the NYMEX that are based on light,
sweet crude oil. It may also purchase contracts on other exchanges, including
the ICE Futures and the Singapore Exchange. The contracts provide for delivery
of several grades of domestic and internationally traded foreign crudes,
and,
among other things, serves the diverse needs of the physical market.
Light,
Sweet Crude Oil.
Light, sweet crudes are preferred by refiners because of their low
sulfur
content and relatively high yields of high-value products such as gasoline,
diesel fuel, heating oil, and jet fuel. The price of light, sweet crude oil
has historically exhibited periods of significant volatility.
Demand
for petroleum products by consumers, as well as agricultural, manufacturing
and
transportation industries, determines demand for crude oil by refiners.
Since
the precursors of product demand are linked to economic activity, crude
oil
demand will tend to reflect economic conditions. However, other factors
such as
weather also influence product and crude oil demand.
Crude
oil
supply is determined by both economic and political factors. Oil prices
(along
with drilling costs, availability of attractive prospects for drilling,
taxes
and technology, among other factors) determine exploration and development
spending, which influence output capacity with a lag. In the short run,
production decisions by the Organization of Petroleum Exporting Countries
("OPEC") also affect supply and prices. Oil export embargoes and the current
conflict in Iraq represent other routes through which political developments
move the market. It is not possible to predict the aggregate effect of
all or
any combination of these factors.
In
Europe, Brent crude oil is the standard for futures contracts traded on
the ICE
Futures, an electronic marketplace for energy trading and price discovery.
Brent
crude oil is the price reference for two-thirds of the world’s traded
oil.
10
Heating
Oil. Heating oil,
also known as No. 2 fuel oil, accounts for 25% of the yield of a barrel
of crude
oil, the second largest “cut” from oil after gasoline. The heating oil futures
contract, listed and traded on the NYMEX, trades in units of 42,000 gallons
(1,000 barrels) and is based on delivery in the New York harbor, the principal
cash market center. The price of heating oil has historically been
volatile.
Gasoline.
Gasoline
is the
largest single volume refined product sold in the U.S. and accounts for
almost
half of national oil consumption. The gasoline futures contract, listed
and
traded on the NYMEX, trades in units of 42,000 gallons (1,000 barrels)
and is
based on delivery at petroleum products terminals in the New York harbor,
the
major East Coast trading center for imports and domestic shipments from
refineries in the New York harbor area or from the Gulf Coast refining
centers.
The price of gasoline has historically been volatile.
Natural
Gas. Natural gas
accounts for almost a quarter of U.S. energy consumption. The natural gas
futures contract, listed and traded on the NYMEX, trades in units of 10,000
million British thermal units (mmBtu) and is based on delivery at the Henry
Hub in Louisiana, the nexus of 16 intra- and interstate natural gas pipeline
systems that draw supplies from the region’s prolific gas deposits. The
pipelines serve markets throughout the U.S. East Coast, the Gulf Coast,
the
Midwest, and up to the Canadian border. The price of natural gas has
historically been volatile.
Why
Does USOF Purchase and Sell Oil
Futures Contracts?
USOF’s
investment objective is to have the changes in percentage terms of the
units’
NAV reflect the changes in percentage terms of the Benchmark Oil Futures
Contract, less USOF’s expenses. USOF invests primarily in Oil Futures Contracts.
USOF seeks to have its aggregate NAV approximate at all times the aggregate
face
amount of the Oil Futures Contracts (or Other Oil Interests) USOF
holds.
Other
than investing in Oil Futures Contracts and Other Oil Interests, USOF only
invests in assets to support these investments in oil interests. At any
given
time, most of USOF’s investments will be in Treasuries, cash and/or cash
equivalents that serve as segregated assets supporting USOF’s positions in
Oil Futures Contracts and Other Oil Interests. For example, the purchase
of an
Oil Futures Contract with a stated value of $10 million would not require
USOF
to pay $10 million upon entering into the contract; rather, only a margin
deposit, generally of 5% to 10% of the stated value of the Oil Futures
Contract,
would be required. To secure its Oil Futures Contract obligations, USOF
would deposit the required margin with the futures commission merchant and
hold, through its Custodian, Treasuries, cash and/or cash
equivalents in an amount equal to the balance of the current market value
of the contract, which at the contract’s inception would be $10 million minus
the amount of the margin deposit, or $9.5 million (assuming a 5%
margin).
As
a
result of the foregoing, typically only 5% to 10% of USOF’s assets are held as
margin in segregated accounts with the futures commission merchant. In
addition to the Treasuries or cash it posts with the futures commission
merchant for the Oil Futures Contracts it owns, USOF holds through the
Custodian, Treasuries, cash and/or cash equivalents that can be posted as
margin or as collateral to support its over-the-counter contracts. USOF
earns
interest income from the Treasuries and/or
cash equivalents that it purchases, and on the cash it holds through the
Custodian. It anticipates that the earned interest income will increase
the NAV
and limited partners’ capital contribution accounts. USOF reinvests the earned
interest income, holds it in cash, or uses it to pay its expenses. If USOF
reinvests the earned interest income, it will make investments that are
consistent with its investment objectives.
11
What
is the Flow of
Units?
What
are the Trading Policies of
USOF?
Liquidity
USOF
invests only in Oil Futures Contracts and Other Oil Interests that are traded
in
sufficient volume to permit, in the opinion of the General Partner, ease
of
taking and liquidating positions in these financial interests.
Spot
Commodities
While
the
Oil Futures Contracts traded on the NYMEX can be physically settled, USOF
does
not intend to take or make physical delivery. USOF may from time to time
trade
in Other Oil Interests, including contracts based on the spot price of
crude oil.
12
While
USOF’s historical ratio of margin to total assets has generally ranged from
0% to 5%, the General Partner endeavors to have the value of USOF’s Treasuries,
cash and/or cash equivalents, whether held by USOF or posted as margin or
collateral, at all times approximate the aggregate face value of USOF's
obligations under its Oil Futures Contracts and Other Oil
Interests.
Borrowings
Borrowings
are not used by USOF, unless USOF is required to borrow money in the event
of
physical delivery, if USOF trades in cash commodities, or for short-term
needs
created by unexpected redemptions. USOF expects to have the value of its
Treasuries, cash and/or cash equivalents whether held by USOF or posted as
margin or collateral, at all times approximate the aggregate face value of
its
obligations under its Oil Futures Contracts and Other Oil Interests. USOF
has
not established and does not plan to establish credit lines.
USOF
has
not and will not employ the technique, commonly known as pyramiding, in which
the speculator uses unrealized profits on existing positions as variation
margin
for the purchase or sale of additional positions in the same or another
commodity interest.
Who
are the Service
Providers?
BBH&Co.
is the registrar and transfer agent for the units. BBH&Co. is also the
Custodian for USOF. In this capacity, BBH&Co. holds USOF’s Treasuries,
cash and/or cash equivalents pursuant to a custodial agreement. In
addition, BBH&Co. performs certain administrative and accounting services
for USOF and prepares certain Securities and Exchange Commission ("SEC")
and
CFTC reports on behalf of USOF. The General Partner pays BBH&Co. a fee for
these services.
USOF
also
employs a Marketing Agent. The General Partner pays the Marketing
Agent fee of $425,000 per annum plus an incentive fee as follows: 0.00% on
USOF’s assets from $0-500 million; 0.04% on USOF’s assets from $500 million-$4
billion; and 0.03% on USOF’s assets in excess of $4 billion; provided, however,
that in no event may the aggregate compensation paid to the Marketing Agent
and
any affiliate of the General Partner for distribution-related services in
connection with the offering of units exceed ten percent (10%) of the gross
proceeds of the offering.
UBS
Securities LLC (“UBS Securities”) is USOF’s futures commission merchant. USOF
and UBS Securities have entered into an Institutional Futures Client Account
Agreement. This Agreement requires UBS Securities to provide services to
USOF in
connection with the purchase and sale of oil interests that may be purchased
or
sold by or through UBS Securities for USOF’s account. USOF pays the fees of UBS
Securities.
UBS
Securities’ principal business address is 677 Washington Blvd, Stamford, CT
06901. UBS Securities is a futures clearing broker for USOF. UBS Securities
is
registered in the U.S. with the Financial Industry Regulatory
Authority ("FINRA") as a broker-dealer and with the CFTC as a futures
commission merchant. UBS Securities is a member of various U.S. futures and
securities exchanges.
UBS
Securities was involved in the 2003 Global Research Analyst Settlement. This
settlement was part of the global settlement that UBS Securities and nine
other
firms reached with the U.S. Securities and Exchange Commission (the "SEC"),
FINRA, New York Stock Exchange (the "NYSE") and various state regulators.
As
part of the settlement, UBS Securities agreed to pay $80,000,000 divided
among retrospective relief, for procurement of independent research and for
investor education. UBS Securities has also undertaken to adopt enhanced
policies and procedures reasonably designed to address potential conflicts
of
interest arising from research practices.
On
June
27, 2007, the Office of the Secretary of the Commonwealth of Massachusetts
filed
an administrative complaint (the “Complaint”) and notice of adjudicatory
proceeding, captioned In The Matter of UBS Securities, LLC, Docket No.
E-2007-0049, which alleges, in sum and substance, that UBS Securities has
been
violating the Massachusetts Uniform Securities Act (the “MUSA”) and related
regulations by providing the advisers for certain hedge funds with gifts
and
gratuities in the form of below market office rents, personal loans with
below
market interest rates, event tickets and other perks, in order to induce
those
hedge fund advisers to increase or retain their level of prime brokerage
fees
paid to UBS Securities. The Secretary seeks to require UBS Securities
to permanently cease and desist from conduct that violates the MUSA and
regulations, to censure UBS Securities, to require UBS Securities to pay
an
administrative fine of an unspecified amount, and to find as fact the
allegations of the Complaint.
13
Further,
UBS Securities, like most large, full service investment banks and
broker-dealers, receives inquiries and is sometimes involved in investigations
by the SEC, FINRA, NYSE and various other regulatory organizations,
exchanges and government agencies. UBS Securities fully cooperates with the
authorities in all such requests. UBS
Securities regularly discloses to FINRA arbitration awards, disciplinary
action
and regulatory events.
These disclosures are publicly available on FINRA’s website at www.finra.org.
Actions with respect to UBS Securities’s futures commission merchant business
are publicly available on the website of the NFA (www.nfa.futures.org/).
UBS
Securities acts only as clearing broker for USOF and, as such, is paid
commissions for executing and clearing trades on behalf of USOF. UBS
Securities neither acts in any supervisory capacity with respect to the General
Partner nor participates in the management of the General Partner or
USOF.
Currently,
the General Partner does not employ commodity trading advisors. If, in the
future, the General Partner does employ commodity trading advisors, it will
choose each advisor based on arms-length negotiations and will consider the
advisor’s experience, fees and reputation.
Fees
of USOF
Fees
and Compensation Arrangements with the General Partner and Non-Affiliated
Service Providers*
|
Service
Provider
|
Compensation
Paid by the General Partner
|
|
Brown
Brothers Harriman & Co.,
Custodian
and Administrator
|
A
$25,000 annual fee for its transfer agency services; and for
its custody,
fund accounting and fund administration services, the greater
of a minimum
amount of $125,000 annually or an asset-based charge of (a) 0.06%
for the
first $500 million of USOF, USNG, US12OF and USG’s net assets, (b) 0.0465%
for USOF, USNG, US12OF and USG’s net assets greater than $500 million but
less than $1 billion, and (c) and 0.035% of USOF, USNG, US12OF
and USG’s
net assets that exceed $1 billion.
|
|
ALPS
Distributors, Inc., Marketing Agent
|
425,000
per annum plus an incentive fee as follows: 0.0% on USOF’s assets from
$0-500 million; 0.04% on USOF’s assets from $500 million-$4 billion; 0.03%
on USOF’s assets in excess of $4
billion.
|
*
The
General Partner pays this
compensation.
Compensation
to the General Partner
USOF
pays
a management fee to the General Partner as follows:
|
Assets
|
Management
Fee
|
|
First
$1,000,000,000
|
0.50%
of NAV
|
|
After
the first $1,000,000,000
|
0.20%
of NAV
|
Fees
are
calculated on a daily basis (accrued at 1/365 of the applicable percentage
of
NAV on that day) and paid on a monthly basis.
Fees
and Compensation Arrangements between USOF and Non-Affiliated Service
Providers**
|
Service
Provider
|
Compensation
Paid by USOF
|
|
UBS
Securities LLC, Futures Commission Merchant
|
Approximately
$3.50 per buy or sell
|
|
Non-Affiliated
Brokers
|
Approximately
0.16% of assets
|
**USOF
pays this
compensation.
New
York Mercantile Exchange Licensing Fee***
|
Assets
|
Licensing
Fee
|
|
First
$1,000,000,000
|
0.04%
of NAV
|
|
After
the first $1,000,000,000
|
0.02%
of NAV
|
|
***
|
Fees
are calculated on a daily basis (accrued at 1/365 of the applicable
percentage of NAV on that day) and paid on a monthly basis.
USOF is
responsible for its pro rata share of the assets held by USOF,
USNG,
US12OF and USG as well as other funds managed by the General Partner,
including US12NG and USHO, when and if such funds commence
operations.
|
14
Expenses
Paid by USOF through December 31, 2007 in dollar terms:
|
Expenses
|
Amount
in Dollar Terms
|
|
Amount
Paid to General Partner:
|
$3,622,613
|
|
Amount
Paid in Portfolio Brokerage Commissions:
|
$1,184,956
|
|
Other
Amounts Paid or Accrued:
|
$1,530,281
|
|
Total
Expenses Paid or Accrued:
|
$6,337,850
|
Expenses
Paid by USOF through December 31, 2007 as a Percentage of Average Daily
Net
Assets:
|
Expenses
|
Amount
as a Percentage of Average Daily Net
Assets
|
|
General
Partner
|
0.50%
annualized
|
|
Portfolio
Brokerage Commissions
|
0.16%
annualized
|
|
Other
Amounts Paid or Accrued
|
0.21%
annualized
|
|
Total
Expense Ratio
|
0.87%
annualized
|
Form
of Units
Registered
Form.
Units
are issued in registered form in accordance with the LP Agreement. The
Administrator has been appointed registrar and transfer agent for the purpose
of
transferring units in certificated form. The Administrator keeps a record
of all
holders of the units in the registry (the “Register”). The General Partner
recognizes transfers of units in certificated form only if done in accordance
with the LP Agreement. The beneficial interests in such units are held
in
book-entry form through participants and/or accountholders in the Depository
Trust Company ("DTC").
Book
Entry.
Individual certificates are not issued for the units. Instead, units are
represented by one or more global certificates, which are deposited by
the
Administrator with DTC and registered in the name of Cede & Co., as nominee
for DTC. The global certificates evidence all of the units outstanding
at any
time. Unitholders are limited to (1) participants in DTC such as banks,
brokers, dealers and trust companies ("DTC Participants"), (2) those who
maintain, either directly or indirectly, a custodial relationship with
a DTC
Participant ("Indirect Participants"), and (3) those banks, brokers,
dealers, trust companies and others who hold interests in the units through
DTC
Participants or Indirect Participants, in each case who satisfy the requirements
for transfers of units. DTC Participants acting on behalf of investors
holding
units through such participants’ accounts in DTC will follow the delivery
practice applicable to securities eligible for DTC’s Same-Day Funds Settlement
System. Units are credited to DTC Participants’ securities accounts following
confirmation of receipt of payment.
DTC.
DTC is
a limited purpose trust company organized under the laws of the State of
New
York and is a member of the Federal Reserve System, a “clearing corporation”
within the meaning of the New York Uniform Commercial Code and a “clearing
agency” registered pursuant to the provisions of Section 17A of the Securities
Exchange Act of 1934, as amended (the “Exchange Act”). DTC holds securities for
DTC Participants and facilitates the clearance and settlement of transactions
between DTC Participants through electronic book-entry changes in accounts
of
DTC Participants.
15
Transfer
of Units
Transfers
of Units Only Through
DTC. The units are only transferable through the book-entry
system
of DTC. Limited partners who are not DTC Participants may transfer their
units
through DTC by instructing the DTC Participant holding their units (or
by
instructing the Indirect Participant or other entity through which their
units
are held) to transfer the units. Transfers are made in accordance with
standard
securities industry practice.
Transfers
of interests in units with DTC will be made in accordance with the usual
rules
and operating procedures of DTC and the nature of the transfer. DTC has
established procedures to facilitate transfers among the participants and/or
accountholders of DTC. Because DTC can only act on behalf of DTC Participants,
who in turn act on behalf of Indirect Participants, the ability of a person
or
entity having an interest in a global certificate to pledge such interest
to
persons or entities that do not participate in DTC, or otherwise take actions
in
respect of such interest, may be affected by the lack of a definitive security
in respect of such interest.
DTC
has
advised us that it will take any action permitted to be taken by a unitholder
(including, without limitation, the presentation of a global certificate
for
exchange) only at the direction of one or more DTC Participants in whose
account
with DTC interests in global certificates are credited and only in respect
of
such portion of the aggregate principal amount of the global certificate
as to
which such DTC Participant or Participants has or have given such
direction.
Transfer/Application
Requirements. All purchasers of USOF’s units, and potentially any
purchasers of units in the future, who wish to become limited partners
or other
record holders and receive cash distributions, if any, or have certain
other
rights, must deliver an executed transfer application in which the purchaser
or
transferee must certify that, among other things, he, she or it agrees
to be
bound by USOF’s LP Agreement and is eligible to purchase USOF’s securities. Each
purchaser of units must execute a transfer application and certification.
The
obligation to provide the form of transfer application will be imposed
on the
seller of units or, if a purchase of units is made through an exchange,
the form
may be obtained directly through USOF. Further, the General Partner may
request
each record holder to furnish certain information, including that holder’s
nationality, citizenship or other related status. A record holder is a
unitholder that is, or has applied to be, a limited partner. An investor
who is
not a U.S. resident may not be eligible to become a record holder or one
of the
USOF’s limited partners if that investor’s ownership would subject USOF to the
risk of cancellation or forfeiture of any of USOF’s assets under any federal,
state or local law or regulation. If the record holder fails to furnish
the
information or if the General Partner determines, on the basis of the
information furnished by the holder in response to the request, that such
holder
is not qualified to become one of USOF’s limited partners, the General Partner
may be substituted as a holder for the record holder, who will then be
treated
as a non-citizen assignee, and USOF will have the right to redeem those
securities held by the record holder.
A
transferee’s broker, agent or nominee may complete, execute and deliver a
transfer application and certification. USOF may, at its discretion, treat
the
nominee holder of a unit as the absolute owner. In that case, the beneficial
holder’s rights are limited solely to those that it has against the nominee
holder as a result of any agreement between the beneficial owner and the
nominee
holder.
A
person
purchasing USOF’s existing units, who does not execute a transfer application
and certify that the purchaser is eligible to purchase those securities
acquires
no rights in those securities other than the right to resell those securities.
Whether or not a transfer application is received or the consent of the
General
Partner obtained, our units will be securities and will be transferable
according to the laws governing transfers of securities.
16
Any
transfer of units will not be recorded by the transfer agent or recognized
by
the General Partner unless a completed transfer application is delivered
to the
General Partner or the Administrator. When acquiring units, the transferee
of
such units that complete a transfer application will:
·
be
an
assignee until admitted as a substituted limited partner upon the consent
and
sole discretion of the General Partner and the recording of the assignment
on
the books and records of the partnership;
·
automatically
request admission as a substituted limited partner;
·
agree
to
be bound by the terms and conditions of, and execute, our LP
Agreement;
·
represent
that such transferee has the capacity and authority to enter into our LP
Agreement;
·
grant
powers of attorney to our General Partner and any liquidator of us;
and
·
make
the
consents and waivers contained in our LP Agreement.
An
assignee will become a limited partner in respect of the transferred units
upon
the consent of our General Partner and the recordation of the name of the
assignee on our books and records. Such consent may be withheld in the
sole
discretion of our General Partner.
If
consent of the General Partner is withheld, such transferee shall be an
assignee. An assignee shall have an interest in the partnership equivalent
to
that of a limited partner with respect to allocations and distributions,
including, without limitation, liquidating distributions, of the partnership.
With respect to voting rights attributable to units that are held by assignees,
the General Partner shall be deemed to be the limited partner with respect
thereto and shall, in exercising the voting rights in respect of such units
on
any matter, vote such units at the written direction of the assignee who
is the
record holder of such units. If no such written direction is received,
such
units will not be voted. An assignee shall have no other rights of a limited
partner.
Until
a
unit has been transferred on our books, we and the transfer agent may treat
the
record holder of the unit as the absolute owner for all purposes, except
as
otherwise required by law or stock exchange regulations.
Withdrawal
of Limited
Partners
As
discussed in the LP Agreement, if the General Partner gives at least fifteen
(15) days’ written notice to a limited partner, then the General Partner may for
any reason, in its sole discretion, require any such limited partner to
withdraw
entirely from the partnership or to withdraw a portion of its partner capital
account. If the General Partner does not give at least fifteen (15) days’
written notice to a limited partner, then it may only require withdrawal
of all
or any portion of the capital account of any limited partner in the following
circumstances: (i) the unitholder made a misrepresentation to the General
Partner in connection with its purchase of units; or (ii) the limited
partner’s ownership of units would result in the violation of any law or
regulations applicable to the partnership or a partner. In these circumstances,
the General Partner without notice may require the withdrawal at any time,
or
retroactively. The limited partner thus designated shall withdraw from
the
partnership or withdraw that portion of its partner capital account specified,
as the case may be, as of the close of business on such date as determined
by
the General Partner. The limited partner thus designated shall be deemed
to have
withdrawn from the partnership or to have made a partial withdrawal from
its
partner capital account, as the case may be, without further action on
the part
of the limited partner and the provisions of the LP Agreement shall
apply.
17
Calculating
NAV
USOF’s
NAV is calculated by:
|
·
|
Taking
the current market value of its total
assets
|
|
·
|
Subtracting
any liabilities
|
The
Administrator calculates the NAV of USOF once each trading day. The NAV
for a
particular trading day is released after 4:15 p.m. New York time. It calculates
the NAV as of the earlier of the close of the NYSE or 4:00 p.m. New York
time.
Trading on the AMEX typically closes at 4:15 p.m. New York time. USOF uses
the
NYMEX closing price (determined at the earlier of the close of the NYMEX
or 2:30
p.m. New York time) for the contracts held on the NYMEX, but calculates
or
determines the value of all other USOF investments as of the earlier of
the
close of the NYSE or 4:00 p.m. New York time.
In
addition, in order to provide updated information relating to USOF for
use by
investors and market professionals, the AMEX calculates and disseminates
throughout the trading day an updated indicative fund value. The indicative
fund
value is calculated by using the prior day’s closing NAV per unit of USOF as a
base and updating that value throughout the trading day to reflect changes
in
the most recently reported trade price for the Benchmark Oil Futures Contracts
on the NYMEX. The prices reported for the active Benchmark Oil Futures
Contract
month are adjusted based on the prior day’s spread differential between
settlement values for that contract and the spot month contract. In the
event
that the spot month contract is also the active contract, the last sale
price
for the active contract is not adjusted. The indicative fund value unit
basis
disseminated during AMEX trading hours should not be viewed as an actual
real
time update of the NAV, because the NAV is calculated only once at the
end of
each trading day.
