United States Oil Fund, LP - Annual Report: 2006 (Form 10-K)
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, 2006.
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¨
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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.)
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1320
Harbor Bay Parkway, Suite 145
Alameda,
California 94502
(Address
of principal executive offices)
(510)
522-3336
(Registrant’s
telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
(Title
of class)
(Name of exchange on which registered)
Units American
Stock
Exchange
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 of this chapter) 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
Yes ¨
No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one.)
Large
accelerated filer ¨ Accelerated
filer ¨ Non-accelerated
filer x
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 common stock held by non-affiliates
of the registrant as of June 30, 2006 was: $265,126,000.
The
registrant had 18,800,000 outstanding units as of March 26, 2007.
DOCUMENTS
INCORPORATED BY REFERENCE:
None.
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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.
It
operates pursuant to the terms of the Third Amended and Restated Agreement
of
Limited Partnership dated as of January 19, 2007 ("LP Agreement"),
which grants full management control to the General Partner.
Who
is the General Partner?
Our
sole
General Partner is Victoria Bay Asset Management, LLC, a single member limited
liability company that was formed in the state of Delaware on May 10, 2005
and
which changed its name on June 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 ("NFA") and
is
registered with the Commodity Futures Trading Commission ("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 United States Natural Gas Fund,
LP
("USNG'), another limited partnership that will be a commodity pool and intends
to issue units to be traded on the American Stock Exchange. The investment
objective of USNG is for the changes in percentage terms of the unit’s net asset
value to reflect the changes in percentage terms of the price of natural
gas
delivered at the Henry Hub, Louisiana as measured by the “Benchmark Futures
Contract,” less USNG’s expenses. The General Partner is the general partner of
USNG and will be responsible for the management of the USNG. Wainwright will
be
the initial limited partner of USNG.
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, review daily positions and margin requirements of
USOF,
and manage USOF’s investments. The General Partner also pays the fees of ALPS
Distributors, Inc. ("Marketing Agent"), Brown Brothers Harriman & Co.
("Administrator"), and Brown Brothers Harriman & Co.
("Custodian").
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 our outstanding limited partner interests (excluding
for purposes of such determination interests owned 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 2/3 percent of our outstanding limited partnership
interests (excluding limited partnership interests owned 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 our General Partner are managed by a board of directors,
which is comprised of four management directors who are also its executive
officers (“Management Directors”) and three independent directors who meet the
independent director requirements established by the American Stock Exchange
and
the Sarbanes-Oxley Act of 2002. Notwithstanding the foregoing, the Management
Directors have the authority to manage the General Partner pursuant to
its
Limited Liability Company Agreement. 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. Mr. Fobes and
Mr. Ellis meet the financial sophistication requirements of the American
Stock Exchange and the audit committee charter. Through its Management
Directors, the General Partner manages the day-to-day operations of
USOF.
1
How
Does USOF Operate?
The
net
assets of USOF consist primarily of investments in futures contracts for
West
Texas Intermediate ("WTI") 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 New York Mercantile Exchange, 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 oil and 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 cash equivalents for margining purposes and as
collateral.
The
investment objective of USOF is for the changes in percentage terms of
the
units’ net asset value ("NAV") to reflect the changes in percentage terms of the
spot price of WTI light, sweet crude oil delivered to Cushing, Oklahoma,
as
measured by the changes in the price of the futures contract on WTI light,
sweet
crude oil as traded on the New York Mercantile Exchange 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 to
expire.
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 (“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 WTI 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 WTI light,
sweet crude oil traded on the New York Mercantile Exchange 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 WTI light,
sweet
crude oil traded on the New York Mercantile Exchange.
More
specifically, 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, and
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·
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B
is the average daily change in the price of the Benchmark Oil
Futures
Contract over the same period.
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The
General Partner believes that market arbitrage opportunities cause changes
in
USOF’s unit price on the American Stock Exchange to closely track changes in
USOF’s NAV. The General Partner further believes that the prices of the
Benchmark Oil Futures Contract have historically closely tracked the spot
prices
of WTI 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 changes
in
the price of USOF’s units on the American Stock Exchange will continue to
closely track the changes in the spot price of a barrel of WTI light, sweet
crude oil, less USOF’s expenses. The following graph
demonstrates the correlation between the NAV of USOF and the spot price
of WTI
light, sweet crude oil during the last thirty valuation days ending December
31,
2006.
