You've probably seen the ticker. USO. It pops up every time tensions flare in the Middle East or whenever some analyst on TV starts screaming about "black gold." If you’re like most people, you look at the price of the United States Oil Fund and think, "Hey, gas is getting expensive, maybe I should buy some of this and make a buck."
Stop.
Honestly, that’s how people lose their shirts. The United States Oil Fund (USO) is perhaps one of the most misunderstood financial instruments on the NYSE Arca. It’s an Exchange Traded Security, sure. It’s popular. But it is not a "buy and hold" investment for your retirement account. It’s a tool. A sharp, double-edged tool that can cut you if you don’t understand the weird, mechanical guts of the oil futures market.
Most folks think buying USO is like buying a barrel of oil and sticking it in their garage. It isn't. When you buy USO, you’re buying a slice of a fund that manages a complex portfolio of West Texas Intermediate (WTI) light, sweet crude oil futures contracts. This distinction matters. It matters a lot because of something called "contango," a word that sounds like a dance but usually just means your money is slowly evaporating.
How the United States Oil Fund Actually Operates
The fund's objective is pretty simple on paper. It wants the daily changes in percentage terms of its share price to reflect the daily changes in the spot price of WTI crude oil. Simple, right? Well, the manager, United States Commodity Funds (USCF), can’t actually go out and buy millions of physical barrels of oil. They don’t have the warehouses. Instead, they use futures.
Specifically, they mostly play with the "near-month" contract. This is the contract for oil delivery that is closest to expiring.
Here is where it gets sticky. Because those contracts expire every single month, the fund has to "roll" its position. It sells the expiring month and buys the next month. This happens every month like clockwork.
If the price of oil for delivery next month is higher than the price for delivery this month—which is the normal state of the market known as contango—the fund is essentially selling low and buying high. Every. Single. Month. You can see how that eats away at your returns over time. Even if the "spot" price of oil stays flat for a year, the United States Oil Fund could lose 10%, 20%, or even more of its value just because of those rolling costs.
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During the chaos of April 2020, things got even weirder. You might remember when oil prices famously went negative. USO almost collapsed. They had to radically change their strategy, moving away from just the "front-month" contract to a mix of contracts months or even years out. They did this to survive. It worked, but it also changed the personality of the fund. It became less of a pure "oil tracker" and more of a complex oil-derivative hybrid.
The Massive Misconception About Long-Term Holding
Don't hold this for five years. Just don't.
If you look at a long-term chart of the United States Oil Fund, it looks like a slide into an abyss. Look at the 10-year return. It’s brutal. Meanwhile, the actual price of a barrel of oil might be higher than it was a decade ago. This "tracking error" is the bane of the retail investor's existence.
Why does this happen? It’s the math of compounding the roll yield.
Think about it this way. You’re paying a "storage fee" via the futures market. If you owned a physical gold ETF like GLD, the fund actually keeps gold in a vault in London. The costs are low. With oil, you can't just put it in a vault for free. It’s volatile, bulky, and dangerous. The futures market builds those storage and insurance costs into the price of the "outer" months.
USO is for traders. It’s for people who think oil is going to jump 5% in the next 48 hours because of a hurricane in the Gulf or a geopolitical shift. It is a tactical instrument. Using it as a structural piece of a portfolio is like using a blowtorch to light a candle. You might get the job done, but you’re probably going to burn the house down.
Understanding the Tax Man and the K-1 Headache
Here is something nobody mentions until it's too late: taxes.
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USO is structured as a limited partnership. This isn't a standard corporation. When you invest in the United States Oil Fund, you aren't just a shareholder; you are technically a partner. This means every year, you don't get a simple 1099-B like you do with Apple or Microsoft. You get a Schedule K-1.
K-1s are notorious. They often arrive late—sometimes in late March or early April—which means you might have to file for a tax extension. They are also significantly more complicated for your accountant (or your tax software) to handle.