The
indicative fund value is disseminated on a per unit basis every 15 seconds
during regular AMEX trading hours of 9:30 a.m. New York time to 4:15 p.m.
New
York time. The normal trading hours of the NYMEX are 10:00 a.m. New York
time to
2:30 p.m. New York time. This means that there is a gap in time at the
beginning
and the end of each day during which USOF’s units are traded on the AMEX, but
real-time NYMEX trading prices for oil futures contracts traded on the
NYMEX are
not available. As a result, during those gaps there will be no update to
the
indicative fund value.
The
AMEX
disseminates the indicative fund value through the facilities of CTA/CQ
High
Speed Lines. In addition, the indicative fund value is published on the
AMEX’s
website and is available through on-line information services such as Bloomberg
and Reuters.
Dissemination
of the indicative fund value provides additional information that is not
otherwise available to the public and is useful to investors and market
professionals in connection with the trading of USOF units on the AMEX.
Investors and market professionals are able throughout the trading day
to
compare the market price of USOF and the indicative fund value. If the
market
price of USOF units diverges significantly from the indicative fund value,
market professionals will have an incentive to execute arbitrage trades.
For
example, if USOF appears to be trading at a discount compared to the indicative
fund value, a market professional could buy USOF units on the AMEX and
sell
short oil futures contracts. Such arbitrage trades can tighten the tracking
between the market price of USOF and the indicative fund value and thus
can be
beneficial to all market participants.
In
addition, other Oil Futures Contracts, Other Oil Interests and Treasuries
held
by USOF are valued by the Administrator, using rates and points received
from
client approved third party vendors (such as Reuters and WM Company) and
advisor
quotes. These investments are not included in the indicative value. The
indicative fund value is based on the prior day’s NAV and moves up and down
according solely to changes in the average of the prices of the Benchmark
Oil
Futures Contract.
18
Creation
and Redemption of
Units
USOF
creates and redeems units from time to time, but only in one or more Creation
Baskets or Redemption Baskets. The creation and redemption of baskets are
only
made in exchange for delivery to USOF or the distribution by USOF of the
amount
of Treasuries and any cash represented by the baskets being created or
redeemed,
the amount of which is based on the combined NAV of the number of units
included
in the baskets being created or redeemed determined as of 4:00 p.m. New
York
time on the day the order to create or redeem baskets is properly
received.
Authorized
Purchasers are the only persons that may place orders to create and redeem
baskets. Authorized Purchasers must be (1) registered broker-dealers or
other
securities market participants, such as banks and other financial institutions,
that are not required to register as broker-dealers to engage in securities
transactions as described below, and (2) DTC Participants. To become an
Authorized Purchaser, a person must enter into an Authorized Purchaser
Agreement
with the General Partner. The Authorized Purchaser Agreement provides the
procedures for the creation and redemption of baskets and for the delivery
of
the Treasuries and any cash required for such creations and redemptions.
The
Authorized Purchaser Agreement and the related procedures attached thereto
may
be amended by USOF, without the consent of any limited partner or unitholder
or
Authorized Purchaser. Authorized Purchasers pay a transaction fee of $1,000
to
USOF for each order they place to create or redeem one or more baskets.
Authorized Purchasers who make deposits with USOF in exchange for baskets
receive
no fees, commissions or other form of compensation or inducement of any
kind
from either USOF or the General Partner, and no such person will have any
obligation or responsibility to the General Partner or USOF to effect any
sale
or resale of units. As of December 31, 2007, 8 Authorized Purchasers had
entered
into agreements with USOF to purchase Creation Baskets.
Certain
Authorized Purchasers are expected to have the facility to participate
directly
in the physical crude oil market and the crude oil futures market. In
some
cases, an Authorized Purchaser or its affiliates may from time to time
acquire
crude oil or sell crude oil and may profit in these instances. The General
Partner believes that the size and operation of the crude oil market
make it
unlikely that an Authorized Purchaser’s direct activities in the crude oil or
securities markets will impact the price of crude oil, Oil Futures Contracts,
or
the price of the units.
Each
Authorized Purchaser is required to be registered as a broker-dealer under
the
Exchange Act and is a member in good standing with FINRA, or exempt from
being
or otherwise not required to be licensed as a broker-dealer or a member
of
FINRA, and qualified to act as a broker or dealer in the states or other
jurisdictions where the nature of its business so requires. Certain Authorized
Purchasers may also be regulated under federal and state banking laws and
regulations. Each Authorized Purchaser has its own set of rules and procedures,
internal controls and information barriers as it determines is appropriate
in
light of its own regulatory regime.
Under
the
Authorized Purchaser Agreement, the General Partner has agreed to indemnify
the
Authorized Purchasers against certain liabilities, including liabilities
under
the Securities Act of 1933, as amended, and to contribute to the payments
the
Authorized Purchasers may be required to make in respect of those
liabilities.
The
following description of the procedures for the creation and redemption
of
baskets is only a summary and an investor should refer to the relevant
provisions of the LP Agreement and the form of Authorized Purchaser Agreement
for more detail, each of which is attached as an exhibit to this annual
report
on Form 10-K.
Creation
Procedures
On
any
business day, an Authorized Purchaser may place an order with the Marketing
Agent to create one or more baskets. For purposes of processing purchase
and
redemption orders, a “business day” means any day other than a day when any of
the AMEX, the NYMEX or the NYSE is closed for regular trading. Purchase
orders
must be placed by 12:00 p.m. New York time or the close of regular trading
on
the AMEX, whichever is earlier; except in the case of the initial Authorized
Purchaser’s or any other Authorized Purchaser’s initial order to purchase one or
more Creation Baskets on the first day the baskets are to be offered and
sold,
when such orders shall be placed by 9:00 a.m. New York time on the day
agreed to
by the General Partner and the initial Authorized Purchaser. The day on
which
the Marketing Agent receives a valid purchase order is the purchase order
date.
By
placing a purchase order, an Authorized Purchaser agrees to deposit Treasuries,
cash, or a combination of Treasuries and cash with USOF, as described below.
Prior to the delivery of baskets for a purchase order, the Authorized Purchaser
must also have wired to the Custodian the non-refundable transaction fee
due for
the purchase order. Authorized Purchasers may not withdraw a creation
request.
Determination
of Required Deposits
The
total deposit required to create each basket (“Creation Basket Deposit”) is the
amount of Treasuries and/or cash that is in the same proportion to the
total
assets of USOF (net of estimated accrued but unpaid fees, expenses and
other
liabilities) on the date the order to purchase is accepted as the number
of
units to be created under the purchase order is in proportion to the
total
number of units outstanding on the date the order is received. The General
Partner determines, directly in its sole discretion or in consultation
with the
Administrator, the requirements for Treasuries and the amount of cash,
including
the maximum permitted remaining maturity of a Treasury and proportions
of
Treasury and cash that may be included in deposits to create baskets.
The
Marketing Agent publishes such requirements at the beginning of each
business
day. The amount of cash deposit required is the difference between the
aggregate
market value of the Treasuries required to be included in a Creation
Basket
Deposit as of 4:00 p.m. New York time on the date the order to purchase
is
properly received and the total required deposit.
Delivery
of Required Deposits
An
Authorized Purchaser who places a purchase order is responsible for transferring
to USOF’s account with the Custodian the required amount of Treasuries and cash
by the end of the third business day following the purchase order date.
Upon
receipt of the deposit amount, the Administrator directs DTC to credit
the
number of baskets ordered to the Authorized Purchaser’s DTC account on the third
business day following the purchase order date. The expense and risk
of delivery
and ownership of Treasuries until such Treasuries have been received
by the
Custodian on behalf of USOF shall be borne solely by the Authorized
Purchaser.
Because
orders to purchase baskets must be placed by 12:00 p.m., New York time,
but the
total payment required to create a basket during the continuous offering
period
will not be determined until 4:00 p.m., New York time, on the date the
purchase
order is received, Authorized Purchasers will not know the total amount
of the
payment required to create a basket at the time they submit an irrevocable
purchase order for the basket. USOF’s NAV and the total amount of the payment
required to create a basket could rise or fall substantially between
the time an
irrevocable purchase order is submitted and the time the amount of the
purchase
price in respect thereof is determined.
19
Rejection
of Purchase Orders
The
General Partner acting by itself or through the Marketing Agent may reject
a
purchase order or a Creation Basket Deposit if:
|
·
|
it
determines that the investment alternative available to USOF
at that time
will not enable it to meet its investment
objective;
|
|
·
|
it
determines that the purchase order or the Creation Basket Deposit
is not
in proper form;
|
|
·
|
it
believes that the purchase order or the Creation Basket Deposit
would have
adverse tax consequences to USOF or its
unitholders;
|
|
·
|
the
acceptance or receipt of the Creation Basket Deposit would,
in the opinion
of counsel to the General Partner, be unlawful;
or
|
|
·
|
circumstances
outside the control of the General Partner, Marketing Agent
or Custodian
make it, for all practical purposes, not feasible to process
creations of
baskets.
|
None
of the General Partner, Marketing Agent or Custodian will be liable for
the
rejection of any purchase order or Creation Basket Deposit.
Redemption
Procedures
The
procedures by which an Authorized Purchaser can redeem one or more baskets
mirror the procedures for the creation of baskets. On any business day,
an
Authorized Purchaser may place an order with the Marketing Agent to redeem
one
or more baskets. Redemption orders must be placed by 12:00 p.m. New York
time or
the close of regular trading on the AMEX, whichever is earlier. A redemption
order so received will be effective on the date it is received in satisfactory
form by the Marketing Agent. The redemption procedures allow Authorized
Purchasers to redeem baskets and do not entitle an individual unitholder
to
redeem any units in an amount less than a basket, or to redeem baskets
other
than through an Authorized Purchaser. By placing a redemption order, an
Authorized Purchaser agrees to deliver the baskets to be redeemed through
DTC’s
book-entry system to USOF not later than 3:00 p.m. New York time on the
third
business day following the effective date of the redemption order. Prior
to the
delivery of the redemption distribution for a redemption order, the Authorized
Purchaser must also have wired to USOF’s account at the Custodian the
non-refundable transaction fee due for the redemption order. Authorized
Purchasers may not withdraw a redemption request.
Determination
of Redemption Distribution
The
redemption distribution from USOF consists of a transfer to the redeeming
Authorized Purchaser of an amount of Treasuries and/or cash that is in
the same
proportion to the total assets of USOF (net of estimated accrued but
unpaid
fees, expenses and other liabilities) on the date the order to redeem
is
properly received as the number of units to be redeemed under the redemption
order is in proportion to the total number of units outstanding on the
date the
order is received. The General Partner, directly or in consultation with
the
Administrator, determines the requirements for Treasuries and the amounts
of
cash, including the maximum permitted remaining maturity of a Treasury,
and the
proportions of Treasuries and cash that may be included in distributions
to
redeem baskets. The Marketing Agent publishes such requirements as of
4:00 p.m.
New York time on the redemption order date.
Delivery
of Redemption Distribution
The
redemption distribution due from USOF will be delivered to the Authorized
Purchaser by 3:00 p.m. New York time on the third business day following
the
redemption order date if, by 3:00 p.m. New York time on such third business
day,
USOF’s DTC account has been credited with the baskets to be redeemed. If USOF’s
DTC account has not been credited with all of the baskets to be redeemed
by such
time, the redemption distribution will be delivered to the extent of
whole
baskets received. Any remainder of the redemption distribution will be
delivered
on the next business day to the extent of remaining whole baskets received
if
USOF receives the fee applicable to the extension of the redemption distribution
date which the General Partner may, from time to time, determine and
the
remaining baskets to be redeemed are credited to USOF’s DTC account by 3:00 p.m.
New York time on such next business day. Any further outstanding amount
of the
redemption order shall be cancelled. Pursuant to information from the
General
Partner, the Custodian will also be authorized to deliver the redemption
distribution notwithstanding that the baskets to be redeemed are not
credited to
USOF’s DTC account by 3:00 p.m. New York time on the third business day
following the redemption order date if the Authorized Purchaser has
collateralized its obligation to deliver the baskets through DTC’s book
entry-system on such terms as the General Partner may from time to time
determine.
Suspension
or Rejection of Redemption Orders
The
General Partner may, in its discretion, suspend the right of redemption,
or
postpone the redemption settlement date, (1) for any period during which
the
AMEX or the NYMEX is closed other than customary weekend or holiday closings,
or
trading on the AMEX or the NYMEX is suspended or restricted, (2) for
any period
during which an emergency exists as a result of which delivery, disposal
or
evaluation of Treasuries is not reasonably practicable, or (3) for such
other
period as the General Partner determines to be necessary for the protection of
the limited partners. None of the General Partner, the Marketing Agent,
the
Administrator, or the Custodian will be liable to any person or in any
way for
any loss or damages that may result from any such suspension or
postponement.
The
General Partner will reject a redemption order if the order is not in
proper
form as described in the Authorized Purchaser Agreement or if the fulfillment
of
the order, in the opinion of its counsel, might be unlawful.
Creation
and Redemption Transaction
Fee
To
compensate USOF for its expenses in connection with the creation and redemption
of baskets, an Authorized Purchaser is required to pay a transaction fee
to USOF
of $1,000 per order to create or redeem baskets. An order may include multiple
baskets. The transaction fee may be reduced, increased or otherwise changed
by
the General Partner. The General Partner shall notify DTC of any change
in the
transaction fee and will not implement any increase in the fee for the
redemption of baskets until 30 days after the date of the
notice.
Tax
Responsibility
Authorized
Purchasers are responsible for any transfer tax, sales or use tax, stamp
tax,
recording tax, value added tax or similar tax or governmental charge applicable
to the creation or redemption of baskets, regardless of whether or not
such tax
or charge is imposed directly on the Authorized Purchaser, and agree to
indemnify the General Partner and USOF if they are required by law to pay
any
such tax, together with any applicable penalties, additions to tax or interest
thereon.
Secondary
Market
Transactions
As
noted,
USOF will create and redeem units from time to time, but only in one or
more
Creation Baskets or Redemption Baskets. The creation and redemption of
baskets
will only be made in exchange for delivery to USOF or
the
distribution by USOF of the amount of Treasuries and cash represented by
the
baskets being created or redeemed, the amount of which will be based on
the
aggregate NAV of the number of units included in the baskets being created
or
redeemed determined on the day the order to create or redeem baskets is
properly
received.
20
As
discussed above, Authorized Purchasers are the only persons that may place
orders to create and redeem baskets. Authorized Purchasers must be registered
broker-dealers or other securities market participants, such as banks and
other
financial institutions that are not required to register as broker-dealers
to
engage in securities transactions. An Authorized Purchaser is under no
obligation to create or redeem baskets, and an Authorized Purchaser is
under no
obligation to offer to the public units of any baskets it does create.
Authorized Purchasers that do offer to the public units from the baskets
they
create will do so at per-unit offering prices that are expected to reflect,
among other factors, the trading price of the units on the AMEX, the NAV
of USOF
at the time the Authorized Purchaser purchased the Creation Baskets and
the NAV
of the units at the time of the offer of the units to the public, the supply
of
and demand for units at the time of sale, and the liquidity of the Oil
Futures
Contract market and the market for Other Oil Interests. The prices of units
offered by Authorized Purchasers are expected to fall between USOF’s NAV and the
trading price of the units on the AMEX at the time of sale. Units initially
comprising the same basket but offered by Authorized Purchasers to the
public at
different times may have different offering prices. An order for one or
more
baskets may be placed by an Authorized Purchaser on behalf of multiple
clients.
Authorized Purchasers who make deposits with USOF in exchange for baskets
receive no fees, commissions or other form of compensation or inducement
of any
kind from either USOF or the General Partner, and no such person has any
obligation or responsibility to the General Partner or USOF to effect any
sale
or resale of units. Units are expected to trade in the secondary market
on the
AMEX. Units may trade in the secondary market at prices that are lower
or higher
relative to their NAV per unit. The amount of the discount or premium in
the
trading price relative to the NAV per unit may be influenced by various
factors,
including the number of investors who seek to purchase or sell units in
the
secondary market and the liquidity of the Oil Futures Contracts market
and the
market for Other Oil Interests. While the units trade on the AMEX until
4:15
p.m. New York time, liquidity in the market for Oil Futures Contracts and
Other
Oil Interests may be reduced after the close of the NYMEX at 2:30 p.m.
New York
time. As a result, during this time, trading spreads, and the resulting
premium
or discount, on the units may widen.
Prior
Performance of USOF and
Affiliates
USOF’s
offering began on April 10, 2006 and is a continuous offering. As of
December 31, 2007, the total amount of money raised by USOF from Authorized
Purchasers was $6,142,802,106;
the total number of Authorized Purchasers was 12, the number of baskets
purchased by Authorized Purchasers was 1,074; and the aggregate amount
of units
purchased was 107.4 million. For more information on the performance of
USOF,
see the Performance Tables below.
PAST
PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
Experience
in Raising and Investing
in Funds through
December 31, 2007
|
Dollar
Amount Offered:
|
$
|
7,094,860,000
|
|
|
||
|
Dollar
Amount Raised:
|
$
|
6,142,801,105
|
|
|
||
|
Offering
Expenses*:
|
||
|
SEC
registration fee**:
|
$
|
800,474
|
| FINRA fee**: |
$
|
377,500 |
|
AMEX
Listing fee**:
|
$
|
5,000
|
|
Auditor's
fees and expenses**:
|
$
|
59,000
|
|
Legal
fees and expenses**:
|
$
|
1,249,109
|
|
Printing
expenses:
|
$
|
241,977
|
|
|
||
|
Length
of Offering:
|
Continuous
|
——————
*
Amounts are for organizational and offering expenses incurred in connection
with
the offerings from April 10, 2006 through December 31, 2007.
**
Paid
for
by the General Partner in connection with the initial public
offering.
Performance
Capsule
|
Name
of Commodity Pool:
|
USOF
|
|||
|
Type
of Commodity Pool:
|
Exchange
traded security
|
|||
|
Inception
of Trading:
|
April
10, 2006
|
|||
|
Aggregate
Gross Capital Subscriptions (from inception through
December 31, 2007):
|
$
|
6,142,801,105
|
||
|
Total
Net Assets as of December 31, 2007:
|
$
|
485,222,737
|
*
|
|
|
Initial
NAV Per Unit as of Inception:
|
$
|
67.39
|
||
|
NAV
per Unit as of December 31, 2007:
|
$
|
75.82
|
||
|
Worst
Monthly Percentage Draw-down:
|
September
2006 (11.71
|
%)
|
||
|
Worst
Peak-to-Valley Draw-down:
|
June
2006-January 2007 (30.60
|
%)
|
||
|
Total
Rate of Return Since Inception:
|
12.51
|
%
|
||
——————
* Inclusive
of transactions recorded on a trade date + 1 basis.
|
Month
|
Rates of Return
For the Year 2007
|
|||
|
January
|
(6.55 | %) | ||
|
February
|
5.63 | % | ||
|
March
|
4.61 | % | ||
|
April
|
(4.26
|
%)
|
||
|
May
|
(4.91
|
%)
|
||
|
June
|
9.06
|
%
|
||
|
July
|
10.57
|
%
|
||
|
August
|
(4.95
|
%)
|
||
|
September
|
12.11
|
%
|
||
|
October
|
16.98
|
%
|
||
|
November
|
(4.82
|
%)
|
||
|
December
|
8.67
|
%
|
||
21
The
General Partner is also currently the general partner of US12OF, USNG and
USG.
Each of the General Partner, USNG, US12OF and USG is located in
California.
US12OF
is
a publicly traded limited partnership which seeks to have the changes
in
percentage terms of its units’ NAV track the changes in percentage
terms of the price of light, sweet crude oil delivered to Cushing, Oklahoma,
as
measured by the changes in the average of the prices of 12 futures contracts
on
crude oil traded on the NYMEX, consisting of the near month contract
to expire
and the contracts for the following 11 months for a total of 12 consecutive
months’ contracts, except when the near month contract is within two weeks of
expiration, in which case it will be measured by the futures contracts
that are
the next month contract to expire and the contracts for the following
11
consecutive months, less US12OF’s expenses. US12OF invests in a
mixture of listed crude oil futures contracts, other non-listed oil related
investments, Treasuries, cash and cash equivalents. US12OF began
trading on the AMEX on December 6, 2007 and is a continuous
offering. As of December 31, 2007, the total amount of money raised
by US12OF from Authorized Purchasers was $20,127,316; the total number
of
Authorized Purchasers was 2; the number of baskets purchased by Authorized
Purchasers was 4; and the aggregate amount of units purchased was
400,000.
USNG
is a
publicly traded limited partnership which seeks to have the changes
in
percentage terms of its unit’s NAV track the changes in percentage terms of the
price of natural gas delivered at the Henry Hub, Louisiana as measured by
the futures contract on natural gas traded on the NYMEX, less USNG's
expenses. USNG invests in a mixture of listed natural gas futures contracts,
other natural gas related investments, Treasuries, cash and cash equivalents.
USNG began trading on the AMEX on April 18, 2007 and is a continuous
offering. As of December 31, 2007, the total amount of money raised
by USNG from Authorized Purchasers was $1,458,787,976; the total number
of
Authorized Purchasers was 4; the number of baskets purchased by Authorized
Purchasers was 379; and the aggregate amount of units purchased was
37,900,000.
USG
is a publicly traded limited partnership which
seeks to have the changes in percentage terms of its units’ NAV track the
changes in percentage terms of the price of unleaded gasoline delivered to
the
New York harbor, as measured by the changes in the price of the futures contract
on gasoline traded on the NYMEX, less USG’s expenses. USG invests in
a mixture of listed gasoline futures contracts, other gasoline related
investments, Treasuries, cash and cash equivalents. USG began trading
on the AMEX on February 26, 2008 and is a continuous offering. During
the year ended December 31, 2007, USG had not yet commenced investment
activities nor issued units.
Since
the
offering of US12OF units to the public on December 6, 2007 to December
31, 2007,
the simple average daily change in its benchmark oil futures contract
was
0.480%, while the simple average daily change in the NAV of US12OF over
the same
time period was 0.489%. The average daily difference was 0.009% (or 0.9
basis
point, where 1 basis point equals 1/100 of 1%). As a percentage of the
daily
movement of the benchmark oil futures contract, the average error in
daily
tracking by the NAV was 2.651%, meaning that over this time period US12OF’s
tracking error was within the plus or minus 10% range established as
its
benchmark tracking goal.
Since
the
offering of USNG units to the public on April 18, 2007 to December 31,
2007, the
simple average daily change in its benchmark futures contract was -0.154%,
while
the simple average daily change in the NAV of USNG over the same time
period was
-0.143%. The average daily difference was 0.012% (or 1.2 basis points,
where 1
basis point equals 1/100 of 1% ). As a percentage of the daily movement of
the benchmark futures contract, the average error in daily tracking by
the NAV
was 1.994%, meaning that over this time period USNG’s tracking error was within
the plus or minus 10% range established as its benchmark tracking
goal.