2
An
investment in the units allows both retail and institutional investors
to easily
gain exposure to the oil market in a cost-effective manner. The units also
provide additional means for diversifying an investor’s investments or hedging
exposure to changes in oil prices.
The
Benchmark Oil Futures Contract will be changed or “rolled” from the near month
contract to expire to the next month to expire over a four (4) day
period.
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 American Stock Exchange. The price of
units
fluctuates in response to USOF’s NAV and the supply and demand
pressures
of the Exchange. Because of certain arbitrage opportunities, the
General
Partner believes the price of USOF’s units traded on the
Exchange
will correlate closely with USOF’s NAV.
Changes
in USOF’s NAV Are Expected to Correlate Closely With
the
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.
Changes
in the Price of the Benchmark Oil Futures
Contract
Are Expected to Correlate Closely With Changes
in
the Spot Price of WTI 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 WTI light, sweet crude oil
3
The
General Partner employs a “neutral” investment strategy in order to track
changes in the spot price of WTI light, sweet crude oil regardless
of whether
the price of oil 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 oil-related transactions.
USOF’s
total portfolio composition is disclosed each business day that the American
Stock Exchange is open for trading on USOF’s website at
http://www.unitedstatesoilfund.com and through the American Stock Exchange’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 cash and 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 and CFTC
regulations.
The
units may be purchased 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 American Stock Exchange publishes an approximate NAV intra-day
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
Units
may
also be purchased and sold in smaller increments than a Creation Basket on
the American Stock Exchange. However, these transactions 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.
Graph
A
and Graph B on the following page illustrate the historical correlation
between
the monthly average spot price of WTI light, sweet crude oil and the monthly
average price of futures contracts for WTI light, sweet crude oil delivered
to
Cushing, Oklahoma traded on the New York Mercantile Exchange. In addition,
Graph
C illustrates the historical correlation between the Benchmark Oil Futures
Contract and other fuel-based commodity futures contracts in which USOF
may
invest.
These
correlations are relevant because the General Partner endeavors to invest
USOF’s
assets in Oil Futures Contracts and Other Oil Interests so that the changes
in
USOF’s NAV correlate as closely as possible with the changes in the price
of the
Benchmark Oil Futures Contract. As noted, the General Partner also believes
that
the changes in the price of the Benchmark Oil Futures Contract will closely
correlate with the changes in the spot price of WTI light, sweet crude
oil.
Assuming that the units’ value tracks the Benchmark Oil Futures Contract as
intended because of the correlations illustrated by the following charts,
the
stated objective of USOF for the units’ NAV to reflect the performance of the
spot price of WTI light, sweet crude oil would be met if the trend reflected
over the past ten years were to continue. However, there is no guarantee
that
such trend will continue. To obtain the monthly average prices presented
below,
USOF added the closing prices for every day in each month and then divided
that
number by the total number of days in that month.
4
GRAPH
A
GRAPH
B
5
GRAPH
C
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 purchased,
the
General Partner purchases oil interests, such as an Oil Futures Contract
for WTI
light, sweet crude oil traded on the New York Mercantile Exchange, that
have an
aggregate face amount that approximates the amount of Treasuries and cash
received upon the issuance of one or more Creation Baskets.
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 WTI 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 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.
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 New York Mercantile Exchange
Oil
Futures Contracts, as USOF reaches certain position limits on
the New York Mercantile Exchange, 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 American Stock Exchange 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 New York Mercantile
Exchange 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 American Stock Exchange will
continue to closely track the changes in the spot price of WTI 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 New York Mercantile Exchange. Oil Futures Contracts
trade in units of 1,000 barrels. The price of futures contracts
traded on the New York Mercantile Exchange 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 New
York Mercantile Exchange have established accountability levels and position
limits on the maximum net long or net short Oil 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 New York Mercantile Exchange, 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 New York Mercantile Exchange are not
a fixed
ceiling, but rather a threshold above which the New York Mercantile
Exchange may
exercise greater scrutiny and control over an investor’s positions. The current
accountability level for investments at any one time in Oil Futures
Contracts
(including investments in the Benchmark Oil Futures Contract) is 20,000
contracts. If USOF exceeds this accountability level for investments
in Oil
Futures Contracts, the New York Mercantile Exchange 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 New York Mercantile
Exchange, it
could also order USOF to reduce its position back to the accountability
level.