Furthermore, because it's a commodity pool, you are subject to the "60/40 rule" under Section 1256 of the tax code. This means 60% of your gains or losses are treated as long-term capital gains, and 40% are short-term, regardless of how long you held the shares. This can actually be a benefit if you’re a short-term trader, as you get a lower tax rate than typical short-term gains. But if you didn't know it was coming, it’s a massive headache.
The 2020 Pivot and the "New" USO
The United States Oil Fund today is not the same beast it was in 2019. Back then, it was almost entirely invested in the front-month WTI contract. When the market broke in 2020 and prices went sub-zero, the fund’s managers realized they were sitting ducks.
Now, the fund has the flexibility to invest in a variety of oil-related contracts, including those further out on the "curve."
The Current Strategy Breakdown
- Front-Month Contracts: Still a big chunk, providing that immediate sensitivity to oil prices.
- Back-Month Contracts: Used to mitigate the "roll decay" when contango is high.
- Cash and Collateral: Since they are buying futures, they only need to put down a small amount of margin. The rest of the fund's money sits in T-bills, earning interest.
This change made the fund more resilient, but it also made it "slower." When oil prices suddenly spike, the "new" USO might not move as much as you’d expect because some of its holdings are tied to oil prices for delivery two years from now, which are less volatile than the daily spot price.
Real-World Examples of USO in Action
Let's look at a specific scenario. Imagine there's a supply disruption in Libya. The spot price of oil jumps from $75 to $82 in three days. In this environment, the United States Oil Fund will likely perform beautifully. It will capture a large portion of that move.
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But now imagine oil stays at $82 for the next six months. The market is in contango. Every month, the fund rolls its contracts. By the end of those six months, the price of oil is still $82, but your USO shares might be worth 8% less than they were when you started.
You were "right" about the price of oil, but you still lost money.
This is the "contango trap." It's why institutional investors like John Paulson or Pierre Andurand use direct futures or options rather than retail ETFs when they want long-term exposure. They have the infrastructure to manage the roll. You, sitting at home with a brokerage account, have USO.
Better Alternatives for Most People
If you want to bet on oil but you don't want to deal with K-1s or roll decay, you have other options.
Many people find that energy equities—stocks of companies like ExxonMobil (XOM) or Chevron (CVX)—are a better proxy. These companies are "long" oil because they own it in the ground. When the price of oil goes up, their profits explode. Plus, they pay you a dividend to wait. USO doesn't pay you; you pay it (via the expense ratio and the roll).
Another option is the XLE, the Energy Select Sector SPDR Fund. It holds a basket of oil companies. It correlates strongly with the price of oil, but it’s a standard stock ETF. No K-1. No roll decay. You get the benefit of the commodity's rise without the mechanical drag of the futures market.
Actionable Insights for Using USO
If you are still dead-set on using the United States Oil Fund, you need a plan. Don't just "wing it" because you saw a headline about OPEC.
- Check the Curve: Before buying, look up the "WTI Forward Curve." If the future months are significantly more expensive than the current month (Contango), the headwinds for USO are strong. If future months are cheaper (Backwardation), the fund actually gets a tailwind from the roll.
- Set a Time Limit: Treat USO like a hotel room, not a house. You’re staying for a few days, maybe a week. If you find yourself holding it for more than a month, you need a very specific reason why.
- Mind the Position Size: Because of its volatility and the K-1 tax complexity, USO should rarely be a "core" holding. Most pros keep it to a tiny percentage of their speculative "play" money.
- Watch the Dollar: Oil is priced in U.S. Dollars globally. Often, USO moves not because of oil supply, but because the Dollar is getting stronger or weaker. If the Dollar rallies, oil (and USO) usually falls.
- Read the Prospectus: Seriously. Look at the "Risk Factors" section. It's terrifying, but it's honest. It explains exactly how they might fail to track the price of oil.
The United States Oil Fund is a fascinating piece of financial engineering. It brought the world of professional oil trading to the average person's brokerage account. But with that access comes a responsibility to understand the math under the hood. It isn't "broken" when it doesn't track oil perfectly over a year; it's doing exactly what its internal mechanics dictate. Use it for the short sprints, but find another vehicle for the marathon.