There
are
significant differences between investing in US12OF and USNG and investing
directly in the futures market. The General Partner’s results with US12OF and
USNG may not be representative of results that may be experienced with
a fund
directly investing in futures contracts or other managed funds investing
in
futures contracts. For more information on the performance of US12OF
and USNG,
see the Performance Tables below. Since
USG
did not commence investment activities nor issue units during the year
ended
December 31, 2007, performance information has not been included for
USG.
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Experience
in Raising and Investing in Funds through December 31, 2007
|
Dollar
Amount Offered in US12OF Offering*:
|
$ | 550,000,000 | ||
|
Dollar
Amount Raised in US12OF Offering:
|
$ | 20,127,316 | ||
|
Organizational
Expenses in US12OF Offering:
|
||||
|
SEC
registration fee**:
|
$ | 16,885 | ||
|
FINRA
registration fee**:
|
$ | 75,500 | ||
|
AMEX
listing fee**:
|
$ | 5,000 | ||
|
Auditor’s
fees and expenses**:
|
$ | 10,700 | ||
|
Legal
fees and expenses**:
|
$ | 233,799 | ||
|
Printing
expenses**:
|
$ | 23,755 | ||
|
Length
of US12OF offering:
|
Continuous
|
|||
|
*
|
Reflects
the offering price per unit set forth on the cover page of
the
registration statement registering such units filed with the
SEC.
|
|
**
|
These
expenses were paid for by the General Partner.
|
|
Dollar
Amount Offered in USNG Offering*:
|
$ | 3,664,500,000 | ||
|
Dollar
Amount Raised in USNG Offering:
|
$ | 1,458,787,976 | ||
|
Organizational
Expenses in USNG Offering:
|
||||
|
SEC
registration fee**:
|
$ | 104,010 | ||
|
FINRA
registration fee**:
|
$ | 151,000 | ||
|
AMEX
listing fee**:
|
$ | 5,000 | ||
|
Auditor’s
fees and expenses**:
|
$ | 29,000 | ||
|
Legal
fees and expenses**:
|
$ | 526,746 | ||
|
Printing
expenses**:
|
$ | 40,323 | ||
|
Length
of USNG offering:
|
Continuous
|
|||
|
*
|
Reflects
the offering price per unit set forth on the cover page of
the
registration statement registering such units filed with the
SEC.
|
|
**
|
These
expenses were paid for by the General Partner and USNG.
|
22
Compensation
to the General Partner and Other Compensation
US12OF:
Expenses
Paid by US12OF through
December 31, 2007 in dollar terms (unaudited):
|
Expense
|
Amount
in Dollar
Terms
|
|||
|
Amount
Paid to General Partner in US12OF Offering:
|
$ | 8,790 | ||
|
Amount
Paid in Portfolio Brokerage Commissions in US12OF
offering:
|
$ | 892 | ||
|
Other
Amounts Paid in US12OF Offering:
|
$ | 3,479 | ||
|
Total
Expenses Paid in US12OF Offering:
|
$ | 13,161 | ||
Expenses
Paid by US12OF through
December 31, 2007 as a Percentage of Average Daily Net Assets
(unaudited):
|
Expenses
in US12OF Offering:
|
Amount
As a Percentage of Average
Daily Net Assets
|
|||
|
General
Partner:
|
0.60%
annualized
|
|||
|
Portfolio
Brokerage Commissions:
|
0.06%
annualized
|
|||
|
Other
Amounts Paid in US12OF Offering
|
0.24%
annualized
|
|||
|
Total
Expense Ratio:
|
0.90%
annualized
|
|||
|
US12OF
Performance:
|
||||
|
Name
of Commodity
Pool:
|
US12OF
|
|||
|
Type
of Commodity
Pool:
|
Exchange
traded
security
|
|||
|
Inception
of
Trading:
|
December
6,
2007
|
|||
|
Aggregate
Subscriptions (from
inception through December 31, 2007):
|
$ | 20,126,316 | ||
|
Total
Net Assets as of December
31, 2007:
|
$ | 21,691,479 | ||
|
Initial
NAV Per Unit as of
Inception:
|
$ | 50.00 | ||
|
NAV
per Unit as of December 31,
2007:
|
$ | 54.23 | ||
|
Worst
Monthly Percentage
Draw-down:
|
N/A | |||
|
Worst
Peak-to-Valley
Draw-down:
|
N/A | |||
USNG:
Expenses
Paid by USNG through
December 31, 2007 in dollar terms (unaudited):
|
Expense
|
Amount
in Dollar
Terms
|
|||
|
Amount
Paid to General Partner in USNG Offering:
|
$ | 1,239,862 | ||
|
Amount
Paid in Portfolio Brokerage Commissions in USNG offering:
|
$ | 351,310 | ||
|
Other
Amounts Paid in USNG Offering:
|
$ | 454,149 | ||
|
Total
Expenses Paid in USNG Offering:
|
$ | 2,045,321 | ||
Expenses
Paid by USNG through
December31, 2007 as a Percentage of Average Daily Net Assets
(unaudited):
|
Expenses
in USNG Offering:
|
Amount
As a Percentage of Average
Daily Net Assets
|
|
General
Partner:
|
0.60%
annualized
|
|
Portfolio
Brokerage Commissions:
|
0.17%
annualized
|
|
Other
Amounts Paid in USNG Offering
|
0.22%
annualized
|
|
Total
Expense Ratio:
|
0.99%
annualized
|
|
USNG
Performance:
|
||||
|
Name
of Commodity
Pool:
|
USNG
|
|||
|
Type
of Commodity
Pool:
|
Exchange
traded
security
|
|||
|
Inception
of
Trading:
|
April
18,
2007
|
|||
|
Aggregate
Subscriptions (from
inception through December 31, 2007):
|
$ | 1,458,786,977 | ||
|
Total
Net Assets as of December
31, 2007:
|
$ | 593,394,981 | ||
|
Initial
NAV Per Unit as of
Inception:
|
$ | 50.00 | ||
|
NAV
per Unit as of December 31,
2007:
|
$ | 36.18 | ||
|
Worst
Monthly Percentage
Draw-down:
|
November
2007 (16.16%)
|
|||
|
Worst
Peak-to-Valley
Draw-down:
|
April
2007 - August 2007 (34.74%)
|
|||
23
COMPOSITE
PERFORMANCE DATA FOR US12OF
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
|
Month
|
Rates
of Return For
the Year 2007
|
|||
|
December*
|
8.46 | % | ||
|
Annual
Rate of Return (through December 31, 2007)
|
8.46 | % | ||
*
Partial
from December 6, 2007.
COMPOSITE
PERFORMANCE DATA FOR USNG
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
|
Month
|
Rates
of Return For
the Year 2007
|
|||
|
April*
|
4.30 | % | ||
|
May
|
(0.84 | )% | ||
|
June
|
(15.90 | )% | ||
|
July
|
(9.68 | )% | ||
|
August
|
(13.37 | )% | ||
|
September
|
12.28 | % | ||
| October | 12.09 | % | ||
| November | (16.16 | )% | ||
| December | 0.75 | % | ||
|
Annual
Rate of Return (through December 31, 2007)
|
(27.64 | )% | ||
*
Partial
from April 17, 2007.
Draw-down:
Losses experienced over a specified period. Draw-down is measured on
the basis
of monthly returns only and does not reflect intra-month figures.
Worst
Monthly Percentage Draw-down: The largest single month loss sustained
since
inception of trading.
Worst
Peak-to-Valley Draw-down: The largest percentage decline in the NAV per
unit
over the history of the fund. This need not be a continuous decline,
but can be
a series of positive and negative returns where the negative returns
are larger
than the positive returns. Worst Peak-to-Valley Draw-down represents
the greatest percentage decline from any month-end NAV per unit that
occurs
without such month-end NAV per unit being equaled or exceeded as of a
subsequent
month-end. For example, if the NAV per unit declined by $1 in each of
January
and February, increased by $1 in March and declined again by $2 in April,
a
“peak-to-trough drawdown” analysis conducted as of the end of April would
consider that “drawdown” to be still continuing and to be $3 in amount, whereas
if the NAV per unit had increased by $2 in March, the January-February
drawdown
would have ended as of the end of February at the $2 level.
Nicholas
Gerber, the president and CEO of the General Partner, ran the Marc Stevens
Futures Index Fund over 10 years ago. This fund combined commodity futures
with
equity stock index futures. It was a very small private offering, which
had
under $1 million in assets. The Marc Stevens Futures Index Fund was a
commodity
pool and Mr. Gerber was the CPO. Ameristock Corporation is an affiliate
of the
General Partner and it is a California-based registered investment advisor
registered under the Investment Advisers Act of 1940, as amended (the
"Advisers
Act") that has been sponsoring and providing portfolio management services
to
mutual funds since 1995. Ameristock Corporation is the investment adviser
to the
Ameristock Mutual Fund, Inc., a mutual fund registered under the Investment
Company Act of 1940, as amended (the "1940 Act") that focuses on large
cap U.S.
equities that has approximately $425 million in assets as of December
31, 2007.
Ameristock
Corporation is also the investment advisor to the Ameristock ETF Trust,
an
open-end management investment company registered under the 1940 Act
that seeks
investment results that correspond to the performance of U.S. Treasury
indices
owned and compiled by Ryan Holdings LLC and Ryan ALM,
Inc.
Investments
The
General Partner applies substantially all of USOF’s assets toward trading in Oil
Futures Contracts and Other Oil Interests, Treasuries, cash and/or cash
equivalents. The General Partner has sole authority to determine the percentage
of assets that are:
|
·
|
held
on deposit with the futures commission merchant or other
custodian,
|
|
·
|
used
for other investments, and
|
|
·
|
held
in bank accounts to pay current obligations and as
reserves.
|
The
General Partner deposits substantially all of USOF’s net assets with the futures
commission merchant or other custodian for trading. When USOF purchases
an Oil
Futures Contract and certain exchange traded Other Oil Interests, USOF
is
required to deposit with the selling futures commission merchant on behalf
of
the exchange a portion of the value of the contract or other interest as
security to ensure payment for the obligation under oil interests at maturity.
This deposit is known as “margin.” USOF invests the remainder of its assets
equal to the difference between the margin deposited and the face value
of the
futures contract in Treasuries, cash and/or cash equivalents.
The
General Partner believes that all entities that hold or trade USOF’s assets are
based in the United States and are subject to United States
regulations.
Approximately
5% to 10% of USOF’s assets have normally been committed as margin for Futures
Contracts. However, from time to time, the percentage of assets committed
as
margin may be substantially more, or less, than such range. The General
Partner
invests the balance of USOF’s assets not invested in oil interests or held in
margin as reserves to be available for changes in margin. All interest
income is
used for USOF’s benefit.
The
futures commission merchant, a government agency or a commodity exchange
could
increase margins applicable to USOF to hold trading positions at any time.
Moreover, margin is merely a security deposit and has no bearing on the
profit
or loss potential for any positions taken.
USOF’s
assets are held in segregation pursuant to the CEA and CFTC
regulations.
24
The
Commodity Interest
Markets
General
The
CEA
governs the regulation of commodity interest transactions, markets and
intermediaries. In December 2000, the CEA was amended by the Commodity
Futures
Modernization Act of 2000 (the "CFMA"), which substantially revised the
regulatory framework governing certain commodity interest transactions
and the
markets on which they trade. The CEA, as amended by the CFMA, now provides
for
varying degrees of regulation of commodity interest transactions depending
upon
the variables of the transaction. In general, these variables include (1)
the
type of instrument being traded (e.g., contracts for future delivery, options,
swaps or spot contracts), (2) the type of commodity underlying the instrument
(distinctions are made between instruments based on agricultural commodities,
energy and metals commodities and financial commodities), (3) the nature
of the
parties to the transaction (retail, eligible contract participant, or eligible
commercial entity), (4) whether the transaction is entered into on a
principal-to-principal or intermediated basis, (5) the type of market on
which
the transaction occurs, and (6) whether the transaction is subject to clearing
through a clearing organization. Information regarding commodity interest
transactions, markets and intermediaries, and their associated regulatory
environment, is provided below.
Futures
Contracts
A
futures
contract such as an Oil Futures Contract is a standardized contract traded
on,
or subject to the rules of, an exchange that calls for the future delivery
of a
specified quantity and type of a commodity at a specified time and place.
Futures contracts are traded on a wide variety of commodities, including
agricultural products, bonds, stock indices, interest rates, currencies,
energy
and metals. The size and terms of futures contracts on a particular commodity
are identical and are not subject to any negotiation, other than with respect
to
price and the number of contracts traded between the buyer and
seller.
The
contractual obligations of a buyer or seller may generally be satisfied
by
taking or making physical delivery of the underlying of commodity or by
making
an offsetting sale or purchase of an identical futures contract on the
same or
linked exchange before the designated date of delivery. The difference
between
the price at which the futures contract is purchased or sold and the price
paid
for the offsetting sale or purchase, after allowance for brokerage commissions,
constitutes the profit or loss to the trader. Some futures contracts, such
as
stock index contracts, settle in cash (reflecting the difference between
the
contract purchase/sale price and the contract settlement price) rather
than by
delivery of the underlying commodity.
In
market
terminology, a trader who purchases a futures contract is long in the market
and
a trader who sells a futures contract is short in the market. Before a
trader
closes out his long or short position by an offsetting sale or purchase,
his
outstanding contracts are known as open trades or open positions. The aggregate
amount of open positions held by traders in a particular contract is referred
to
as the open interest in such contract.
Forward
Contracts
A
forward
contract is a contractual obligation to purchase or sell a specified quantity
of
a commodity at or before a specified date in the future at a specified
price
and, therefore, is economically similar to a futures contract. Unlike futures
contracts, however, forward contracts are typically traded in the
over-the-counter markets and are not standardized contracts. Forward contracts
for a given commodity are generally available for various amounts and maturities
and are subject to individual negotiation between the parties involved.
Moreover, generally there is no direct means of offsetting or closing out
a
forward contract by taking an offsetting position as one would a futures
contract on a U.S. exchange. If a trader desires to close out a forward
contract
position, he generally will establish an opposite position in the contract
but
will settle and recognize the profit or loss on both positions simultaneously
on
the delivery date. Thus, unlike in the futures contract market where a
trader
who has offset positions will recognize profit or loss immediately, in
the
forward market a trader with a position that has been offset at a profit
will
generally not receive such profit until the delivery date, and likewise
a trader
with a position that has been offset at a loss will generally not have
to pay
money until the delivery date. In recent years, however, the terms of forward
contracts have become more standardized, and in some instances such contracts
now provide a right of offset or cash settlement as an alternative to making
or
taking delivery of the underlying commodity.
The
forward markets provide what has typically been a
highly liquid market for foreign exchange trading, and in certain cases
the
prices quoted for foreign exchange forward contracts may be more favorable
than
the prices for foreign exchange futures contracts traded on U.S. exchanges.
The
forward markets are largely unregulated. Forward contracts are, in general,
not
cleared or guaranteed by a third party. Commercial banks participating
in
trading foreign exchange forward contracts often do not require margin
deposits,
but rely upon internal credit limitations and their judgments regarding
the
creditworthiness of their counterparties. In recent years, however, many
over-the-counter market participants in foreign exchange trading have begun
to
require that their counterparties post margin.
Further,
as the result of the CFMA, over-the-counter derivative instruments such
as
forward contracts and swap agreements (and options on forwards and physical
commodities) may begin to be traded on lightly-regulated exchanges or
electronic
trading platforms that may, but are not required to, provide for clearing
facilities. Exchanges and electronic trading platforms on which over-the-counter
instruments may be traded and the regulation and criteria for that trading
are
more fully described below under “Futures Exchanges and Clearing Organizations.”
Nonetheless, absent a clearing facility, USOF’s trading in foreign exchange and
other forward contracts is exposed to the creditworthiness of the counterparties
on the other side of the trade.
25
Options
on Futures
Contracts
Options
on futures contracts are standardized contracts traded on an exchange.
An option
on futures contract gives the buyer of the option the right, but not the
obligation, to take a position at a specified price (the striking, strike,
or
exercise price) in the underlying futures contract or underlying interest.
The
buyer of a call option acquires the right, but not the obligation, to purchase
or take a long position in the underlying interest, and the buyer of a
put
option acquires the right, but not the obligation, to sell or take a short
position in the underlying interest.
The
seller, or writer, of an option is obligated to take a position in the
underlying interest at a specified price opposite to the option buyer if
the
option is exercised. Thus, the seller of a call option must stand ready
to take
a short position in the underlying interest at the strike price if the
buyer
should exercise the option. The seller of a put option, on the other hand,
must
stand ready to take a long position in the underlying interest at the strike
price.
A
call
option is said to be in-the-money if the strike price is below current
market
levels and out-of-the-money if the strike price is above current market
levels.
Conversely, a put option is said to be in-the-money if the strike price
is above
the current market levels and out-of-the-money if the strike price is below
current market levels.
Options
have limited life spans, usually tied to the delivery or settlement date
of the
underlying interest. Some options, however, expire significantly in advance
of
such date. The purchase price of an option is referred to as its premium,
which
consists of its intrinsic value (which is related to the underlying market
value) plus its time value. As an option nears its expiration date, the
time
value shrinks and the market and intrinsic values move into parity. An
option
that is out-of-the-money and not offset by the time it expires becomes
worthless. On certain exchanges, in-the-money options are automatically
exercised on their expiration date, but on others unexercised options simply
become worthless after their expiration date.
Regardless
of how much the market swings, the most an option buyer can lose is the
option
premium. The option buyer deposits his premium with his broker, and the
money
goes to the option seller. Option sellers, on the other hand, face risks
similar
to participants in the futures markets. For example, since the seller of
a call
option is assigned a short futures position if the option is exercised,
his risk
is the same as someone who initially sold a futures contract. Because no
one can
predict exactly how the market will move, the option seller posts margin
to
demonstrate his ability to meet any potential contractual
obligations.
Options
on Forward Contracts or
Commodities
Options
on forward contracts or commodities operate in a manner similar to
options on
futures contracts. An option on a forward contract or commodity gives
the buyer
of the option the right, but not the obligation, to take a position
at a
specified price in the underlying forward contract or commodity. However,
similar to forward contracts, options on forward contracts or on commodities
are
individually negotiated contracts between counterparties and are typically
traded in the over-the-counter market. Therefore, options on forward
contracts
and physical commodities possess many of the same characteristics of
forward
contracts with respect to offsetting positions and credit risk that
are
described above.
Swap
Contracts
Swap
transactions generally involve contracts between two parties to exchange
a
stream of payments computed by reference to a notional amount and the
price of
the asset that is the subject of the swap. Swap contracts are principally
traded
off-exchange, although recently, as a result of regulatory changes
enacted as
part of the CFMA, certain swap contracts are now being traded in electronic
trading facilities and cleared through clearing organizations.
Swaps
are
usually entered into on a net basis, that is, the two payment streams
are netted
out in a cash settlement on the payment date or dates specified in
the
agreement, with the parties receiving or paying, as the case may be,
only the
net amount of the two payments. Swaps do not generally involve the
delivery of
underlying assets or principal. Accordingly, the risk of loss with
respect to
swaps is generally limited to the net amount of payments that the party
is
contractually obligated to make. In some swap transactions one or both
parties
may require collateral deposits from the counterparty to support that
counterparty’s obligation under the swap agreement. If the counterparty to such
a swap defaults, the risk of loss consists of the net amount of payments
that
the party is contractually entitled to receive less any collateral deposits
it is holding.
Participants
The
two
broad classes of persons who trade commodities are hedgors and speculators.
Hedgors include financial institutions that manage or deal in interest
rate-sensitive instruments, foreign currencies or stock portfolios,
and
commercial market participants, such as farmers and manufacturers,
that market
or process commodities. Hedging is a protective procedure designed
to lock in
profits that could otherwise be lost due to an adverse movement in
the
underlying commodity, for example, the adverse price movement between
the time a
merchandiser or processor enters into a contract to buy or sell a raw
or
processed commodity at a certain price and the time he must perform
the
contract. In such a case, at the time the hedgor contracts to physically
sell
the commodity at a future date he will simultaneously buy a futures
or forward
contract for the necessary equivalent quantity of the commodity. At
the time for
performance of the contract, the hedgor may accept delivery under his
futures
contract and sell the commodity quantity as required by his physical
contract or
he may buy the actual commodity, sell if under the physical contract
and close
out his position by making an offsetting sale of a futures
contract.
26
The
commodity interest markets enable the hedgor to shift the risk of
price
fluctuations. The usual objective of the hedgor is to protect the
profit that he
expects to earn from farming, merchandising, or processing operations
rather
than to profit from his trading. However, at times the impetus for
a hedge
transaction may result in part from speculative objectives.
Unlike
the hedgor, the speculator generally expects neither to make nor
take delivery
of the underlying commodity. Instead, the speculator risks his capital
with the
hope of making profits from price fluctuations in the commodities.
The
speculator is, in effect, the risk bearer who assumes the risks that
the hedgor
seeks to avoid. Speculators rarely make or take delivery of the underlying
commodity; rather they attempt to close out their positions prior
to the
delivery date. Because the speculator may take either a long or short
position
in commodities, it is possible for him to make profits or incur losses
regardless of whether prices go up or down.
Futures
Exchanges and Clearing
Organizations
Futures
exchanges provide centralized market facilities in which multiple persons
have
the ability to execute or trade contracts by accepting bids and offers
from
multiple participants. Futures exchanges may provide for execution
of trades at
a physical location utilizing trading pits and/or may provide for trading
to be
done electronically through computerized matching of bids and offers
pursuant to
various algorithms. Members of a particular exchange and the trades
executed on
such exchanges are subject to the rules of that exchange. Futures exchanges
and
clearing organizations are given reasonable latitude in promulgating
rules and
regulations to control and regulate their members. Examples of regulations
by
exchanges and clearing organizations include the establishment of initial
margin
levels, rules regarding trading practices, contract specifications,
speculative
position limits, daily price fluctuation limits, and execution and
clearing
fees.
Clearing
organizations provide services designed to mutualize or transfer the
credit risk
arising from the trading of contracts on an exchange or other electronic
trading
facility. Once trades made between members of an exchange or electronic
trading
facility have been confirmed, the clearing organization becomes substituted
for
the clearing member acting on behalf of each buyer and each seller
of contracts
traded on the exchange or trading platform and in effect becomes the
other party
to the trade. Thereafter, each clearing member party to the trade looks
only to
the clearing
organization for performance. The clearing organization generally establishes
some sort of security or guarantee fund to which all clearing members
of the
exchange must contribute; this fund acts as an emergency buffer that
is intended
to enable the clearing organization to meet its obligations with regard
to the
other side of an insolvent clearing member’s contracts. Furthermore, the
clearing organization requires margin deposits and continuously marks
positions
to market to provide some assurance that its members will be able to
fulfill
their contractual obligations. Thus, a central function of the clearing
organization is to ensure the integrity of trades, and members effecting
transactions on an exchange need not concern themselves with the solvency
of the
party on the opposite side of the trade; their only remaining concerns
are the
respective solvencies of their own customers, their clearing broker
and the
clearing organization. The clearing organizations do not deal with
customers,
but only with their member firms and the guarantee of performance for
open
positions provided by the clearing organization does not run to
customers.
U.S.
Futures
Exchanges
Futures
exchanges in the United States are subject to varying degrees of regulation
by
the CFTC based on their designation as one of the following: a designated
contract market, a derivatives transaction execution facility, an exempt
board
of trade or an electronic trading facility.