As of December 31, 2006, USOF held 12,871 Oil Futures Contracts traded
on the
New York Mercantile Exchange and 300 Oil Futures Contracts traded on
the ICE
Futures.
If
the
New York Mercantile Exchange orders USOF to reduce its position back
to the
accountability level, or to an accountability level that the New York
Mercantile
Exchange 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 New York Mercantile Exchange has determined that USOF
may not
own more than 20,000 contracts in 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 New
York
Mercantile Exchange. 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 New York Mercantile Exchange
imposes
limits. If the New York Mercantile Exchange 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 New York Mercantile Exchange 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 over a four-day
period beginning two weeks from expiration of the contract.
U.S.
futures exchanges, including the New York Mercantile Exchange, also limit
the
amount of price fluctuation for Oil Futures Contracts. For example, the
New York
Mercantile Exchange imposes a $10.00 per barrel ($10,000 per contract)
price
fluctuation limit for Oil Futures Contracts. This limit is initially
based off
the previous trading day’s settlement price. If any 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
WTI 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.
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Futures
Contract
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Position
Accountability
Levels
and Limits
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Maximum
Daily Price Fluctuation
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New
York Mercantile Exchange WTI Light, Sweet Crude Oil
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Any
one month/all months: 20,000 net futures, but not to exceed 2,000
contracts in the last three days of trading in the spot
month.
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$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.
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ICE Brent
Crude Futures
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There
are no position limits.
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There
is no maximum daily price fluctuation limit.
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ICE
WTI Crude Futures
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There
are no position limits.
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There
is no maximum daily price fluctuation
limit.
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New
York Mercantile Exchange Heating Oil
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7,000
contracts for all months combined, but not to exceed 1,000 in
the last
three days of trading in the spot month.
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$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.
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New
York Mercantile Exchange Gasoline
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Any
one month/all months: 7,000 net futures.
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$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.
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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 barrels of 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 additional
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?
WTI
Light, Sweet Crude Oil. USOF may purchase Oil Futures Contracts traded on
the New York Mercantile Exchange that are based on WTI light, sweet crude
oil.
It may also purchase contracts on other exchanges, including the ICE Futures
and
the Singapore Exchange. The contract provides 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 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 WTI 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 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 New
York Mercantile Exchange, 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.
Natural
Gas. Natural gas accounts for almost a quarter of U.S. energy consumption.
The natural gas futures contract, listed and traded on the New York Mercantile
Exchange, 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.
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 New York Mercantile Exchange, 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.
Why
Does USOF Purchase and Sell Oil Futures Contracts?
USOF’s
investment objective is for changes in percentage terms of the units’ NAV to
reflect the changes in percentage terms of the spot price of WTI light,
sweet
crude oil delivered to Cushing, Oklahoma, 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, a significant majority of USOF’s investments will be in Treasuries 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%-10% of the stated value of the Oil Futures Contract, would be required.
To
secure its Oil Futures Contract obligations, USOF would then deposit the
required margin with the futures commission merchant and hold, through
its
Custodian, Treasuries, cash and 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 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 a futures commission merchant. In addition
to
the Treasuries it posts with the futures commission merchant for the Oil
Futures
Contracts it owns, USOF holds through the Custodian, Treasuries, cash and
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,
cash
and
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 contracts traded on the New York Mercantile Exchange 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 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 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 be 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 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?
Brown
Brothers Harriman & Co. is the registrar and transfer agent for the units.
Brown Brothers Harriman & Co. is also the custodian for USOF. In this
capacity, Brown Brothers Harriman & Co. holds USOF’s cash and Treasuries
pursuant to a custodial agreement. In addition, Brown Brothers Harriman
&
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 Brown Brothers Harriman & Co.’s
fees for these services.
USOF
also
employs ALPS Distributors, Inc. as a Marketing Agent. The General Partner
pays
ALPS Distributors, Inc.’s marketing fee of $425,000 per annum plus an
incentive fee as follows: 0.0% on USOF’s assets from $0-500 million; .04% on
USOF’s assets from $500 million-$4 billion; .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 National Association of Securities Dealers
("NASD") 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 is part of the global settlement that UBS Securities and nine
other
firms have reached with the SEC, NASD, New York Stock Exchange and various
state
regulators. As part of the settlement, UBS Securities has 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.