A
designated contract market is the most highly regulated level of futures
exchange. Designated contract markets may offer products to retail
customers on
an unrestricted basis. To be designated as a contract market, the exchange
must
demonstrate that it satisfies specified general criteria for designation,
such
as having the ability to prevent market manipulation, rules and procedures
to
ensure fair and equitable trading, position limits, dispute resolution
procedures, minimization of conflicts of interest and protection of
market
participants. Among the principal designated contract markets in the
United
States are the Chicago Board of Trade, the Chicago Mercantile Exchange
and the
NYMEX. Each of the designated contract markets in the United States
must provide
for the clearance and settlement of transactions with a CFTC-registered
derivatives clearing organization.
27
A
derivatives transaction execution facility (a "DTEF"), is a new type
of exchange
that is subject to fewer regulatory requirements than a designated
contract
market but is subject to both commodity interest and participant limitations.
DTEFs limit access to eligible traders that qualify as either eligible
contract
participants or eligible commercial entities for futures and option
contracts on
commodities that have a nearly inexhaustible deliverable supply, are
highly
unlikely to be susceptible to the threat of manipulation, or have no
cash
market, security futures products, and futures and option contracts
on
commodities that the CFTC may determine, on a case-by-case basis, are
highly
unlikely to be susceptible to the threat of manipulation. In addition,
certain
commodity interests excluded or exempt from the CEA, such as swaps,
etc. may be
traded on a DTEF. There is no requirement that a DTEF use a clearing
organization, except with respect to trading in security futures contracts,
in
which case the clearing organization must be a securities clearing
agency.
However, if futures contracts and options on futures contracts on a
DTEF are
cleared, then it must be through a CFTC-registered derivatives clearing
organization, except that some excluded or exempt commodities traded
on a DTEF
may be cleared through a clearing organization other than one registered
with
the CFTC.
An
exempt
board of trade is also a newly designated form of exchange. An exempt
board of
trade is substantially unregulated, subject only to CFTC anti-fraud
and
anti-manipulation authority. An exempt board of trade is permitted
to trade
futures contracts and options on futures contracts provided that the
underlying
commodity is not a security or securities index and has an inexhaustible
deliverable supply or no cash market. All traders on an exempt board
of trade
must qualify as eligible contract participants. Contracts deemed eligible
to be
traded on an exempt board of trade include contracts on interest rates,
exchange
rates, currencies, credit risks or measures, debt instruments, measures
of
inflation, or other macroeconomic indices or measures. There is no
requirement
that an exempt board of trade use a clearing organization. However,
if contracts
on an exempt board of trade are cleared, then it must be through a
CFTC-registered derivatives clearing organization. A board of trade
electing to
operate as an exempt board of trade must file a written notification
with the
CFTC.
An
electronic trading facility is a new form of exchange that operates
by means of
an electronic or telecommunications network and maintains an automated
audit
trail of bids, offers, and the matching of orders or the execution
of
transactions on the electronic trading facility. The CEA does not apply
to, and
the CFTC has no jurisdiction over, transactions on an electronic trading
facility in certain excluded commodities that are entered into between
principals that qualify as eligible contract participants, subject
only to CFTC
anti-fraud and anti-manipulation
authority. In general, excluded commodities include interest rates,
currencies,
securities, securities indices or other financial, economic or commercial
indices or measures.
The
General Partner intends to monitor the development of and opportunities
and
risks presented by the new less-regulated exchanges and exempt boards
and may,
in the future, allocate a percentage of USOF’s assets to trading in products on
these exchanges. Provided USOF maintains assets exceeding $5 million,
USOF would
qualify as an eligible contract participant and thus would be able
to trade on
such exchanges.
Non-U.S.
Futures
Exchanges
Non-U.S.
futures exchanges differ in certain respects from their U.S. counterparts.
Importantly, non-U.S. futures exchanges are not subject to regulation
by the
CFTC, but rather are regulated by their home country regulator. In
contrast to
U.S. designated contract markets, some non-U.S. exchanges are principals’
markets, where trades remain the liability of the traders involved,
and the
exchange or an affiliated clearing organization, if any, does not become
substituted for any party. Due to the absence of a clearing system,
such
exchanges are significantly more susceptible to disruptions. Further,
participants in such markets must often satisfy themselves as to the
individual
creditworthiness of each entity with which they enter into a trade.
Trading on
non-U.S. exchanges is often in the currency of the exchange’s home jurisdiction.
Consequently, USOF is subject to the additional risk of fluctuations
in the
exchange rate between such currencies and U.S. dollars and the possibility
that
exchange controls could be imposed in the future. Trading on non-U.S.
exchanges
may differ from trading on U.S. exchanges in a variety of ways and,
accordingly,
may subject USOF to additional risks.
28
Accountability
Levels and Position
Limits
The
CFTC
and U.S. designated contract markets 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 a hedgor, which USOF is not) may hold,
own or
control. Among the purposes of accountability levels and position limits
is to
prevent a corner or squeeze on a market or undue influence on prices
by any
single trader or group of traders. The position limits currently established
by
the CFTC apply to certain agricultural commodity interests, such as
grains
(oats, barley, and flaxseed), soybeans, corn, wheat, cotton, eggs,
rye, and
potatoes, but not to interests in energy products. In addition, U.S.
exchanges
may set accountability levels and position limits for all commodity
interests
traded on that exchange. For example, the current accountability level
for
investments at any one time in Oil Futures Contracts (including investments
in
the Benchmark Oil Futures Contract) on the NYMEX is 20,000 contracts.
The NYMEX
also imposes position limits on contracts held in the last few days
of trading
in the near month contract to expire. Certain exchanges or clearing
organizations also set limits on the total net positions that may be
held by a
clearing broker. In general, no position limits are in effect in forward
or
other over-the-counter contract trading or in trading on non-U.S. futures
exchanges, although the principals with which USOF and the clearing
brokers may
trade in such markets may impose such limits as a matter of credit
policy. For
purposes of determining accountability levels and position limits USOF’s
commodity interest positions will not be attributable to investors
in their own
commodity interest trading.
Daily
Price
Limits
Most
U.S.
futures exchanges (but generally not non-U.S. exchanges) may limit
the amount of
fluctuation in some futures contract or options on a futures contract
prices
during a single trading day by regulations. These regulations specify
what are
referred to as daily price fluctuation limits or more commonly, daily
limits.
The daily limits establish the maximum amount that the price of a futures
or
options on futures contract may vary either up or down from the previous
day’s
settlement price. Once the daily limit has been reached in a particular
futures
or options on futures contract, no trades may be made at a price beyond
the
limit. Positions in the futures or options contract may then be taken
or
liquidated, if at all, only at inordinate expense or if traders are
willing to
effect trades at or within the limit during the period for trading
on such day.
Because the daily limit rule governs price movement only for a particular
trading day, it does not limit losses and may in fact substantially
increase
losses because it may prevent the liquidation of unfavorable positions.
Futures
contract prices have occasionally moved to the daily limit for several
consecutive trading days, thus preventing prompt liquidation of positions
and
subjecting the trader to substantial losses for those days. The concept
of daily
price limits is not relevant to over-the-counter contracts, including
forwards
and swaps, and thus such limits are not imposed by banks and others
who deal in
those markets.
In
contrast, the NYMEX does not impose daily limits but rather limits
the amount of
price fluctuation for Oil Futures Contracts. For example, the NYMEX
imposes a
$10.00 per barrel ($10,000 per contract) price fluctuation limit for the
Benchmark Oil Futures Contract. This limit is initially based off the
previous trading day’s settlement price. If any Benchmark Oil Futures Contract
is traded, bid, or offered at the limit for five minutes, trading is
halted for
five minutes. When trading resumes it begins at the point where the
limit was
imposed and the limit is reset to be $10.00 per barrel in either direction
of
that point. If another halt were triggered, the market would continue
to be
expanded by $10.00 per barrel in either direction after each successive
five-minute trading halt. There is no maximum price fluctuation limits
during
any one trading session.
Commodity
Prices
Commodity
prices are volatile and, although ultimately determined by the interaction
of
supply and demand, are subject to many other influences, including
the
psychology of the marketplace and speculative assessments of future
world and
economic events. Political climate, interest rates, treaties, balance
of
payments, exchange controls and other governmental interventions as
well as
numerous other variables affect the commodity markets, and even with
comparatively complete information it is impossible for any trader
to predict
reliably commodity prices.
29
Regulation
Futures
exchanges in the United States are subject to varying degrees of regulation
under the CEA depending on whether such exchange is a designated contract
market, DTEF, exempt board of trade or electronic trading facility.
Derivatives
clearing organizations are also subject to the CEA and CFTC regulation.
The CFTC
is the governmental agency charged with responsibility for regulation
of futures
exchanges and commodity interest trading conducted on those exchanges.
The
CFTC’s function is to implement the CEA’s objectives of preventing price
manipulation and excessive speculation and promoting orderly and efficient
commodity interest markets. In addition, the various exchanges and
clearing
organizations themselves exercise regulatory and supervisory authority
over
their member firms.
The
CFTC
possesses exclusive jurisdiction to regulate the activities of CPOs
and
commodity trading advisors and has adopted regulations with respect
to the
activities of those persons and/or entities. Under the CEA, a registered
CPO,
such as the General Partner, is required to make annual filings with
the CFTC
describing its organization, capital structure, management and controlling
persons. In addition, the CEA authorizes the CFTC to require and review
books
and records of, and documents prepared by, registered CPOs. Pursuant
to this
authority, the CFTC requires CPOs to keep accurate, current and orderly
records
for each pool that they operate. The CFTC may suspend the registration
of a CPO
(1) if the CFTC finds that the operator’s trading practices tend to disrupt
orderly market conditions, (2) if any controlling person of the operator
is
subject to an order of the CFTC denying such person trading privileges
on any
exchange, and (3) in certain other circumstances. Suspension, restriction
or
termination of the General Partner’s registration as a CPO would prevent it,
until that registration were to be reinstated, from managing USOF,
and might
result in the termination of USOF. USOF itself is not required to be
registered
with the CFTC in any capacity.
The
CEA
gives the CFTC similar authority with respect to the activities of
commodity
trading advisors. If a trading advisor’s commodity trading advisor registration
were to be terminated, restricted or suspended, the trading advisor
would be
unable, until the registration were to be reinstated, to render trading
advice
to USOF.
The
CEA
requires all futures commission merchants, such as USOF’s clearing brokers, to
meet and maintain specified fitness and financial requirements, to
segregate
customer funds from proprietary funds and account separately for all
customers’
funds and positions, and to maintain specified books and records open
to
inspection by the staff of the CFTC. The CFTC has similar authority
over
introducing brokers, or persons who solicit or accept orders for commodity
interest trades but who do not accept margin deposits for the execution
of
trades. The CEA authorizes the CFTC to regulate trading by futures
commission
merchants and by their officers and directors, permits the CFTC to
require
action by exchanges in the event of market emergencies, and establishes
an
administrative procedure under which customers may institute complaints
for
damages arising from alleged violations of the CEA. The CEA also gives
the
states powers to enforce its provisions and the regulations of the
CFTC.
USOF’s
investors are afforded prescribed rights for reparations under the
CEA.
Investors may also be able to maintain a private right of action for
violations
of the CEA. The CFTC has adopted rules implementing the reparation
provisions of
the CEA, which provide that any person may file a complaint for a reparations
award with the
CFTC
for violation of the CEA against a floor broker or a futures commission
merchant, introducing broker, commodity trading advisor, commodity
pool
operator, and their respective associated persons.
Pursuant
to authority in the CEA, the NFA has been formed and registered with
the CFTC as
a registered futures association. At the present time, the NFA is the
only
self-regulatory organization for commodity interest professionals,
other than
futures exchanges. The CFTC has delegated to the NFA responsibility
for the
registration of commodity trading advisors, commodity pool operators,
futures
commission merchants, introducing brokers, and their respective associated
persons and floor brokers. The General Partner, each trading advisor,
the
selling agents and the clearing brokers are members of the NFA. As
such, they
are subject to NFA standards relating to fair trade practices, financial
condition and consumer protection. USOF itself is not required to become
a
member of the NFA. As the self-regulatory body of the commodity interest
industry, the NFA promulgates rules governing the conduct of professionals
and
disciplines those professionals that do not comply with these rules.
The NFA
also arbitrates disputes between members and their customers and conducts
registration and fitness screening of applicants for membership and
audits of
its existing members.
30
The
regulations of the CFTC and the NFA prohibit any representation by
a person
registered with the CFTC or by any member of the NFA, that registration
with the
CFTC, or membership in the NFA, in any respect indicates that the CFTC
or the
NFA, as the case may be, has approved or endorsed that person or that
person’s
trading program or objectives. The registrations and memberships of
the parties
described in this summary must not be considered as constituting any
such
approval or endorsement. Likewise, no futures exchange has given or
will give
any similar approval or endorsement.
The
regulation of commodity interest trading in the 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 the CFTC, the NFA, the futures exchanges,
clearing
organizations and other regulatory bodies.
The
function of the CFTC is to implement the objectives of the CEA of preventing
price manipulation and other disruptions to market integrity, avoiding
systemic
risk, preventing fraud and promoting innovation, competition and financial
integrity of transactions. As mentioned above, this regulation, among
other
things, provides that the trading of commodity interest contracts generally
must
be upon exchanges designated as contract markets or DTEFs and that
all trading
on those exchanges must be done by or through exchange members. Under
the CFMA,
commodity interest trading in some commodities between sophisticated
persons may
be traded on a trading facility not regulated by the CFTC. As a general
matter,
trading in spot contracts, forward contracts, options on forward contracts
or
commodities, or swap contracts between eligible contract participants
is not
within the jurisdiction of the CFTC and may therefore be effectively
unregulated. The trading advisors may engage in those transactions
on behalf of
USOF in reliance on this exclusion from regulation.
In
general, the CFTC does not regulate the interbank and forward foreign
currency
markets with respect to transactions in contracts between certain sophisticated
counterparties such as USOF or between certain regulated institutions
and retail
investors. Although U.S. banks are regulated in various ways by the
Federal
Reserve Board, the Comptroller of the Currency and other U.S. federal
and state
banking officials, banking authorities do not regulate the forward
markets.
While
the
U.S. government does not currently impose any restrictions on the movements
of
currencies, it could choose to do so. The imposition or relaxation
of exchange
controls in various jurisdictions could significantly affect the market
for that
and other jurisdictions’ currencies. Trading in the interbank market also
exposes USOF to a risk of default since failure of a bank with which
USOF had
entered into a forward contract would likely result in a default and
thus
possibly substantial losses to USOF.
The
CFTC
is 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 in the United States. These
regulations
permit certain contracts traded on non-U.S. exchanges to be offered
and sold in
the United States.
Commodity
Margin
Original
or initial margin is the minimum amount of funds that must be deposited
by a
commodity interest trader with the trader’s broker to initiate and maintain an
open position in futures contracts. Maintenance margin is the amount
(generally
less than the original margin) to which a trader’s account may decline before he
must deliver additional margin. A margin deposit
is like a
cash performance bond. It helps assure the trader’s performance of the futures
contracts that he or she purchases or sells. Futures contracts are
customarily
bought and sold on initial margin that represents a very small percentage
(ranging upward from less than 2%) of the aggregate purchase or sales
price of
the contract. Because of such low margin requirements, price fluctuations
occurring in the futures markets may create profits and losses that,
in relation
to the amount invested, are greater than are customary in other forms
of
investment or speculation. As discussed below, adverse price changes
in the
futures contract may result in margin requirements that greatly exceed
the
initial margin. In addition, the amount of margin required in connection
with a
particular futures contract is set from time to time by the exchange
on which
the contract is traded and may be modified from time to time by the
exchange
during the term of the contract.
31
Brokerage
firms, such as USOF’s clearing brokers, carrying accounts for traders in
commodity interest contracts may not accept lower, and generally require
higher,
amounts of margin as a matter of policy to further protect themselves.
The
clearing brokers require USOF to make margin deposits equal to exchange
minimum
levels for all commodity interest contracts. This requirement may be
altered
from time to time in the clearing brokers’ discretion.
Trading
in the over-the-counter markets where no clearing facility is provided
generally
does not require margin but generally does require the extension of
credit
between counterparties.
When
a
trader purchases an option, there is no margin requirement; however,
the option
premium must be paid in full. When a trader sells an option, on the
other hand,
he or she is required to deposit margin in an amount determined by
the margin
requirements established for the underlying interest and, in addition,
an amount
substantially equal to the current premium for the option. The margin
requirements imposed on the selling of options, although adjusted to
reflect the
probability that out-of-the-money options will not be exercised, can
in fact be
higher than those imposed in dealing in the futures markets directly.
Complicated margin requirements apply to spreads and conversions, which
are
complex trading strategies in which a trader acquires a mixture of
options
positions and positions in the underlying interest.
Margin
requirements are computed each day by a trader’s clearing broker. When the
market value of a particular open commodity interest position changes
to a point
where the margin on deposit does not satisfy maintenance margin requirements,
a
margin call is made by the broker. If the margin call is not met within
a
reasonable time, the broker may close out the trader’s position. With respect to
USOF’s trading, USOF (and not its investors personally) is subject to margin
calls.
Finally,
many major U.S. exchanges have passed certain cross margining arrangements
involving procedures pursuant to which the futures and options positions
held in
an account would, in the case of some accounts, be aggregated and margin
requirements would be assessed on a portfolio basis, measuring the
total risk of
the combined positions.
SEC
Reports
USOF
makes available, free of charge, on its website, its Annual Reports
on Form
10-K, its Quarterly Reports on Form 10-Q, its Current Reports on
Form 8-K and
amendments to these reports filed or furnished pursuant to Section
13(a) or
15(d) of the Exchange Act as soon as reasonably practicable after
these forms
are filed with, or furnished to, the SEC.
32
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Risk
Factors.
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The
risk
factors should be read in connection with the other information
included in this
annual report on Form 10-K, including Management’s Discussion and Analysis of
Financial Condition and Results of Operations and USOF’s condensed financial
statements and the related notes.
Risks
Associated With Owning Direct
or Indirect Interests in Oil
Investing
in oil interests subjects
USOF to the risks of the crude oil industry and this could result
in large
fluctuations in the price of USOF’s units.
USOF
is
subject to the risks and hazards of the crude oil industry because
it invests in
oil interests. The risks and hazards that are inherent in the oil
industry may
cause the price of oil to widely fluctuate. If USOF’s units accurately track the
spot price of light, sweet crude oil, then the price of its units may also
fluctuate.
The
risks
of crude oil drilling and production activities include the
following:
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·
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no
commercially productive crude oil or natural gas reservoirs
may be
found;
|
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·
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crude
oil and natural gas drilling and production activities
may be shortened,
delayed or canceled;
|
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·
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the
ability of an oil producer to develop, produce and market
reserves may be
limited by:
|
· title
problems,
· political
conflicts, including war,
· weather
conditions,
· compliance
with governmental requirements,
· refinery
capacity, and
· mechanical
difficulties or shortages or delays in the delivery of drilling rigs
and other
equipment;
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·
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decisions
of the cartel of oil producing countries ( e.g.
,
OPEC), to produce more or less oil;
|
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·
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increases
in oil production due to price rises may make it more economical
to
extract oil from additional sources and may later temper
further oil price
increases; and
|
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·
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economic
activity of users, as certain economies’ expand, oil consumption increases
( e.g.
,
China, India) and as economies contract (in a recession
or depression),
oil demand and prices fall.
|
The
crude
oil industry experiences numerous operating risks. These operating
risks include
the risk of fire, explosions, blow-outs, pipe failure, abnormally
pressured
formations and environmental hazards. Environmental hazards include
oil spills,
natural gas leaks, ruptures and discharges of toxic gases.
33
Crude
oil
operations also are subject to various U.S. federal, state and local
regulations
that materially affect operations. Matters regulated include discharge
permits
for drilling operations, drilling and abandonment bonds, reports
concerning
operations, the spacing of wells and pooling of properties and taxation.
At
various times, regulatory agencies have imposed price controls and
limitations
on production. In order to conserve supplies of crude oil and natural
gas, these
agencies have restricted the rates of flow of crude oil and natural
gas wells
below actual production capacity. Federal, state, and local laws
regulate
production, handling, storage, transportation and disposal of crude
oil and
natural gas, by-products from crude oil and natural gas and other
substances and
materials produced or used in connection with crude oil and natural
gas
operations.
The
price of USOF’s units may be
influenced by factors such as the short-term supply and demand for
oil and the
short-term supply and demand for USOF’s units. This may cause the units to trade
at a price that is above or below USOF’s NAV per unit. Accordingly, changes in
the price of units may substantially vary from the changes in the
spot price
of light, sweet crude oil. If this variation occurs, then investors
may not
be able to effectively use USOF as a way to hedge against oil-related
losses or
as a way to indirectly invest in oil.
While
it
is expected that the trading prices of units will fluctuate in accordance
with
changes in USOF’s NAV, the prices of units may also be influenced by other
factors, including the short-term supply and demand for oil and the
units. There
is no guarantee that the units will not trade at appreciable discounts
from,
and/or premiums to, USOF’s NAV. This could cause changes in the price of units
to substantially vary from changes in the spot price of light, sweet crude
oil. This may be harmful to investors because if changes in the price
of units
vary substantially from changes in the spot price of light, sweet crude
oil, then investors may not be able to effectively use USOF as a
way to hedge
the risk of losses in their oil-related transactions or as a way
to indirectly
invest in oil.
Changes
in USOF’s NAV may not
correlate with changes in the price of the Benchmark Oil Futures
Contract. If
this were to occur, investors may not be able to effectively use USOF as a
way to hedge against oil-related losses or as a way to indirectly
invest in
oil.
The
General Partner endeavors to invest USOF’s assets as fully as possible in
short-term Oil Futures Contracts and Other Oil Interests so that
the changes in
NAV closely correlate with the changes in the price of the Benchmark
Oil Futures
Contract. However, changes in USOF’s NAV may not correlate with the changes in
the price of the Benchmark Oil Futures Contract for several reasons
as set forth
below:
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USOF
(i) may not be able to buy/sell the exact amount of Oil
Futures Contracts
and Other Oil Interests to have a perfect correlation with
NAV; (ii) may
not always be able to buy and sell Oil Futures Contracts
or Other Oil
Interests at the market price; (iii) may not experience
a perfect
correlation between the spot price of light, sweet crude oil and the
underlying investments in Oil Futures Contracts and Other
Oil Interests
and Treasuries, cash and/or cash equivalents; and (iv)
is required to pay
brokerage fees and the management fee, which will have an effect on
the correlation.
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Short-term
supply and demand for light, sweet crude oil may cause the market
price of the changes in the Benchmark Oil Futures Contract
to vary from
changes in USOF’s NAV if USOF has fully invested in Oil Futures Contracts
that do not reflect such supply and demand and it is unable
to replace
such contracts with Oil Futures Contracts that do reflect
such supply and
demand. In addition, there are also technical differences
between the two
markets, e.g., one is a physical market while the other
is a futures
market traded on exchanges, that may cause variations between
the spot
price of crude oil and the prices of related futures
contracts.
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·
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USOF
plans to buy only as many Oil Futures Contracts and Other
Oil Interests
that it can to get the changes in the NAV as close as possible
to the
price of the changes in Benchmark Oil Futures Contract.
The remainder of
its assets will be invested in Treasuries, cash and/or
cash equivalents
and will be used to satisfy initial margin and additional
margin
requirements, if any, and to otherwise support its investments
in oil
interests. Investments in Treasuries, cash and/or cash
equivalents, both
directly and as margin, will provide rates of return that
will vary from
changes in the value of the spot price of light, sweet crude oil and
the price of the Benchmark Oil Futures
Contract.
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34
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In
addition, because USOF incurs certain expenses in connection
with its
investment activities, and holds most of its assets in
more liquid
short-term securities for margin and other liquidity
purposes and for
redemptions that may be necessary on an ongoing basis,
the General Partner
is generally not able to fully invest USOF’s assets in Oil Futures
Contracts or Other Oil Interests and there cannot be perfect
correlation
between changes in USOF’s NAV and the changes in the price of the
Benchmark Oil Futures Contract.
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As
USOF grows, there may be more or less correlation. For
example, if USOF
only has enough money to buy three Benchmark Oil Futures
Contracts and it
needs to buy four contracts to track the price of oil then
the correlation
will be lower, but if it buys 20,000 Benchmark Oil Futures
Contracts and
it needs to buy 20,001 contracts then the correlation will
be higher. At
certain asset levels, USOF may be limited in its ability
to purchase the
Benchmark Oil Futures Contract or other Oil Futures Contracts
due to
accountability levels imposed by the relevant exchanges.
To the extent
that USOF invests in these other Oil Futures Contracts
or Other Oil
Interests, the correlation with the Benchmark Oil Futures
Contracts may be
lower. If USOF is required to invest in other Oil Futures
Contracts and
Other Oil Interests that are less correlated
with the Benchmark Oil Futures Contract, USOF would likely
invest in
over-the-counter contracts to increase the level of correlation
of USOF’s
assets. Over-the-counter contracts entail certain risks
described below
under “Over-the-Counter Contract
Risk.”
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USOF
may not be able to buy the exact number of Oil Futures
Contracts and Other
Oil Interests to have a perfect correlation with the Benchmark
Oil Futures
Contract if the purchase price of Oil Futures Contracts
required to be
fully invested in such contracts is higher than the proceeds
received for
the sale of a Creation Basket on the day the basket was
sold. In such
case, USOF could not invest the entire proceeds from the
purchase of the
Creation Basket in such futures contracts (for example,
assume USOF
receives $6,679,000 for the sale of a Creation Basket and
assume that the
price of an Oil Futures Contract for light, sweet crude oil is
$66,800, then USOF could only invest in only 99 Oil Futures
Contracts with
an aggregate value of $6,613,200). USOF would be required
to invest a
percentage of the proceeds in Treasuries to be deposited
as margin with
the futures commission merchant through which the contract
was purchased.
The remainder of the purchase price for the Creation Basket
would remain
invested in cash and Treasuries as determined by the General
Partner from
time to time based on factors such as potential calls for
margin or
anticipated redemptions. If the trading market for Oil
Futures Contracts
is suspended or closed, USOF may not be able to purchase
these investments
at the last reported price for such
investments.
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If
changes in USOF’s NAV do not correlate with changes in the price of the
Benchmark Oil Futures Contract, then investing
in USOF may not be an effective way to hedge against oil-related
losses or
indirectly invest in oil.
The
Benchmark Oil Futures Contract
may not correlate with the spot price of light, sweet, crude oil and this
could cause the price of units to substantially vary from the changes
in the
spot price of light, sweet crude oil. If this were to occur, then
investors may
not be able to effectively use USOF as a way to hedge against crude
oil-related
losses or as a way to indirectly invest in crude oil.
When
using the Benchmark Oil Futures Contract as a strategy to track
the spot price
of light, sweet crude oil, at best the correlation between changes
in
prices of such oil interests and the spot price of crude oil can be only
approximate. The degree of imperfection of correlation depends
upon
circumstances such as variations in the speculative oil market,
supply of and
demand for such oil interests and technical influences in oil futures
trading.
If there is a weak correlation between the oil interests and the
spot price
of light, sweet, crude oil, then the price of units may not accurately
track the spot price of light, sweet crude oil and investors may not be
able to effectively use USOF as a way to hedge the risk of losses
in their
oil-related transactions or as a way to indirectly invest in oil.
USOF
may experience a loss if it is
required to sell Treasuries at a price lower than the price at
which they were
acquired.
The
value
of Treasuries generally moves inversely with movements in interest
rates. If
USOF is required to sell Treasuries at a price lower than the price
at which
they were acquired, USOF will experience a loss. This loss may
adversely impact
the price of the units and may decrease the correlation between
the price of the
units, the price of USOF’s Oil Futures Contracts and Other Oil Interests, and
the spot price of light, sweet crude oil.
35
Certain
of USOF’s investments could
be illiquid which could cause large losses to investors at any
time or from time
to time.
USOF
may
not always be able to liquidate its positions in its investments
at the desired
price. It is difficult to execute a trade at a specific price when
there is a
relatively small volume of buy and sell orders in a market. A market
disruption,
such as a foreign government taking political actions that disrupt
the market in
its currency, its oil production or exports, or in another major
export, can
also make it difficult to liquidate a position. Alternatively,
limits imposed by
futures exchanges or other regulatory organizations, such as accountability
levels, position limits and daily price fluctuation limits, may
contribute to a
lack of liquidity with respect to some commodity interests.
Unexpected
market illiquidity may cause major losses to investors at any time
or from time
to time. In addition, USOF has not and does not intend to establish
a credit
facility, which would provide an additional source of liquidity
and instead will
rely only on the Treasuries, cash and/or cash equivalents that
it holds. The
anticipated large value of the positions in Oil Futures Contracts that the
General Partner will acquire or enter into for USOF, increases
the risk of
illiquidity. Such positions may be more difficult to liquidate
at favorable
prices and there is an additional risk that losses may be incurred
during the
period in which positions are being liquidated. The Other Oil Interests
that
USOF invests in, such as negotiated over-the-counter contracts, may have a
greater likelihood
of being
illiquid since they are contracts between two parties that take
into account not
only market risk, but also the relative credit, tax, and settlement
risks under
such contracts. Such contracts also have limited transferability
that results
from such risks and the contract’s express limitations.
Because
both Oil Futures Contracts and Other Oil Interests may be illiquid,
USOF’s oil
interests may be more difficult to liquidate at favorable prices
in periods of
illiquid markets and losses may be incurred during the period
in which positions
are being liquidated.
If
the nature of hedgors and
speculators in futures markets has shifted such that crude oil
purchasers are
the predominant hedgors in the market, USOF might have to reinvest
at higher
futures prices or choose Other Oil Interests.
The
changing nature of the hedgors and speculators in the crude oil
market
influences whether futures prices are above or below the expected
future spot
price. In order to induce speculators to take the corresponding
long side of the
same futures contract, crude oil producers must generally be willing
to sell
futures contracts at prices that are below expected future spot
prices.
Conversely, if the predominant hedgors in the futures market are
the purchasers
of the crude oil who purchase futures contracts to hedge against
a rise in
prices, then speculators will only take the short side of the futures
contract
if the futures price is greater than the expected future spot price
of crude
oil. This can have significant implications for USOF when it is
time to reinvest
the proceeds from a maturing futures contract into a new futures
contract.
While
USOF does not intend to take
physical delivery of oil under Oil Futures Contracts, physical
delivery under
such contracts impacts the value of the contracts.
While
USOF has not and does not intend to take physical delivery of oil
under its Oil
Futures Contracts, futures contracts are not required to be cash-settled,
and it
is possible to take delivery under these contracts. Storage costs
associated
with purchasing oil could result in costs and other liabilities
that could
impact the value of Oil Futures Contracts or Other Oil Interests.
Storage costs
include the time value of money invested in oil as a physical commodity
plus the
actual costs of storing the oil less any benefits from ownership
of oil that are
not obtained by the holder of a futures contract. In general, Oil
Futures
Contracts have a one-month delay for contract delivery and the
back month (the
back month is any future delivery month other than the spot month)
includes
storage costs. To the extent that these storage costs change for
oil while USOF
holds Oil Futures Contracts or Other Oil Interests, the value of
the Oil Futures
Contracts or Other Oil Interests, and therefore USOF’s NAV, may change as
well.
36
The
price relationship between the
near month contract and the next to near month contract that compose
the
Benchmark Oil Futures Contract will vary and may impact both the
total return
over time of USOF’s NAV, as well as the degree to which its total return tracks
other crude oil price indices’ total returns.
The
design of USOF's Benchmark Oil Futures Contract is such that every month
it begins by using the near month contract to expire until the near month
contract is within two weeks of expiration, when it will use the
next month
contract to expire as its benchmark contract and keeps that contract
as
its benchmark until it becomes the near month contract and close to
expiration. In the event of an oil futures market where near month
contracts
trade at a higher price than next to near month contracts, a situation
described
as “backwardation” in the futures market occurs. Absent the impact of the
overall movement in crude oil prices the value of the benchmark
contract would
tend to rise as it approaches expiration. As a result the total
return of the
Benchmark Oil Futures Contract would tend to track higher. Conversely,
in the
event of a crude oil futures market where near month contracts
trade at a lower
price than next to near month contracts, a situation described
as “contango” in
the futures market occurs. Absent the impact of the overall movement
in crude
oil prices the value of the benchmark contract would tend to decline
as it
approaches expiration. As a result the total return of the Benchmark
Oil Futures
Contract would tend to track lower. When compared to total return
of other price
indices, such as the spot price of crude oil, the impact of backwardation
and
contango may lead the total return of USOF’s NAV to vary significantly. In the
event of a prolonged period of contango, and absent the impact
of rising or
falling oil prices, this could have a significant negative impact
on USOF’s NAV
and total return.
Regulation
of the commodity
interests and energy markets is extensive and constantly changing;
future
regulatory developments are impossible to predict but may significantly
and
adversely affect USOF.
The
regulation of commodity interest transactions in the United States
is a rapidly
changing area of law and is subject to ongoing modification by
government and
judicial action. In addition, various national governments have
expressed
concern regarding the disruptive effects of speculative trading
in the energy
markets and the need to regulate the derivatives markets in general.
The effect
of any future regulatory change on USOF is impossible to predict,
but could be
substantial and adverse.
Investing
in USOF for purposes of
hedging may be subject to several risks including the possibility
of losing the
benefit of favorable market movement.
Participants
in the crude oil or in other industries may use USOF as a vehicle
to hedge the
risk of losses in their crude oil-related transactions. There are
several risks
in connection with using USOF as a hedging device. While hedging
can provide
protection against an adverse movement in market prices, it can
also preclude a
hedgor’s opportunity to benefit from a favorable market movement. In a
hedging
transaction, the hedgor may be concerned that the hedged item will
increase in
price, but must recognize the risk that the price may instead decline
and if
this happens he will have lost his opportunity to profit from the
change in
price because the hedging transaction will result in a loss rather
than a gain.
Thus, the hedgor foregoes the opportunity to profit from favorable
price
movements.
In
addition, if the hedge is not a perfect one, the hedgor can lose
on the hedging
transaction and not realize an offsetting gain in the value of
the underlying
item being hedged.
When
using futures contracts as a hedging technique, at best, the correlation
between
changes in prices of futures contracts and of the items being hedged
can be only
approximate. The degree of imperfection of correlation depends
upon
circumstances such as: variations in speculative markets, demand
for futures and
for oil products, technical influences in futures trading, and
differences
between anticipated energy costs being hedged and the instruments
underlying the
standard futures contracts available for trading. Even a well-conceived
hedge
may be unsuccessful to some degree because of unexpected market
behavior as well
as the expenses associated with creating the hedge.
In
addition, using an investment in USOF as a hedge for changes in
energy costs
(e.g.
,
investing in crude oil, heating oil, gasoline, natural gas or other
fuels, or
electricity) may not correlate because changes in the spot price
of crude oil
may vary from changes in energy costs because the spot price may
not be
at the same rate as changes in the price of other energy products,
and, in any
case, the price of crude oil does not reflect the refining, transportation,
and
other costs that may impact the hedgor’s energy costs.
37
An
investment in USOF may provide
little or no diversification benefits. Thus, in a declining market,
USOF may
have no gains to offset losses from other investments, and an investor
may
suffer losses on an investment in USOF while incurring losses with
respect to
other asset classes.
Historically,
Oil Futures Contracts and Other Oil Interests have generally been
non-correlated
to the performance of other asset classes such as stocks and bonds.
Non-correlation means that there is a low statistically valid relationship
between the performance of futures and other commodity interest
transactions, on
the one hand, and stocks or bonds, on the other hand. However,
there can be no
assurance that such non-correlation will continue during future
periods. If,
contrary to historic patterns, USOF’s performance were to move in the same
general direction as the financial markets, investors will obtain
little or no
diversification benefits from an investment in the units. In such
a case, USOF
may have no gains to offset losses from other investments, and investors
may suffer losses on their investment in USOF at the same time
they incur losses
with respect to other investments.
Variables
such as drought, floods, weather, embargoes, tariffs and other
political events
may have a larger impact on crude oil prices and crude oil-linked
instruments, including Oil Futures Contracts and Other Oil Interests,
than on
traditional securities. These additional variables may create additional
investment risks that subject USOF’s investments to greater volatility than
investments in traditional securities.
Non-correlation
should not be confused with negative correlation, where the performance
of two
asset classes would be opposite of each other. There is no historic
evidence
that the spot price of crude oil and prices of other financial assets, such
as stocks and bonds, are negatively correlated. In the absence
of negative
correlation, USOF cannot be expected to be automatically profitable
during
unfavorable periods for the stock market, or vice versa.
USOF’s
Operating
Risks
USOF
is not a registered investment
company so unitholders do not have the protections of the 1940
Act.
USOF
is
not an investment company subject to the 1940 Act. Accordingly, investors
do not have the protections afforded by that statute which, for
example,
requires investment companies to have a majority of
disinterested directors and regulates the relationship between
the investment
company and its investment manager.
The
General Partner is leanly
staffed and relies heavily on key personnel to manage trading
activities.
In
managing and directing the day-to-day activities and affairs
of USOF, the
General Partner relies heavily on Messrs. Nicholas Gerber, John Love
and John Hyland. If Messrs. Gerber, Love or Hyland were to leave
or be unable to carry out their present responsibilities, it
may have an adverse
effect on the management of USOF. Furthermore, Messrs. Gerber, Love
and Hyland are currently involved in the management of USNG, US12OF
and
USG, and the General Partner is currently in the process of registering
two
other exchange traded security funds, USHO and US12NG. Messrs.
Gerber and Love are also employed by Ameristock Corporation, a registered
investment adviser that manages a public mutual fund. It is estimated
that Mr.
Gerber will spend approximately 50% of his time on USOF, USNG,
USHO, USG, US12OF
and US12NG matters. Mr. Love will spend approximately 95% of his time
on USOF, USNG, USHO, USG, US12OF and US12NG matters and Mr. Hyland
will spend
approximately 75% of his time on USOF, USNG, USHO, USG, US12OF
and US12NG
matters. To the extent that the General Partner establishes additional
funds,
even greater demands will be placed on Messrs. Gerber, Love
and Hyland, as well as the other officers of the General Partner,
including
Mr. Mah, the Chief Financial Officer, and its Board of
Directors.
38
Accountability
levels, position
limits, and daily price fluctuation limits set by the exchanges
have the
potential to cause a tracking error, which could cause the price
of units to
substantially vary from the price of the Benchmark Oil Futures
Contract and
prevent investors from being able to effectively use USOF as a
way to hedge
against crude oil-related losses or as a way to indirectly invest
in crude
oil.
U.S.
designated contract markets such as the NYMEX 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 as a hedge, which an investment in
USOF is not)
may hold, own or control. For example, the current accountability
level for
investments at any one time in the Benchmark Oil Futures Contract is
20,000. While this is not a fixed ceiling, it is a threshold above
which the
NYMEX may exercise greater scrutiny and control over an investor,
including
limiting an investor to holding no more than 20,000 Benchmark Oil
Futures
Contracts. With regard to position limits, the NYMEX limits an
investor from
holding more than 3,000 net futures in the last 3 days of trading
in the near
month contract to expire.
In
addition to accountability levels and position limits, the NYMEX
also sets daily
price fluctuation limits on Oil 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
Oil
Futures Contract, no trades may be made at a price beyond that
limit.
For
example, the NYMEX imposes a $10.00 per barrel ($10,000 per contract)
price
fluctuation limit for the Benchmark Oil Futures Contract. This
limit is
initially based off of the previous trading day’s settlement price. If any
Benchmark Oil Futures Contract is traded, bid, or offered at the
limit for five
minutes, trading is halted for five minutes. When trading resumes
it begins at
the point where the limit was imposed and the limit is reset to
be $10.00 per
barrel in either direction of that point. If another halt were
triggered, the
market would continue to be expanded by $10.00 per barrel in either
direction
after each successive five-minute trading halt. There is no maximum
price
fluctuation limits during any one trading session.
All
of
these limits may potentially cause a tracking error between the
price of the
units and the price of the Benchmark Oil Futures Contract.This
may in turn
prevent investors from being able to effectively use USOF as a
way to hedge
against oil-related losses or as a way to indirectly invest in
crude
oil.
USOF
has
not limited the size of its offering and is committed to utilizing
substantially
all of its proceeds to purchase Oil Futures Contracts and Other
Oil Interests.
If USOF encounters accountability levels, position limits, or price
fluctuation
limits for crude oil contracts on the NYMEX, it has and will continue
to, if
permitted under applicable regulatory requirements, purchase futures
contracts
on the ICE Futures (formerly, the International Petroleum Exchange)
or other
exchanges that trade listed oil futures. The futures contracts
available on the
ICE Futures are generally comparable to the contracts on the NYMEX,
but they may
have different underlying commodities, sizes, deliveries, and
prices.
There
are technical and fundamental
risks inherent in the trading system the General Partner intends
to
employ.
The
General Partner’s trading system is quantitative in nature and it is possible
that the General Partner might make a mathematical error. In addition,
it is
also possible that a computer or software program may malfunction
and cause an
error in computation.
USOF
and the General Partner may
have conflicts of interest, which may permit them to favor their
own interests
to the detriment of unitholders.
USOF
and
the General Partner may have inherent conflicts to the extent the
General
Partner attempts to maintain USOF’s asset size in order to preserve its fee
income and this may not always be consistent with USOF’s objective of tracking
changes in the spot price of light, sweet crude oil. The General Partner’s
officers, directors and employees do not devote their time exclusively
to USOF.
These persons are directors, officers or employees of other entities
that may
compete with USOF for their services. They could have a conflict
between their
responsibilities to USOF and to those other entities.
39
In
addition, the General Partner’s principals, officers, directors or employees may
trade futures and related contracts for their own account. A conflict
of
interest may exist if their trades are in the same markets and
at the same time
as USOF trades using the clearing broker to be used by USOF. A
potential
conflict also may occur if the General Partner’s principals, officers, directors
or employees trade their accounts more aggressively or take positions
in their
accounts which are opposite, or ahead of, the positions taken by
USOF.
The
General Partner has sole current authority to manage the investments
and
operations of USOF, and this may allow it to act in a way that
furthers its own
interests which may create a conflict with the best interests of
investors.
Limited partners have limited voting control, which will limit
the ability to
influence matters such as amendment of the LP Agreement, change
in USOF’s basic
investment policy, dissolution of this fund, or the sale or distribution
of
USOF’s assets.
The
General Partner serves as the general partner to each of USOF,
USNG, US12OF and
USG and will serve as the general partner for USHO and US12NG, if
such
other funds offer their securities to the public or begin operations.
The
General Partner may have a conflict to the extent that its trading
decisions for
USOF may be influenced by the effect they would have on the other
funds it
manages. These trading decisions may be influenced since the
General Partner
also serves as the general partner for all of the funds and is
required to meet
all of the funds’ investment objectives as well as USOF’s. If the General
Partner believes that a trading decision it made on behalf of
USOF might (i)
impede its other funds from reaching their investment objectives,
or (ii)
improve the likelihood of meeting its other funds’ objectives, then the General
Partner may choose to change its trading decision for USOF, which
could either
impede or improve the opportunity for USOF from meeting its investment
objective. In addition, the General Partner is required to indemnify
the
officers and directors of its other funds if the need for indemnification
arises. This potential indemnification will cause the General
Partner’s assets
to decrease. If the General Partner’s other sources of income are not sufficient
to compensate for the indemnification, then the General Partner
may terminate
and you could lose your investment.
Unitholders
may only vote on the
removal of the General Partner and limited partners have only limited
voting
rights. Unitholders and limited partners will not participate in
the management
of USOF and do not control the General Partner so they will not
have influence
over basic matters that affect USOF.
Unitholders
that have not applied to become limited partners have no voting
rights, other
than to remove the General Partner. Limited partners will have
limited voting
rights with respect to USOF’s affairs. Unitholders may remove the General
Partner only if 66 and 2/3% of the unitholders elect to do so.
Unitholders and
limited partners will not be permitted to participate in the
management or
control of USOF or the conduct of its business. Unitholders and
limited partners
must therefore rely upon the duties and judgment of the General
Partner to
manage USOF’s affairs.
The
General Partner may manage a
large amount of assets and this could affect USOF’s ability to trade
profitably.
Increases
in assets under management may affect trading decisions. In general,
the General
Partner does not intend to limit the amount of assets of USOF that
it may
manage. The more assets the General Partner manages, the more difficult
it may
be for it to trade profitably because of the difficulty of trading
larger
positions without adversely affecting prices and performance and
of managing
risk associated with larger positions.
USOF
could terminate at any time and
cause the liquidation and potential loss of an investor's investment
and could
upset the overall maturity and timing of an investor's investment
portfolio.
USOF
may
terminate at any time, regardless of whether USOF has incurred
losses, subject
to the terms of the LP Agreement. In particular, unforeseen circumstances,
including the death, adjudication of incompetence, bankruptcy,
dissolution, or
removal of the General Partner could cause USOF 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 interest of the limited partners subject to
certain
conditions. However, no level of losses will require the General
Partner to
terminate USOF. USOF’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.
40
Limited
partners may not have
limited liability in certain circumstances, including potentially
having
liability for the return of wrongful distributions.
Under
Delaware law, a limited partner might be held liable for our obligation
as if it
were a General Partner if the limited partner participates in the
control of the
partnership’s business and the persons who transact business with the
partnership think the limited partner is the General Partner.
A
limited
partner will not be liable for assessments in addition to its initial
capital
investment in any of our capital securities representing units.
However, a
limited partner may be required to repay to us any amounts wrongfully
returned
or distributed to it under some circumstances. Under Delaware law,
we may not
make a distribution to limited partners if the distribution causes
our
liabilities (other than liabilities to partners on account of their
partnership
interests and nonrecourse liabilities) to exceed the fair value
of our assets.
Delaware law provides that a limited partner who receives such
a distribution
and knew at the time of the distribution that the distribution
violated the law
will be liable to the limited partnership for the amount of the
distribution for
three years from the date of the distribution.
With
adequate notice, a limited
partner may be required to withdraw from the partnership for any
reason.
If
the
General Partner gives at least fifteen (15) days’ written notice to a limited
partner, then the General Partner may for any reason, in its sole
discretion,
require any such limited partner to withdraw entirely from the
partnership or to
withdraw a portion of his partner capital account. The General
Partner may
require withdrawal even in situations where the limited partner
has complied
completely with the provisions of the LP Agreement.
USOF’s
existing units are, and any
units USOF issues in the future will be, subject to restrictions
on transfer.
Failure to satisfy these requirements will preclude a transferee
from being able
to have all the rights of a limited partner.
No
transfer of any unit or interest therein may be made if such transfer
would (a)
violate the then applicable federal or state securities laws or
rules and
regulations of the SEC, any state securities commission, the CFTC
or any other
governmental authority with jurisdiction over such transfer, or
(b) cause USOF
to be taxable as a corporation or affect USOF’s existence or qualification as a
limited partnership. In addition, investors may only become limited
partners if
they transfer their units to purchasers that meet certain conditions
outlined in
the LP Agreement, which provides that each record holder or limited
partner or
unitholder applying to become a limited partner (each a record
holder) may be
required by the General Partner to furnish certain information,
including that
holder’s nationality, citizenship or other related status. A transferee
who is
not a U.S. resident may not be eligible to become a record holder
or a limited
partner if its ownership would subject USOF to the risk of cancellation
or
forfeiture of any of its assets under any federal, state or local
law or
regulation. All purchasers of USOF’s units, who wish to become limited partners
or record holders, and receive cash distributions, if any, or have
certain other
rights, must deliver an executed transfer application in which
the purchaser or
transferee must certify that, among other things, he, she or it
agrees
to
be bound by USOF’s LP Agreement and is eligible to purchase USOF’s securities.
Any transfer of units will not be recorded by the transfer agent
or recognized
by us unless a completed transfer application is delivered to the
General
Partner or the Administrator. A person purchasing USOF’s existing units, who
does not execute a transfer application and certify that the purchaser
is
eligible to purchase those securities acquires no rights in those
securities
other than the right to resell those securities. Whether or not
a transfer
application is received or the consent of the General Partner obtained,
our
units will be securities and will be transferable according to
the laws
governing transfers of securities. See “Transfer of Units.”
USOF
does not expect to make cash
distributions.
The
General Partner intends to re-invest any realized gains in additional
oil
interests rather than distributing cash to limited partners. Therefore,
unlike
mutual funds, commodity pools or other investment pools that actively
manage
their investments in an attempt to realize income and gains from
their investing
activities and distribute such income and gains to their investors,
USOF
generally does not expect to distribute cash to limited partners.
An investor
should not invest in USOF if it will need cash distributions from
USOF to pay
taxes on its share of income and gains of USOF, if any, or for
any other reason.
Although USOF does not intend to make cash distributions, the income
earned from
its investments held directly or posted as margin may reach levels
that merit
distribution, e.g., at levels where such income is not necessary
to support its
underlying investments in oil interests and investors adversely
react to being
taxed on such income without receiving distributions that could
be used to pay
such tax. If this income becomes significant then cash distributions
may be
made.
41
There
is a risk that USOF will not
earn trading gains sufficient to compensate for the fees and expenses
that it
must pay and as such USOF may not earn any profit.
USOF
pays
brokerage charges of approximately 0.15%, futures commission merchant fees
of
$3.50 per buy or sell, management fees of 0.50% of NAV on the first
$1,000,000,000 of assets and 0.20% of NAV after the first $1,000,000,000
of
assets, and over-the-counter spreads and extraordinary expenses (i.e.
expenses
not in the ordinary course of business, including the indemnification of
any
person against liabilities and obligations to the extent permitted by law
and
required under the LP Agreement and under agreements entered into by the
General
Partner on USOF’s behalf and the bringing and defending of actions at law or in
equity and otherwise engaging in the conduct of litigation and the incurring
of
legal expenses and the settlement of claims and litigation) that can not
be
quantified. These fees and expenses must be paid in all cases regardless
of
whether USOF’s activities are profitable. Accordingly, USOF must earn trading
gains sufficient to compensate for these fees and expenses before it can
earn
any profit.
USOF
has historically depended upon its affiliates to pay all its expenses.
If this
offering of units does not raise sufficient funds to pay USOF’s future expenses
and no other source of funding of expenses is found, USOF may be forced
to
terminate and investors may lose all or part of their investment.
Prior
to
the offering of units that commenced on January 30, 2007, all of USOF’s expenses
were funded by the General Partner and its affiliates. These payments
by the
General Partner and its affiliates were designed to allow USOF the
ability to commence the public offering of its units. USOF now directly
pays
certain of these fees and expenses. The General Partner will continue
to pay other fees and expenses, as set forth in the LP Agreement. If
the General
Partner and USOF are unable to raise sufficient funds to cover their
expenses or
locate any other source of funding, USOF may be forced to terminate and
investors may lose all or part of their investment.
USOF
may incur higher fees and
expenses upon renewing existing or entering into new contractual
relationships.
The
clearing arrangements between the clearing brokers and USOF generally are
terminable by the clearing brokers once the clearing broker has given USOF
notice. Upon termination, the General Partner may be required to renegotiate
or
make other arrangements for obtaining similar services if USOF intends
to
continue trading in Oil Futures Contracts or Other Oil Interest contracts
at its
present level of capacity.
The
services of any clearing broker may not be available, or even if available,
these services may not be available on the terms as favorable as those
of the
expired or terminated clearing arrangements.
USOF
may miss certain trading
opportunities because it will not receive the benefit of the expertise
of
independent trading advisors.
The
General Partner does not employ trading advisors for USOF; however, it
reserves
the right to employ them in the future. The only advisor to USOF is the
General
Partner. A lack of independent trading advisors may be disadvantageous
to USOF
because it will not receive the benefit of a trading advisor’s
expertise.
An
unanticipated number of
redemption requests during a short period of time could have an adverse
effect
on the NAV of USOF.
If
a
substantial number of requests for redemption of Redemption Baskets are
received
by USOF during a relatively short period of time, USOF may not be able
to
satisfy the requests from USOF’s assets not committed to trading. As a
consequence, it could be necessary to liquidate positions in USOF’s trading
positions before the time that the trading strategies would otherwise dictate
liquidation.
The
failure or bankruptcy of a
clearing broker could result in a substantial loss of USOF’s
assets.
Under
CFTC regulations, a clearing broker maintains customers’ assets in a bulk
segregated account. If a clearing broker fails to do so, or is unable to
satisfy
a substantial deficit in a customer account, its other customers may be
subject
to risk of loss of their funds in the event of that clearing broker’s
bankruptcy. In that event, the clearing broker’s customers, such as USOF, are
entitled to recover, even in respect of property specifically traceable
to them,
only a proportionate share of all property available for distribution to
all of
that clearing broker’s customers. USOF also may be subject to the risk of the
failure of, or delay in performance by, any exchanges and markets and their
clearing organizations, if any, on which commodity interest contracts are
traded.
From
time
to time, the clearing brokers may be subject to legal or regulatory proceedings
in the ordinary course of their business. A clearing broker’s involvement in
costly or time-consuming legal proceedings may divert financial resources
or
personnel away from the clearing broker’s trading operations, which could impair
the clearing broker’s ability to successfully execute and clear USOF’s
trades.
42
Third
parties may infringe upon or
otherwise violate intellectual property rights or assert that the General
Partner has infringed or otherwise violated their intellectual property
rights,
which may result in significant costs and diverted
attention.
Third
parties may utilize USOF’s intellectual property or technology, including the
use of its business methods, trademarks and trading program software,
without
permission. The General Partner has a patent pending for USOF’s business method
and it is registering its trademarks. USOF does not currently have any
proprietary software. However, if it obtains proprietary software in
the future,
then any unauthorized use of USOF’s proprietary software and other technology
could also adversely affect its competitive advantage. USOF may have
difficulty
monitoring unauthorized uses of its patents, trademarks, proprietary
software
and other technology. Also, third parties may independently develop business
methods, trademarks or proprietary software and other technology similar
to that
of the General Partner or claim that the General Partner has violated
their
intellectual property rights, including their copyrights, trademark rights,
trade names, trade secrets and patent rights. As a result, the General
Partner
may have to litigate in the future to protect its trade secrets, determine
the
validity and scope of other parties’ proprietary rights, defend itself against
claims that it has infringed or otherwise violated other parties’ rights, or
defend itself against claims that its rights are invalid. Any litigation
of this
type, even if the General Partner is successful and regardless of the
merits,
may result in significant costs, divert its resources from USOF, or require
it
to change its proprietary software and other technology or enter into
royalty or
licensing agreements. See "Legal Risks" below.
The
success of USOF depends on the
ability of the General Partner to accurately implement trading systems,
and any
failure to do so could subject USOF to losses on such
transactions.
The
General Partner uses mathematical formulas built into a generally available
spreadsheet program to decide whether it should buy or sell oil interests
each
day. Specifically, the General Partner uses the spreadsheet to make mathematical
calculations and to monitor positions in oil interests and Treasuries
and
correlations to the spot price of light, sweet crude oil. The General
Partner must accurately process the spreadsheet’s outputs and execute the
transactions called for by the formulas. In addition, USOF relies on
the General
Partner to properly operate and maintain its computer and communications
systems. Execution of the formulas
and operation of the systems are subject to human error. Any failure,
inaccuracy
or delay in implementing any of the formulas or systems and executing
USOF’s
transactions could impair its ability to achieve USOF’s investment objective. It
could also result in decisions to undertake transactions based on inaccurate
or
incomplete information. This could cause substantial losses on
transactions.
USOF
may experience substantial
losses on transactions if the computer or communications system
fails.
USOF’s
trading activities, including its risk management, depend on the integrity
and
performance of the computer and communications systems supporting them.
Extraordinary transaction volume, hardware or software failure, power
or
telecommunications failure, a natural disaster or other catastrophe could
cause
the computer systems to operate at an unacceptably slow speed or even
fail. Any
significant degradation or failure of the systems that the General Partner
uses
to gather and analyze information, enter orders, process data, monitor
risk
levels and otherwise engage in trading activities may result in substantial
losses on transactions, liability to other parties, lost profit opportunities,
damages to the General Partner’s and USOF’s reputations, increased operational
expenses and diversion of technical resources.
If
the computer and communications
systems are not upgraded, as needed, USOF’s financial condition could be
harmed.
The
development of complex computer and communications systems and new technologies
may render the existing computer and communications systems supporting
USOF’s
trading activities obsolete. In addition, these computer and communications
systems must be compatible with those of third parties, such as the systems
of
exchanges, clearing brokers and the executing brokers. As a result, if
these
third parties upgrade their systems, the General Partner will need to
make
corresponding upgrades to continue effectively its trading activities.
USOF’s
future success will depend on USOF’s ability to respond to changing technologies
on a timely and cost-effective basis.
43
USOF
depends on the reliable
performance of the computer and communications systems of third parties,
such as
brokers and futures exchanges, and may experience substantial losses
on
transactions if they fail.
USOF
depends on the proper and timely function of complex computer and communications
systems maintained and operated by the futures exchanges, brokers and
other data
providers that the General Partner uses to conduct trading activities.
Failure
or inadequate performance of any of these systems could adversely affect
the
General Partner’s ability to complete transactions, including its ability to
close out positions, and result in lost profit opportunities and significant
losses on commodity interest transactions. This could have a material
adverse
effect on revenues and materially reduce USOF’s available capital. For example,
unavailability of price quotations from third parties may make it difficult
or
impossible for the General Partner to use its proprietary software that
it
relies upon to conduct its trading activities. Unavailability of records
from
brokerage firms may make it difficult or impossible for the General Partner
to
accurately determine which transactions have been executed or the details,
including price and time, of any transaction executed. This unavailability
of
information also may make it difficult or impossible for the General
Partner to
reconcile its records of transactions with those of another party or
to
accomplish settlement of executed transactions.
The
occurrence of a terrorist
attack, or the outbreak, continuation or expansion of war or other hostilities
could disrupt USOF’s trading activity and materially affect USOF’s
profitability.
The
operations of USOF, the exchanges, brokers and counterparties with which
USOF
does business, and the markets in which USOF does business could be severely
disrupted in the event of a major terrorist attack or the outbreak, continuation
or expansion of war or other hostilities. The terrorist attacks of September
11,
2001 and the war in Iraq, global anti-terrorism initiatives and political
unrest
in the Middle East and Southeast Asia continue to fuel this
concern.
Risk
of Leverage and
Volatility
If
the General Partner permits USOF
to become leveraged, investors could lose all or substantially all of
their
investment if USOF’s trading positions suddenly turn
unprofitable.
Commodity
pools’ trading positions in futures contracts or other commodity interests 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 interests’)
entire face value. This feature permits commodity pools to “leverage” their
assets by purchasing
or selling futures contracts (or other commodity interests) with an aggregate
value in excess of the commodity pool’s assets. While this leverage can increase
the pool’s profits, relatively small adverse movements in the price of the
pool’s futures contracts can cause significant losses to the pool. While the
General Partner does not currently leverage USOF’s assets, it is not prohibited
from doing so under the LP Agreement or otherwise.
The
price of crude oil is volatile which could cause large fluctuations
in the price
of units.
Movements
in the price of crude oil may be the result of factors outside of the
General
Partner’s control and may not be anticipated by the General Partner. For
example, price movements for barrels of oil are influenced by, among
other
things:
|
•
|
changes
in interest rates;
|
|
•
|
actions
by oil producing countries such as the OPEC
countries;
|
|
•
|
governmental,
agricultural, trade, fiscal, monetary and exchange control
programs and
policies;
|
|
•
|
weather
and climate conditions;
|
|
•
|
changing
supply and demand relationships, including but not limited
to increased
demand by other countries such as
China;
|
|
•
|
changes
in balances of payments and trade;
|
|
•
|
U.S.
and international rates of
inflation;
|
|
•
|
currency
devaluations and revaluations;
|
|
•
|
U.S.
and international political and economic events;
and
|
|
•
|
changes
in philosophies and emotions of market
participants.
|
Over-the-Counter
Contract
Risk
Over-the-counter
transactions are
subject to little, if any, regulation.
A
portion
of USOF’s assets may be used to trade over-the-counter oil interest contracts,
such as forward contracts or swap or spot contracts. Over-the-counter
contracts
are typically traded on a principal-to-principal basis through dealer
markets
that are dominated by major money center and investment banks and other
institutions and are essentially unregulated by the CFTC. Investors therefore
do
not receive the protection of CFTC regulation or the statutory scheme
of the CEA
in connection with this trading activity by USOF. The markets for
over-the-counter contracts rely upon the integrity of market participants
in
lieu of the additional regulation imposed by the CFTC on participants
in the
futures markets. The lack of regulation in these markets could expose
USOF in
certain circumstances to significant losses in the event of trading abuses
or
financial failure by participants.
44
USOF
will be subject to credit risk
with respect to counterparties to over-the-counter contracts entered
into by
USOF or held by special purpose or structured
vehicles.
USOF
faces the risk of non-performance by the counterparties to the over-the-counter
contracts. Unlike in futures contracts, the counterparty to these contracts
is
generally a single bank or other financial institution, rather than a
clearing
organization backed by a group of financial institutions. As a result,
there
will be greater counterparty credit risk in these transactions. A counterparty
may not be able to meet its obligations to USOF, in which case USOF could
suffer
significant losses on these contracts.
If
a
counterparty becomes bankrupt or otherwise fails to perform its obligations
due
to financial difficulties, USOF may experience significant delays in
obtaining
any recovery in a bankruptcy or other reorganization proceeding. USOF
may obtain
only limited recovery or may obtain no recovery in such
circumstances.
USOF
may be subject to liquidity
risk with respect to its over-the-counter contracts.
Over-the-counter
contracts may have terms that make them less marketable than Oil Futures
Contracts. Over-the-counter contracts are less marketable because they
are not
traded on an exchange, do not have uniform terms and conditions, and
are entered
into based upon the creditworthiness of the parties and the availability
of
credit support, such
as
collateral, and in general, they are not transferable without the consent
of the
counterparty. These conditions diminish the ability to realize the full
value of
such contracts.
Risk
of Trading in International
Markets
Trading
in international markets
would expose USOF to credit and regulatory risk.
The
General Partner invests primarily in Oil Futures Contracts, a significant
portion of which are traded on United States exchanges including the
NYMEX.
However, a portion of USOF’s trades take place on markets and exchanges outside
the United States. Some non-U.S. markets present risks because they are
not
subject to the same degree of regulation as their U.S. counterparts.
None of the
CFTC, NFA, or any domestic exchange regulates activities of any foreign
boards
of trade or exchanges, including the execution, delivery and clearing
of
transactions, nor has the power to compel enforcement of the rules of
a foreign
board of trade or exchange or of any applicable non-U.S. laws. Similarly,
the
rights of market participants, such as USOF, in the event of the insolvency
or
bankruptcy of a non-U.S. market or broker are also likely to be more
limited
than in the case of U.S. markets or brokers. As a result, in these markets,
USOF
has less legal and regulatory protection than it does when it trades
domestically.
In
some
of these non-U.S. markets, the performance on a contract is the responsibility
of the counterparty and is not backed by an exchange or clearing corporation
and
therefore exposes USOF to credit risk. Trading in non-U.S. markets also
leaves
USOF susceptible to swings in the value of the local currency against
the U.S.
dollar. Additionally, trading on non-U.S. exchanges is subject to the
risks
presented by exchange controls, expropriation, increased tax burdens
and
exposure to local economic declines and political instability. An adverse
development with respect to any of these variables could reduce the profit
or
increase the loss earned on trades in the affected international
markets.
45
International
trading activities
subject USOF to foreign exchange risk.
The
price
of any non-U.S. futures, options on futures or other commodity interest
contract
and, therefore, the potential profit and loss on such contract, may be
affected
by any variance in the foreign exchange rate between the time the order
is
placed and the time it is liquidated, offset or exercised. As a result,
changes
in the value of the local currency relative to the U.S. dollar may cause
losses
to USOF even if the contract traded is profitable.
USOF’s
international trading would
expose it to losses resulting from non-U.S. exchanges that are less developed
or
less reliable than United States exchanges.
Some
non-U.S. exchanges may be in a more developmental stage so that prior
price
histories may not be indicative of current price dynamics. In addition,
USOF may
not have the same access to certain positions on foreign trading exchanges
as do
local traders, and the historical market data on which General Partner
bases its
strategies may not be as reliable or accessible as it is for U.S.
exchanges.
Tax
Risk
An
investor's tax liability may
exceed the amount of distributions, if any, on its
units.
Cash
or
property will be distributed at the sole discretion of the General Partner,
and
the General Partner currently does not intend to make cash or other
distributions with respect to units. Investors will be required to pay
U.S.
federal income tax and, in some cases, state, local, or foreign income
tax, on
their allocable share of USOF’s taxable income, without regard to whether they
receive distributions or the amount of any distributions. Therefore,
the tax
liability of an investor with respect to its units may exceed the amount of
cash or value of property (if any) distributed.
An
investor's allocable share of
taxable income or loss may differ from its economic income or loss on
its
units.
Due
to
the application of the assumptions and conventions applied by USOF in
making
allocations for tax purposes and other factors, an investor's allocable
share of
USOF’s income, gain, deduction or loss may be different than its
economic
profit or loss from its units for a taxable year. This difference could
be
temporary or permanent and, if permanent, could result in it being taxed
on
amounts in excess of its economic income.
Items
of income, gain, deduction,
loss and credit with respect to units could be reallocated if the IRS
does not
accept the assumptions and conventions applied by USOF in allocating
those
items, with potential adverse consequences for an
investor.
The
U.S.
tax rules pertaining to partnerships are complex and their application
to large,
publicly traded partnerships such as USOF is in many respects uncertain.
USOF
applies certain assumptions and conventions in an attempt to comply with
the
intent of the applicable rules and to report taxable income, gains, deductions,
losses and credits in a manner that properly reflects unitholders’ economic
gains and losses. These assumptions and conventions may not fully comply
with
all aspects of the Internal Revenue Code (the “Code”) and applicable Treasury
Regulations, however, and it is possible that the U.S. Internal Revenue
Service
will successfully challenge our allocation methods and require us to
reallocate
items of income, gain, deduction, loss or credit in a manner that adversely
affects investors. If this occurs, investors may be required to file
an amended
tax return and to pay additional taxes plus deficiency interest.
46
We
could be treated as a corporation
for federal income tax purposes, which may substantially reduce the value
of the
units.
USOF
has
received an opinion of counsel that, under current U.S. federal income
tax laws,
USOF will be treated as a partnership that is not taxable as a corporation
for
U.S. federal income tax purposes, provided that (i) at least 90 percent
of
USOF’s annual gross income consists of “qualifying income” as defined in the
Code, (ii) USOF is organized and operated in accordance with its governing
agreements and applicable law and (iii) USOF does not elect to be taxed
as a
corporation for federal income tax purposes. Although the General Partner
anticipates that USOF will satisfy the “qualifying income” requirement for all
of its taxable years, that result cannot be assured. USOF has not requested
and
will not request any ruling from the IRS with respect to its classification
as a
partnership not taxable as a corporation for federal income tax purposes.
If the
IRS were to successfully assert that USOF is taxable as a corporation
for
federal income tax purposes in any taxable year, rather than passing
through its
income, gains, losses and deductions proportionately to unitholders,
USOF would
be subject to tax on its net income for the year at corporate tax rates.
In
addition, although the General Partner does not currently intend to make
distributions with respect to units, any distributions would be taxable
to
unitholders as dividend income. Taxation of USOF as a corporation could
materially reduce the after-tax return on an investment in units and
could
substantially reduce the value of the units.
Legal
Risks
USOF
has been notified of intellectual property rights that could adversely
impact
USOF.
Goldman,
Sachs & Co. (“Goldman Sachs”) sent USOF a letter on March 17, 2006,
providing USOF and the General Partner notice under 35 U.S.C. Section
154(d) of
two pending United States patent applications, Publication Nos. 2004/0225593A1
and 2006/0036533A1. Both patent applications are generally directed
to a method
and system for creating and administering a publicly traded interest
in a
commodity pool. In particular, the Abstract of each patent application
defines a
means for creating and administering a publicly traded interest in
a commodity
pool that includes the steps of forming a commodity pool having a first
position
in a futures contract and a corresponding second position in a margin
investment, and issuing equity interests of the commodity pool to third
party
investors. Subsequently, two U.S. Patents were issued; the first, patent
number
US7,283,978B2, was issued on October 16, 2007, and the second, patent
number
US7,319,984B2, was issued on January 15, 2008.
Preliminarily,
USOF's management is of the view that the structure and operations of USOF
and its affiliated commodity pools do not infringe these patents. USOF
is also
in the process of reviewing prior art (prior structures and operations
of
similar investment vehicles) that may invalidate one or more of the
claims in
these patents. In addition, USOF has retained patent counsel to advise
it on
these matters and is in the process of obtaining their opinions regarding
the
non-infringement of each of these patents by USOF and/or the patents'
invalidity
based on prior art. If the patents were alleged to apply to USOF's
structure
and/or operations, and are found by a court to be valid and infringed,
Goldman
Sachs may be awarded significant monetary damages and/or injunctive
relief.
See
“USOF's Operating Risks — Third parties may infringe upon or otherwise
violate intellectual property rights or assert that the General Partner
has
infringed or otherwise violated their intellectual property rights,
which may
result in significant costs and diverted attention.”
47
|
Unresolved
Staff
Comments.
|
Not
applicable.
|
Properties.
|
Not
applicable.
|
Legal
Proceedings.
|
Although
USOF may, from time to time, be involved in litigation arising out
of its
operations in the normal course
of
business or otherwise, USOF is currently not a party to any pending
material
legal proceedings, except for the items noted below.
Goldman
Sachs
Goldman
Sachs sent USOF a letter on March 17, 2006, providing USOF and
the General
Partner notice under 35 U.S.C. Section 154(d) of two pending United
States
patent applications, Publication Nos. 2004/0225593A1 and 2006/0036533A1.
Both
patent applications are generally directed to a method and system
for creating
and administering a publicly traded interest in a commodity pool.
In particular,
the Abstract of each patent application defines a means for creating
and
administering a publicly traded interest in a commodity pool that
includes the
steps of forming a commodity pool having a first position in a
futures contract
and a corresponding second position in a margin investment, and
issuing equity
interests of the commodity pool to third party investors. Subsequently,
two U.S.
Patents were issued; the first, patent number US7,283,978B2, was
issued on
October 16, 2007, and the second, patent number US7,319,984B2,
was issued on
January 15, 2008.
Preliminarily, USOF's
management is of the view that the structure and operations of USOF and its
affiliated commodity pools do not infringe these patents. USOF
is also in the
process of reviewing prior art (prior structures and operations
of similar
investment vehicles) that may invalidate one or more of the claims
in these
patents. In addition, USOF has retained patent counsel to advise
it on these
matters and is in the process of obtaining their opinions regarding
the
non-infringement of each of these patents by USOF and/or the patents'
invalidity
based on prior art. If the patents were alleged to apply to USOF's
structure
and/or operations, and are found by a court to be valid and infringed,
Goldman
Sachs may be awarded significant monetary damages and/or injunctive
relief.
See
“USOF's Operating Risks — Third parties may infringe upon or otherwise
violate intellectual property rights or assert that the General
Partner has
infringed or otherwise violated their intellectual property rights,
which may
result in significant costs and diverted attention.”
48
|
Submission
of Matters to a Vote
of Security Holders.
|
Not
applicable.
|
Market
for Registrant’s Common
Equity, Related Stockholder Matters and Issuer Purchases
of Equity
Securities.
|
Price
Range of
Units
USOF’s
units have traded on the AMEX under the symbol “USO” since its initial
public offering on April 10, 2006. The following table sets forth
the range of
reported high and low sales prices of the units as reported on
AMEX for the
periods indicated below.
|
|
High
|
|
Low
|
|
|||
|
Fiscal
year 2007
|
|||||||
|
First
quarter
|
$ | 53.62 | $ | 43.23 | |||
|
Second
quarter
|
$ | 53.56 | $ | 48.01 | |||
|
Third
quarter
|
$ | 63.44 | $ | 52.35 | |||
|
Fourth
quarter
|
$
|
77.34
|
$
|
60.76
|
|||
|
|
High
|
|
Low
|
|
|||
|
Fiscal
year 2006
|
|||||||
|
Second
quarter (beginning April 10, 2006)
|
$ | 73.23 | $ | 64.89 | |||
|
Third
quarter
|
$ | 74.60 | $ | 54.06 | |||
|
Fourth
quarter
|
$
|
56.90
|
$
|
50.25
|
|||
As
of
December 31, 2007, USOF had 14,504 holders
of units.
49
Dividends
USOF
has
not made and does not intend to make cash distributions to its unitholders.
Issuer
Purchases of Equity
Securities
USOF
does
not purchase units directly from its unitholders; however, in connection
with
its redemption of baskets held by Authorized Purchasers, USOF redeemed
875
baskets (comprising 87,500,000 units) during the year ended December
31,
2007.
|
Selected
Financial
Data.
|
Financial
Highlights (for the year
ended December 31, 2007)
(Dollar
amounts in 000’s except for
Loss per unit)
|
Total
assets
|
$
|
485,817
|
||
|
Net
realized and unrealized gain on futures transactions, inclusive
of
commissions
|
$
|
254,426
|
|
|
|
Net
income
|
$
|
284,416
|
||
|
Weighted-average
limited partnership units
|
13,730,137
|
|||
| Net income per unit | $ | 23.95 | ||
|
Net
income per weighted average unit
|
$
|
20.71
|
||
|
Cash
at end of year
|
$
|
354,816
|
50
|
Management’s
Discussion and
Analysis of Financial Condition and Results of
Operations.
|
The
following discussion should be read in conjunction with the consolidated
financial statements and the notes thereto of USOF included elsewhere in
this annual report on Form 10-K.
Forward-Looking
Information
This
annual report on Form 10-K, 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 cause USOF's actual results, performance
or
achievements to be materially different from future results, performance
or
achievements expressed or implied by any forward-looking statements.
Forward-looking statements, which involve assumptions and describe USOF'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, and USOF
cannot
assure investors that these projections included in these forward-looking
statements will come to pass. USOF's actual results could differ materially
from those expressed or implied by the forward-looking statements
as a result of
various factors.
USOF
has
based the forward-looking statements included in this annual report
on Form 10-K
on information available to it on the date of this annual report on Form
10-K, and USOF assumes no obligation to update any such forward-looking
statements. Although USOF 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
that USOF may make directly to them or through reports that USOF in the
future files with the SEC, including annual reports on Form 10-K, quarterly
reports on Form 10-Q and current reports on Form 8-K.
Introduction
USOF,
a
Delaware limited partnership, is a commodity pool that issues units that
may be purchased and sold on the AMEX. The investment objective of USOF is
for changes in percentage terms of the units’ NAV on a daily basis to
reflect the changes in percentage terms in the spot price of light, sweet
crude oil delivered to Cushing, Oklahoma, also on a daily basis,
as measured by
the changes in the price of the futures contract on light, sweet
crude oil as
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 the
futures contract will be the next month contract to expire, less
USOF’s
expenses.
USOF
seeks to achieve its investment objective by investing in a combination
of Oil
Futures Contracts and Other Oil Interests such that changes in
USOF’s NAV,
measured in percentage terms, will closely track the changes in
the price
of the Benchmark Oil Futures Contract, also measured in percentage
terms. USOF’s
General Partner believes the Benchmark Oil Futures Contract historically
has exhibited a close correlation with the spot price of light, sweet
crude
oil. It is not the intent of USOF to be operated in a fashion such
that the NAV
will equal, in dollar terms, the spot price of light, sweet crude
oil or any
particular futures contract based on light, sweet crude oil. Management
believes
that it is not practical to manage the portfolio to achieve such
an investment
goal when investing in listed crude oil futures contracts.
At
present, on any valuation day the Benchmark Oil Futures Contract
is the near
month futures contract for light, sweet crude oil traded on the NYMEX
unless the near month contract will expire within two weeks of
the valuation
day, in which case the Benchmark Oil Futures Contract is the next
month contract
for light, sweet crude oil traded on the NYMEX. “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.
USOF
may
also invest in Oil Futures Contracts and Other Oil Interests. The General
Partner of USOF is registered as a CPO with the CFTC and is authorized
by
the LP Agreement to manage USOF. The General Partner is authorized
by USOF
in its sole judgment to employ, establish the terms of employment
for and
terminate commodity trading advisors or futures commission
merchants.
51
Valuation
of Crude Oil Futures
Contracts and the Computation of the NAV
The
NAV
of USOF units is calculated once each trading day as of the earlier
of the close
of the NYSE or 4:00 p.m.
New York time. The NAV for a particular trading day is released after
4:15 p.m. New York time. Trading
on the AMEX typically closes at 4:15 p.m. New York time. USOF uses the
NYMEX closing price (determined at the earlier of the close of
the NYMEX or
2:30 p.m. New York time) for the contracts held on the NYMEX, but
calculates or determines the value of all other USOF investments,
including ICE
Futures or other futures contracts, as of the earlier of the close of
the NYSE or 4:00 p.m. New York time.
Management’s
Discussion of Results of
Operation and the Crude Oil Market
Results
of
Operations. On April 10, 2006, USOF listed its units on the
AMEX under the ticker symbol “USO.” On that day USOF established its initial
offering price at $67.39 per unit and issued 200,000 units to the
initial
Authorized Purchaser, KV Execution Services LLC, in exchange for
$13,478,000 in
cash.
Since
its
initial offering of 17,000,000 units, USOF has made four subsequent
offerings of
its units: 30,000,000 units which were registered with the SEC on October
18, 2006, 50,000,000 units which were registered with the SEC on January
30, 2007, 30,000,000 units which were registered with the SEC on
December 4, 2007 and an additional 100,000,000 units which were registered
with the SEC on January 24, 2008. Units offered by USOF in subsequent
offerings
were sold by it for cash at the units' NAV as described in the
applicable
prospectus. As of December 31, 2007, USOF had issued 107,400,000
units, 19,600,000 of which were remaining and 6,400,000 of which were
outstanding.
More
units have been issued than are outstanding due to the redemption
of units as
contemplated and permitted under the LP Agreement. Unlike funds
that are
registered under the 1940 Act, units that have been redeemed by
USOF cannot be
resold by USOF without registration of their offering with the
SEC. As a result,
USOF contemplates that further offerings of its units will be
registered with the SEC in the future in anticipation of additional
issuances.
As
of
December 31, 2007, the total unrealized gain on crude oil futures contracts
owned or held on that day was $35,705,020 and USOF established cash
deposits that were equal to $187,445,274. The majority of those
cash assets were
held in overnight deposits at USOF’s Custodian, while less
than
10% of the cash balance was held as margin deposits with the
futures
commission merchant for the Oil Futures Contracts purchased. The
ending per unit
NAV on December 31, 2007 was $75.82.
Portfolio
Expenses.
USOF’s
expenses consist of investment management fees, brokerage fees and
commissions, certain offering costs, licensing fees and the fees
and expenses of
the independent directors of the General Partner. The management fee that
USOF pays to the General Partner is calculated as a percentage
of the total net
assets of USOF. For total net assets of up to $1 billion, the management
fee is
0.5%. For total net assets over $1 billion, the management fee
is 0.2% on the
incremental amount of assets.
During
the period from April 10, 2006 to December 31, 2006, the daily
average total net
assets of USOF were approximately $400,799,633. At no time during 2006
did
the total net assets of USOF exceed $1 billion. The management
fee paid by USOF
amounted to $1,460,448, which was calculated at the 0.50% rate
and accrued
daily. Management expenses as a percentage of total net assets
average 0.50%
over the course of the period.
During
the year ended December 31, 2007, the daily average total net assets
of USOF were $732,683,031. During the year ended December 31,
2007, total net assets of USOF did exceed $1 billion on a number of
days. The management fee paid by USOF amounted to $3,622,613, which was
calculated at the 0.50% rate for the total net assets up to and
including $1
billion and at the rate of 0.20% on total net assets over $1 billion,
and
accrued daily. Management expenses as a percentage of total net
assets averaged
0.50% over the course of the period.
USOF pays
for all brokerage fees, taxes and other expenses, including licensing
fees for
the use of intellectual property, ongoing registration or other
fees paid to the
SEC, FINRA and any other regulatory agency in connection
with offers and sales of its units subsequent to the initial offering
and
all legal, accounting, printing and other expenses associated
therewith. For the year ended December 31, 2007, USOF incurred
$437,974 in ongoing registration fees and other offering expenses.
USOF is
responsible for paying the fees and expenses, including directors'
and officers' liability insurance, of the independent directors of
the
General Partner who are also audit committee members. USOF shares
these fees with USNG and US12OF based on the relative assets of each
fund computed on a daily basis. These fees for calendar year 2007
amounted to a
total of $286,000 for all three funds.
Expenses
incurred from inception through December 31, 2006 in connection
with organizing
USOF and the costs of the initial offering of units were borne by the
General Partner, and are not subject to reimbursement by
USOF.
USOF
also
incurs commissions to brokers for the purchase and sale of Oil
Futures
Contracts, Other Oil Interests or Treasuries. During
the period from April 10, 2006 to December 31, 2006, total commissions
paid
amounted to $478,713. As an annualized percentage of total net assets, the
actual figure for 2006 represents approximately 0.16% of total
net assets.
During 2007, total commissions paid amounted to $1,184,956.
Prior to the
initial offering of its units, USOF had estimated that its annual
level of such
commissions was expected to be 0.35%
of total net assets. As an annualized percentage of total net assets,
the figure for 2007 represents approximately 0.16%
of total net assets. However, there can be no assurance that commission
costs
and portfolio turnover will not cause commission expenses to rise
in future
quarters.
Interest
Income.
USOF
seeks to invest its assets such that it holds Oil Futures Contracts and
Other Oil Interests in an amount equal to the total net assets
of the portfolio.
Typically, such investments do not require USOF to pay the full
amount of the
contract value at the time of purchase, but rather require USOF
to post an
amount as a margin deposit against the eventual settlement of
the contract. As a
result, USOF retains an amount that is approximately equal to
its total net
assets, which USOF invests in Treasuries, cash and/or cash equivalents.
This includes both the amount on deposit with the futures commission
merchant as
margin, as well as unrestricted cash held with USOF’s Custodian. The Treasuries,
cash and/or cash equivalents earn interest that accrues on a
daily basis. For
2006,
USOF earned $13,930,431 in interest income on such cash holdings.
Based on
USOF’s average daily total net assets, this is equivalent to an annualized
yield
of 4.77%. USOF did not purchase Treasuries during 2006 and held all of its
funds in cash and/or cash equivalents during this time period.
For 2007,
USOF earned $34,845,846 in interest income on such cash holdings.
Based on
USOF’s average daily total net assets, this is equivalent to an annualized
yield
of 4.76%. USOF did not purchase Treasuries during 2007 and held all of its
funds in cash and/or cash equivalents during this time
period.
52
Tracking
USOF’s
Benchmark.
USOF
seeks to manage its portfolio such that changes in its average
daily NAV, on a
percentage basis, closely track changes in the average daily price
of the
Benchmark Oil Futures Contract, also on a percentage basis. Specifically,
USOF
seeks to manage the portfolio such that over any rolling period
of 30 valuation
days, the average daily change in the NAV is within a range of
90% to 110% (0.9
to 1.1), of the average daily change of the Benchmark Oil Futures
Contract. As
an example, if the average daily movement of the Benchmark Oil
Futures Contract
for a particular 30-day time period was 0.5% per day, USOF management
would
attempt to manage the portfolio such that the average daily movement
of the 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). USOF’s portfolio management
goals do not include trying to make the nominal price of USOF’s NAV equal to the
nominal price of the current Benchmark Oil Futures Contract or
the spot price
for crude oil. Management believes that it is not practical to
manage the
portfolio to achieve such an investment goal when investing in
listed crude oil
futures contracts.
For
the
30 valuation days ended December 31, 2007, the simple average daily
change in
the Benchmark Oil Futures Contract was 0.166%, while the simple
average daily
change in the NAV of USOF over the same time period was 0.176%.
The average
daily difference was 0.01% (or 1.0 basis points, where 1 basis
point equals
1/100 of 1%). As a percentage of the daily movement of the Benchmark
Oil Futures
Contract, the average error in daily tracking by the NAV was 2.462%,
meaning
that over this time period USOF’s tracking error was within the plus or minus
10% range established as its benchmark tracking goal.
53
Since
the
offering of USOF units to the public on April 10, 2006 to December 31,
2007, the simple average daily change in the Benchmark Oil Futures
Contract was
-0.031%, while the simple average daily change in the NAV of USOF
over the same
time period was 0.042%. The average daily difference was 0.011%
(or 1.1 basis
point, where 1 basis point equals 1/100 of 1%). As a percentage
of the daily
movement of the Benchmark Oil Futures Contract, the average error
in daily
tracking by the NAV was 2.98%, meaning that over this time period
USOF’s
tracking error was within the plus or minus 10% range established
as its
benchmark tracking goal.
An
alternative tracking measurement of the return performance of USOF
versus the
return of its Benchmark Oil Futures Contract can be calculated
by comparing the
actual return of USOF, measured by changes in its NAV, versus the
expected
changes
in its NAV under the assumption that USOF’s returns had been exactly the same as
the daily changes in its Benchmark Oil Futures Contract.
For
the
year ended December 31, 2007, the actual total return of USOF as measured
by changes in its NAV was 46.17%. This is based on initial NAV of $51.87 on
January 2, 2007 and an ending NAV as of December 31, 2007 of $75.82.
During this time period, USOF made no distributions to its unitholders.
However,
if USOF’s daily changes in its NAV had instead exactly tracked the changes
in
the daily return of the Benchmark Oil Futures Contract, USOF would
have ended
2007 with an estimated NAV of $73.01, for a total return over the
relevant time
period of 40.75%. The difference between the actual NAV
total return of USOF of 46.17% and the expected total return based
on the
Benchmark Oil Futures Contract of 40.75% was an error over the
time period of
+5.42%, which is to say that USOF’s actual total return exceeded the benchmark
result by that percentage. Management believes that a portion of the
difference between the actual return and the expected benchmark
return can be
attributed to the impact of the interest that USOF collects on
its cash and cash
equivalent holdings. In addition, during the year ended December
31, 2007, USOF
also collected fees from brokerage firms creating or redeeming
baskets of units.
This income also contributed to USOF’s actual return exceeding the benchmark
results. However, if the total assets of USOF continue to increase,
management
believes that the impact on total returns of these fees from creations
and
redemptions will diminish as a percentage of the total return.
For
the
period April 10, 2006 through December 31, 2006, the actual total
return of USOF
as measured by changes in its NAV was -23.03%. This is based
on initial
NAV of $67.39 on April 10 and an ending NAV as of December 31 of
$51.87
(during this time period USOF made no distributions to its unitholders).
However, if USOF’s daily changes in its NAV had instead exactly tracked the
changes in the daily return of the Benchmark Oil Futures Contracts,
USOF would
have ended 2006 with an estimated NAV of $50.61, for a total
return over the
relevant time period of -24.90%. The difference between the actual
NAV total
return of USOF of -23.03% and the expected total return based
on the Benchmark
Oil Futures Contracts of -24.90 % was an error over the time
period of +1.87%,
which is to say that USOF’s actual total return exceeded the benchmark result by
that percentage. Management believes that the majority of the
difference between
the actual return and the expected benchmark return can be attributed
to the
impact of the interest that USOF collects on its cash and cash
equivalent
holdings. In addition, during the period USOF also collected
fees from brokerage
firms creating or redeeming baskets of units. This income also
contributed to
USOF’s actual return exceeding the benchmark results. However, if
the total
assets of USOF continue to increase, management believes that
the impact on
total returns of these fees from creations and redemptions will
diminish as a
percentage of the total return.
There
are
currently three factors that have impacted, during the latest period,
or are
most likely to impact, USOF’s ability to accurately track its
Benchmark Oil Futures Contract.
First,
USOF may buy or sell its holdings in the then current Benchmark
Oil Futures
Contract at a price other than the closing settlement price of
that contract on
the day in which USOF executes the trade. In that case, USOF may
get a price
that is higher, or lower, than that of the Benchmark Oil Futures
Contract,
which, could cause the changes in the daily NAV of USOF to either be too
high or too low relative to the changes in the daily benchmark.
In 2007,
management attempted to minimize the effect of these transactions
by seeking to
execute its purchase or sales of the Benchmark Oil Futures Contracts
at, or as
close as possible to, the end of the day settlement price. However,
it may not
always be possible for USOF to obtain the closing settlement price
and there is
no assurance that failure to obtain the closing settlement price
in the future
will not adversely impact USOF’s attempt to track its benchmark over
time.
Second,
USOF earns interest on its cash, cash equivalents and Treasury
holdings. USOF is not required to distribute any portion of its
income to its
unitholders and did not make any distribution to unitholders
in 2007. Interest
payments, and any other income, were retained within the portfolio
and added to
USOF’s NAV. When this income exceeds the level of USOF’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 the General Partner), USOF will realize
a net yield
that will tend to cause daily changes in the NAV of USOF to track
slightly
higher than daily changes in the Benchmark Oil Futures Contracts.
During 2007,
USOF earned, on an annualized basis, approximately 4.76% on its
cash holdings.
It also incurred cash expenses on an annualized basis of 0.50%
for management
fees and approximately 0.16% in brokerage commission costs related
to the
purchase and sale of futures contracts, and 0.21% for other expenses.
The
foregoing fees and expenses resulted in a net yield on an annualized
basis of
approximately 3.89% and affected USOF’s ability to track its benchmark. If
short-term interest rates rise above the current 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. If
short-term yields drop to a level lower than the combined expenses
of the
management fee and the brokerage commissions, then the tracking
error would
become a negative number and would tend to cause the daily returns
of the NAV to
underperform the daily returns of the Benchmark Oil Futures
Contract.
Third,
USOF may hold Other Oil Interests 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 could result in daily changes
in the NAV of
USOF that are either too high, or too low, relative to the
daily changes in the
benchmark. During 2007, USOF did not hold any Other Oil Interests. However,
there can be no assurance that in future quarters USOF will
not make use of such
Other Oil Interests.
During
the year ended December 31, 2007, the prices
of front month futures contracts rose from near the $58.00
level to
approximately the $95.00 level. The prices of front month contracts
were
lower than the price of second or third month contracts for the first
six
months of this time period. The prices of front month contracts
were higher than
the price of second or third month contracts for most of the
second six months
of this time period.
54
Term
Structure of Crude Oil Futures
Prices and the Impact on Total Returns. Several factors determine the
total return from investing in a futures contract position. One
factor that
impacts the total return that will result from investing in near month
crude oil futures contracts and “rolling” those contracts forward each month is
the price relationship between the current near month contract
and the later
month contracts. For example, if the price of the near month contract
is higher
than the next month contract (a situation referred to as “backwardation” in the
futures market), then absent any other change there is a tendency
for the price
of a next month contract to rise in value as it becomes the near
month contract
and approaches expiration. Conversely, if the price of a near month
contract is
lower than the next month contract (a situation referred to as
“contango” in the
futures market), then absent any other change there is a tendency
for the price
of a next month contract to decline in value as it becomes the
near month
contract and approaches expiration.
As
an
example, assume that the price of crude oil for immediate delivery
(the “spot”
price), was $50 per barrel, and the value of a position in the
near month
futures contract was also $50. Over time, the price of the barrel
of crude oil
will fluctuate based on a number of market factors, including demand for
oil relative to its supply. The value of the near month contract
will likewise
fluctuate in reaction to a number of market factors. If investors seek
to
maintain their holding in a near month contract position and
not take delivery
of the oil, every month they must sell their current near month
contract as it
approaches expiration and invest in the next month contract.
If
the
futures market is in backwardation, e.g., when the expected price
of oil in the
future would be less, the investor would be buying a next month
contract for a
lower price than the current near month contract. Hypothetically,
and assuming
no other changes 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 interest earned
on Treasuries,
cash and/or cash equivalents), the value of the next month contract
would rise
as it approaches expiration and becomes the new near month contract.
In this
example, the value of the $50 investment would tend to rise faster
than the spot
price of crude oil, or fall slower. As a result, it would be
possible in this
hypothetical example for the price of spot crude oil to have
risen to $60 after
some period of time, while the value of the investment in the
futures contract
would have risen to $65, assuming backwardation is large enough
or enough time
has elapsed. Similarly, the spot price of crude oil could have
fallen to $40
while the value of an investment in the futures contract could
have fallen to
only $45. Over time, if backwardation remained constant, the
difference would
continue to increase.
If
the
futures market is in contango, the investor would be buying a
next month
contract for a higher price than the current near month contract.
Hypothetically, and assuming no other changes 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
interest earned on cash), the value of the next month contract
would fall as it
approaches expiration and becomes the new near month contract.
In this example,
it would mean that the value of the $50 investment would tend
to rise slower
than the spot price of crude oil, or fall faster. As a result,
it would be
possible in this hypothetical example for the spot price of crude oil to
have risen to $60 after some period of time, while the value
of the investment
in the futures contract will have risen to only $55, assuming
contango is large
enough or enough time has elapsed. Similarly, the spot price
of crude oil could
have fallen to $45 while the value of an investment in the futures
contract
could have fallen to $40. Over time, if contango remained constant,
the
difference would continue to increase.
Historically,
the oil futures markets have experienced periods of contango and
backwardation, with backwardation being in place more often
than contango.
During the past two years, including 2006 and the first half
of 2007, these
markets have experienced contango. However, starting early
in the third quarter
of 2007, the crude oil futures market moved into backwardation
and remained in
that condition for the rest of the year. The chart below compares
the price of
the front month contract to the average price of the first
12 months over the
last 10 years (1998-2007). When the price of the front month
contract is higher
than the average price of the front 12 month contracts, the
market would be
described as being in backwardation. When the price of the
front month contract
is lower than the average price of the front 12 month contracts,
the market
would be described as being in contango. Although the prices
of the front month
contract and the average price of the front 12 month contracts
do tend to move
up or down together, it can be seen that at times the front
month prices are
clearly higher than the average price of the 12 month contracts
(backwardation),
and other times they are below the average price of the front
12 month contracts
(contango).
55
An
alternative way to view the same data is to subtract the
dollar price of the
front month contract from the average dollar price of the
front 12 month
contracts. If the resulting number is a positive number,
than the front month
price is higher than the average price of the front 12 months
and the market
could be described as being in backwardation. If the resulting
number is a
negative number, than the front month price is lower than
the average price of
the front 12 months and the market could be described as
being in contango. The
chart below shows the results from subtracting the front
month price from the
average price of the front 12 month contracts for the 10
year period between
1998 and 2007.
A
hypothetical investment in a portfolio that involved owning only
the front month
contract would produce a different result than a hypothetical
investment in a
portfolio that owned an equal number of each of the front 12
month’s worth of
contracts. Generally speaking, when the crude oil futures market
is in
backwardation, the front month only portfolio would tend to have
a higher total
return than the 12 month portfolio. Conversely, if the crude
oil futures market
was in contango, the portfolio containing 12 months worth of
contracts would
tend to outperform the front month only portfolio. The chart
below shows the
hypothetical results of owning a portfolio consisting of the
front month
contract versus a portfolio containing the front 12 month’s worth of contracts.
In this example, each month the front month only portfolio would
sell the front
month contract at expiration and buy the next month out contract.
The portfolio
holding an equal number of the front 12 month’s worth of contracts would sell
the front month contract at expiration and replace it with the
contract that
becomes the new twelfth month contract.
As
seen
in the chart, there have been periods of both positive and negative
annual total
returns for both hypothetical portfolios over the last 10 years.
In addition,
there have been periods during which the front month only approach
had higher
returns, and periods where the 12 month approach had higher total
returns.
Historically,
the oil futures markets have experienced periods of contango and
backwardation, with backwardation being in place more often than
contango.
During the past two years, including 2006 and the first half
of 2007, these
markets have experienced contango. However, starting early in
the third quarter
of 2007 the crude oil futures market moved into backwardation.
While the
investment objective of USOF is not to have the market price
of its units match,
dollar for dollar, changes in the spot price of oil, contango
and backwardation
have impacted the total return on an investment in USOF units
during the past
year relative to a hypothetical direct investment in crude oil. For
example, an investment made in USOF units made during the second
quarter of
2007, a period of contango in the crude oil markets, decreased by
-0.71%, while the spot price of crude oil for immediate delivery
during the same
period increased by 7.30%. Conversely, an investment made in USOF units
during the third quarter of 2007, a period in which the crude
oil futures market
was mostly in backwardation, increased by 17.82% while the spot
price of crude
oil increased by 15.53% (note: these comparisons ignore the potential
costs
associated with physically owning and storing crude oil which
could be
substantial).
These
periods of contango or backwardation do not meaningfully impact
USOF’s
investment objective of having percentage changes in its per
unit NAV track
percentage changes in the price of the Benchmark Oil Futures
Contract since the
impact of backwardation and contango tended to equally impact
the percentage
changes in price of both USOF’s units and the Benchmark Oil Futures
Contract. It is impossible to predict with any degree of certainty
whether
backwardation or contango will occur in the future. It is likely
that both
conditions will occur during different periods.
56
Crude
oil
market. During the year ended December 31, 2007, crude oil
prices were
impacted by several factors. On the consumption side, demand
remained strong as
continued global economic growth, especially in emerging
economies such as China
and India, remained brisk. Additionally, a falling U.S. dollar,
the currency in
which crude oil is traded globally, continued to be weak,
effectively making
crude oil cheaper for most non-U.S. dolar economies. On the supply
side, production remained steady despite concerns about violence impacting
production in Iraq and Nigeria. At the same time, a concern remains about
the ability of major oil producing countries to continue to raise
their
production to accommodate increasing demand. Additionally,
a concern about the
strength of the U.S. economy, and the risk of recession which
might lead to the
U.S. decreasing its oil consumption in 2008, began to be
a factor in the crude
oil markets very late in 2007.
Critical
Accounting
Policies
Preparation
of the condensed financial statements and related disclosures
in compliance with
accounting principles generally accepted in the United States
of America
requires the application of appropriate accounting rules and
guidance, as well
as the use of estimates. USOF's application of these policies
involves judgments
and actual results may differ from the estimates used.
The
General Partner has evaluated the nature and types of estimates
that
it makes in preparing USOF's condensed financial statements and
related
disclosures and has determined that the valuation of its investments which
are not traded on a United States or internationally recognized
futures exchange
(such as forward contracts and over-the-counter contracts)
involves a critical
accounting policy. To the extent USOF makes such investments,
the values used by
USOF for its forward contracts will be provided by its commodity
broker who
values over-the-counter contracts 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, USOF estimates interest income
on a daily basis
using prevailing interest 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
USOF
has
not made, and does not anticipate making, use of borrowings or
other lines of
credit to meet its obligations. USOF has met, and it is anticipated
that USOF
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. USOF’s liquidity needs
include: redeeming units, providing margin deposits for its existing
Oil Futures
Contracts or the purchase of additional crude oil futures contracts
and posting
collateral for its over-the-counter contracts and payment of
its expenses,
summarized below under “Contractual Obligations.”
USOF
currently generates cash primarily from (i) the sale of Creation
Baskets and
(ii) interest earned on Treasuries, cash and/or cash equivalents.
USOF has
allocated substantially all of its nets assets to trading in
oil interests. A
significant portion of the NAV was held in Treasuries, cash and/or
cash
equivalents that were used as margin for USOF's trading in oil
interests. Treasuries, cash and/or cash equivalents as a percentage of
the total net assets vary from period to period as the market
values of the oil
interests change. The balance of the net assets is held in USOF's
Oil Futures
Contracts and Other Oil Interests trading account. Interest earned
on USOF's
interest bearing-funds is paid to USOF.
USOF's
investment in oil interests may be subject to periods of illiquidity
because of
market conditions, regulatory considerations and other reasons.
For example,
commodity exchanges limit the fluctuations in Oil 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 an Oil Futures Contract has increased or decreased by
an amount equal
to the daily limit, positions in the contracts can neither be taken
or
liquidated unless the traders are willing to effect trades at or
within the
specified daily limit. Such market conditions could prevent USOF
from promptly
liquidating its positions in Oil Futures Contracts. During 2007,
USOF was not
forced to purchase or liquidate any of its positions while daily
limits were in
effect; however, USOF cannot predict whether such an event may
occur in the
future.
Prior
to
March 23, 2007, all payments with respect to USOF's and the General
Partner's
expenses were paid by their affiliates. Neither USOF nor the General
Partner has
any obligation or intention to refund such payments by their affiliates.
These
affiliates are under no obligation to pay USOF's or the General
Partner's
current or future expenses. If the General Partner and USOF are
unsuccessful in raising sufficient funds to cover USOF's expenses
or in locating
any other source of funding, USOF will terminate and investors
may lose all or
part of their investment.
Market
Risk
Trading
in Oil Futures Contracts and Other Oil Interests, such as
forwards, involves USOF entering into contractual commitments to purchase
or sell oil at a specified date in the future. The gross or face
amount of
the contracts will significantly exceed USOF's future cash requirements
since USOF intends to close out its open positions prior to settlement.
As a
result, USOF is generally only subject to the risk of loss arising
from the change in value of the contracts. USOF considers the "fair
value'' of
its derivative instruments to be the unrealized gain or loss on
the contracts.
The market risk associated with USOF's commitments to purchase
oil is limited to
the gross face amount of the contacts held. However, should USOF
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 to USOF could be unlimited.
USOF'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 Interests
markets and
the relationships among the contracts held by USOF. The limited
experience that
USOF has in utilizing its model to trade in oil interests in a manner
intended to track the spot price of crude oil, as well as drastic
market
occurrences, could ultimately lead to the loss of all or substantially
all of an
investor’s capital.
57
Credit
Risk
When
USOF
enters into Oil Futures Contracts and Other Oil Interests,
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 foreign futures
exchanges is the clearinghouse associated with the particular
exchange. In
general, 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. 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 to USOF in
such circumstances.
The General Partner attempts to manage the credit risk of USOF by following
various trading limitations and policies. In particular, USOF
posts margin
and/or holds liquid assets that are approximately equal to
the face amount of
its obligations to counterparties under the Oil Futures Contracts
and Other Oil
Interests it holds. The General Partner 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 of USOF to limit its credit exposure. UBS Securities
LLC, USOF's
commodity broker, or any other broker that may be retained
by USOF in the
future, when acting as USOF's futures commission merchant in
accepting orders to
purchase or sell Oil Futures Contracts on United States exchanges,
is required by CFTC regulations to separately account for and
segregate as belonging to USOF, all assets of USOF relating
to domestic Oil
Futures Contracts trading. A futures commission merchant is
not allowed to
commingle USOF's assets with its other assets. In addition,
the CFTC requires
commodity brokers to hold in a secure account the USOF assets
related to foreign
Oil Futures Contracts trading. During the year ended December
31, 2007, the
only foreign exchange on which USOF made investments was the
ICE Futures, which
is a London based futures exchange. Those crude oil contracts are
denominated in U.S. dollars.
Off
Balance Sheet
Financing
As
of
December 31, 2007, USOF has 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 of USOF. While USOF's
exposure under
these indemnification provisions cannot be estimated, they
are not expected to
have a material impact on USOF's financial position.
Redemption
Basket
Obligation
In
order
to meet its investment objective and pay its contractual obligations
described
below, USOF requires liquidity to redeem units, which redemptions must be
in blocks of 100,000 units called Redemption Baskets. USOF 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 units being redeemed.
Contractual
Obligations
USOF's
primary contractual obligations are with the General Partner. In
return for its
services, the General Partner is entitled to a management fee calculated
as a
fixed percentage of USOF's NAV, currently 0.50% for a NAV of $1
billion or less,
and thereafter 0.20% for a NAV above $1 billion. The General
Partner agreed to pay the start-up costs associated with the formation
of
USOF, primarily its legal, accounting and other costs in connection
with the General Partner's registration with the CFTC as a commodity
pool
operator and the registration and listing of USOF and its units
with
the SEC and the AMEX, respectively. However, the costs of registering
and
listing additional units of USOF with the SEC are directly borne
on an ongoing
basis by USOF, and not by the General Partner.
The
General Partner pays the fees of the custodian and transfer agent,
BBH&Co., as well as BBH&Co.'s fees for performing administrative
services, including in connection with the preparation of USOF's condensed
financial statements and its SEC and CFTC reports. The General
Partner also
pays the fees of USOF's accountants and a separate firm for providing
tax
related services, as well as those of the Marketing Agent. The
General Partner
and USOF have also entered into a licensing agreement with the NYMEX
pursuant to which USOF and the affiliated funds managed by the
General
Partner pay a licensing fee to the NYMEX.
In
addition to the General Partner's management fee, USOF pays its
brokerage fees
(including fees to a futures commission merchant), over-the-counter
dealer
spreads, any licensing fees for the use of intellectual property,
registration
and, subsequent to the initial offering, the fees paid to the SEC,
FINRA or any
other regulatory agency in connection with the offer and sale of
units, as well
as legal, printing, accounting and other expenses associated therewith, and
extraordinary expenses. The latter are expenses not incurred in the
ordinary course of USOF'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 a futures commission merchant are on a contract-by-contract, or round
turn, basis. USOF also pays a portion of the fees and expenses
of the
independent directors of the General Partner. See Note 3 to the
Notes to
Condensed Financial Statements.
The
parties cannot anticipate the amount of payments that will be required
under
these arrangements for future periods, as USOF's NAVs and trading
levels to meet
its investment objectives will not be known until a future date.
These
agreements are effective for a specific term agreed upon by the
parties and have
an option to renew, or, in some cases, are in effect for the duration
of USOF's
existence. Either party may terminate these agreements earlier
for certain
reasons described in the agreements.
58
Over-the-Counter
Derivatives
(Including Spreads and Straddles)
In
the
future, USOF may purchase over-the-counter contracts. Unlike
most of the
exchange-traded oil futures contracts or exchange-traded options
on such
futures, each party to over-the-counter contract bears the credit
risk that the
other party may not be able to perform its obligations under
its
contract.
Some
oil-based derivatives transactions contain fairly generic terms
and conditions
and are available from a wide range of participants. Other oil-based
derivatives
have highly customized terms and conditions and are not as widely
available.
Many of these over-the-counter contracts are cash-settled forwards
for the
future delivery of oil- or petroleum-based fuels that have terms
similar to the
Oil Futures Contracts. Others take the form of “swaps” in which the two parties
exchange cash flows based on pre-determined formulas tied to
the spot price of
the crude oil, forward crude oil prices or crude oil futures prices. For
example, USOF may enter into over-the-counter derivative contracts
whose value
will be tied to changes in the difference between the spot price of light,
sweet crude oil, the price of Oil Futures Contracts traded on
NYMEX and the
prices of other Oil Futures Contracts that may be invested in
by
USOF.
To
protect itself from the credit risk that arises in connection
with such
contracts, USOF may enter into agreements with each counterparty
that provide
for the netting of its overall exposure to its counterparty,
such as the
agreements published by the International Swaps and Derivatives
Association,
Inc. USOF also may require that the counterparty be highly rated and/or
provide collateral or other credit support to address USOF’s exposure to the
counterparty. In addition, it is also possible for USOF and its
counterparty to
agree to clear their agreement through an established futures
clearing house
such as those connected to the NYMEX or the ICE Futures. In that
event, USOF
would no longer have credit risk of its original counterparty,
as the clearing
house would now be USOF's counterparty. USOF would still retain
any price risk
associated with its transaction.
USOF
may
employ spreads or straddles in its trading to mitigate the differences
in its
investment portfolio and its goal of tracking the price of the
Benchmark Oil
Futures Contract. USOF would use a spread when it chooses to
take simultaneous
long and short positions in futures written on the same underlying
asset, but
with different delivery months. The effect of holding such combined
positions is
to adjust the sensitivity of USOF to changes in the price relationship
between
futures contracts which will expire sooner and those that will
expire later.
USOF would use such a spread if the General Partner felt that
taking such long
and short positions, when combined with the rest of its holdings,
would more
closely track the investment goals of USOF, or the General Partner
felt if it
would lead to an overall lower cost of trading to achieve a given
level of
economic exposure to movements in oil prices. USOF would enter
into a straddle
when it chooses to take an option position consisting of a long
(or short)
position in both a call option and put option. The economic effect
of holding
certain combinations of put options and call options can be very
similar to that
of owning the underlying futures contracts. USOF would make use
of such a
straddle approach if, in the opinion of the General Partner,
the resulting
combination would more closely track the investment goals of
USOF or if it would
lead to an overall lower cost of trading to achieve a given level
of economic
exposure to movements in oil prices.
During
the year ended December 31, 2007, USOF did not employ any hedging
methods since
all of its investments were made over an exchange. Therefore,
USOF was not
exposed to counterparty risk.
59
|
Financial
Statements and
Supplementary Data.
|
Index
to Financial
Statements
60
To
the
Partners of
United
States Oil Fund, LP
We
have
audited the accompanying statements of financial condition
of United
States Oil Fund, LP, (the “Fund”) as of December 31, 2007,
2006 and 2005, including the schedule of investments as of December
31, 2007 and 2006, and the related statements of operations,
changes in
partners’ capital and cash flows for the year ended December 31, 2007, the
period from April 10, 2006 (commencement of operations) through
December 31,
2006 and the period from May 12, 2005 (inception) to December
31, 2005. These
financial statements are the responsibility of the Fund’s management. Our
responsibility is to express an opinion on these financial
statements based on
our audits.
We
conducted our audits in accordance with standards of the
Public Company
Accounting Oversight Board (United States). Those standards
require that we plan
and perform the audits to obtain reasonable assurance about
whether the
financial statements are free of material misstatement. An
audit includes
examining, on a test basis, evidence supporting the amounts
and disclosures in
the financial statements. An audit also includes assessing
the accounting
principles used and significant estimates made by management,
as well as
evaluating the overall financial statement presentation.
We believe that our
audits provide a reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present
fairly, in all
material respects, the financial position of United States Oil Fund,
LP as of December 31, 2007, 2006 and 2005, and the results of its
operations and its cash flows for the year ended December
31, 2007, the
period from April 10, 2006 (commencement of operations) through
December 31,
2006 and the period from May 12, 2005 (inception) through
December 31,
2005, in conformity with accounting principles generally accepted
in the
United States of America.
We
also
have audited, in accordance with standards of the Public
Company Accounting
Oversight Board (United States), the Fund's internal control
over financial
reporting as of December 31, 2007, based on criteria established
in Internal
Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission and our report dated
March 1, 2008
expressed an unqualified opinion on the Fund's internal control
over financial
reporting.
/s/ SPICER
JEFFRIES
LLP
Greenwood
Village, Colorado
March
1,
2008
61
|
United
States Oil Fund, LP
|
||||||||||
|
Statements
of Financial
Condition
|
||||||||||
|
At
December 31, 2007,
2006 and 2005
|
||||||||||
|
|
||||||||||
|
2007
|
2006
|
2005
|
||||||||
|
Assets
|
||||||||||
|
Cash
and cash equivalents
|
$
|
354,816,049
|
$ |
712,883,812
|
$
|
1,000
|
||||
|
Equity
in UBS Securities LLC trading accounts:
|
||||||||||
|
Cash
|
86,330,750
|
87,123,636
|
-
|
|||||||
|
Unrealized
gain (loss) on open commodity futures contracts
|
35,705,020
|
(34,383,000
|
)
|
- | ||||||
|
Receivable
for units sold
|
7,581,679
|
36,080,896
|
-
|
|||||||
|
Interest
receivable
|
962,551
|
2,626,230
|
-
|
|||||||
|
Other
assets
|
420,705
|
17,000
|
-
|
|||||||
|
Total
assets
|
$
|
485,816,754
|
$ |
804,348,574
|
$
|
1,000
|
||||
|
Liabilities
and Partners'
Capital
|
||||||||||
|
General
Partner management fees (Note 3)
|
$
|
226,782
|
$ |
332,736
|
$
|
-
|
||||
| Accrued Tax Reporting Costs | 239,954 |
-
|
- | |||||||
| License Fee Payable | 47,788 |
22,198
|
- | |||||||
| Accrued Directors' Fees | 33,235 |
-
|
- | |||||||
|
Brokerage
commissions payable
|
22,886
|
44,386
|
- | |||||||
|
Other
liabilities
|
23,372
|
-
|
-
|
|||||||
|
Total
liabilities
|
594,017
|
399,320
|
-
|
|||||||
|
Commitments
and Contingencies
(Notes 3,
4 and 5)
|
||||||||||
|
Partners'
Capital
|
||||||||||
|
General
Partner
|
-
|
-
|
20
|
|||||||
|
Limited
Partners
|
485,222,737
|
803,949,254
|
980
|
|||||||
|
Total
Partners'
Capital
|
485,222,737
|
803,949,254
|
1,000
|
|||||||
|
Total
liabilities and
partners' capital
|
$
|
485,816,754
|
$ |
804,348,574
|
$
|
1,000
|
||||
|
Limited
Partners' units outstanding
|
6,400,000
|
15,500,000
|
-
|
|||||||
|
Net
asset value per unit
|
$
|
75.82
|
$ |
51.87
|
$
|
-
|
||||
|
Market
value per unit
|
$
|
75.75
|
$ |
51.60
|
$
|
-
|
||||
|
See
accompanying notes
to financial statements.
|
||||||||||
62
|
United
States Oil Fund, LP
|
||||||||||
|
Schedule
of
Investments
|
||||||||||
|
At
December 31,
2007
|
||||||||||
|
Open
Futures Contracts
|
||||||||||
|
Gain on
Open
|
||||||||||
|
Number
of
|
Commodity
|
%
of
Partners'
|
||||||||
|
|
Contracts
|
Contracts
|
Capital
|
|||||||
| Foreign Contracts | ||||||||||
|
Crude
Oil Future contracts, expires February 2008
|
300 | $ | 2,361,000 | 0.49 | ||||||
|
United
States
Contracts
|
||||||||||
|
Crude
Oil Future contracts, expires February 2008
|
4,754
|
|
33,344,020
|
|
6.87
|
|
||||
| 5,054 | $ | 35,705,020 | 7.36 | |||||||
|
Cash
Equivalents
|
||||||||||
|
|
Cost
|
Market
Value
|
||||||||
|
United
States - Money Market
Funds
|
||||||||||
|
Goldman
Sachs Financial Square Funds - Treasury Instruments
Fund
|
$ |
253,701,525
|
253,701,525
|
52.28
|
||||||
|
$
|
253,701,525
|
|
253,701,525
|
52.28
|
||||||
| Cash |
101,114,524
|
20.84
|
|||||
| Total cash and cash equivalents |
354,816,049
|
73.12
|
|||||
|
Cash
on deposit with
broker
|
|
86,330,750
|
17.79
|
||||
|
Other
assets in excess of
liabilities
|
8,370,918
|
1.73
|
|||||
|
Total
Partners'
Capital
|
$
|
485,222,737
|
100.00
|
||||
|
United
States Oil Fund, LP
|
||||||||||
|
Schedule
of
Investments
|
||||||||||
|
At
December 31,
2006
|
||||||||||