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, New York Stock Exchange and various other regulatory organizations
and government agencies. UBS Securities fully cooperates with the authorities
in
all such requests. UBS Securities regularly reports to the SEC on Form
B-D
investigations that result in orders. These reports are publicly
available.
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 commodities trading advisors. If, in
the
future, the General Partner does employ commodities trading advisors, it
will
choose each advisor based on arms-length negotiations and will consider
the
advisor’s experience, fees, and reputation.
|
Service
Provider
|
|
Compensation
Paid by the General Partner
|
|
|
|
|
|
Brown
Brothers Harriman & Co., Custodian, Administrator and Transfer
Agent
|
|
A
$50,000 annual fee for its transfer agency services; and for
its custody, fund accounting and fund administration services the
greater of a minimum amount of $250,000 annually or an asset
charge of (a)
0.06% for the first $500 million of USOF's net assets, (b) 0.0465%
for
USOF's net assets greater than $500 million but less than $1
billion, and
(c) 0.035% of USOF'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; .04% on USOF’s assets from $500 million-$4 billion; .03%
on USOF’s assets in excess of $4
billion.
|
——————
*
The
General Partner pays this compensation.
|
Service
Provider
|
Compensation
Paid by USOF
|
Fees
paid during 2006
|
|||||
|
|
|
||||||
|
UBS
Securities LLC, Futures Commission Merchant
|
Approximately
$3.50 per buy or sell
|
$ |
478,713
|
||||
|
Non-Affiliated
Brokers
|
Approximately
0.16%
of assets
|
|
|
||||
——————
**
USOF
pays
this compensation.
14
|
Assets
|
|
Management
Fee
|
Fees
paid during 2006
|
|
|
|
|
|
|
First
$1,000,000,000
|
|
0.04%
of NAV
|
N/A
|
|
After
the first $1,000,000,000
|
|
0.02%
of NAV
|
N/A
|
***
The
General Partner is continuing negotiations with the New York Mercantile
Exchange. As a result, licensing fees in the amount of $22,198 have
been accrued but not paid for 2006.
Assets
of
USOF are aggregated with other funds formed by the General Partner, including
USNG. USOF pays this fee.
Fees
are
to be calculated on a daily basis (accrued at 1/365 of the applicable
percentage
of NAV on that day) and to be paid on a quarterly basis.
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 (“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 (“Exchange Act”). DTC holds securities for DTC
Participants and facilitates the clearance and settlement of transaction
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 limited partner interests 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
NAV as of the earlier of the close of the New York Stock Exchange or
4:00 p.m.
New York time. Trading on the American Stock Exchange typically closes
at 4:15
p.m. New York time. USOF uses the New York Mercantile Exchange closing
price
(determined at the earlier of the close of that Exchange or 2:30 p.m.
New York
time) for the contracts held on the New York Mercantile Exchange, but
calculates
or determines the value of all other USOF investments as of the earlier
of the
close of the New York Stock Exchange 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 American Stock Exchange 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 active
WTI
light, sweet Oil Futures Contract on the New York Mercantile Exchange.
The
prices reported for the active 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 American
Stock Exchange trading hours should not be viewed as an actual real time
update
of the NAV, because 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 American Stock Exchange trading hours of 9:30 a.m. New
York time
to 4:15 p.m. New York time. The normal trading hours of the New York
Mercantile
Exchange 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 American Stock Exchange, but real-time New
York Mercantile Exchange trading prices for oil futures contracts traded
on such
Exchange are not available. As a result, during those gaps there will
be no
update to the indicative fund value.
The
American Stock Exchange disseminates the indicative fund value through
the
facilities of CTA/CQ High Speed Lines. In addition, the indicative fund
value is
published on the American Stock Exchange’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 American
Stock
Exchange. 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 American
Stock
Exchange and sell short oil future 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 near month Oil Futures Contracts for WTI
light,
sweet oil traded on the New York Mercantile Exchange.
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, 2006, 9 Authorized Purchasers
had entered
into agreements with USOF to purchase Creation Baskets of
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 the NASD, or exempt
from
being or otherwise not required to be licensed as a broker-dealer or
a member of
NASD, 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, 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 American Stock Exchange, the New York Mercantile Exchange or the
New York
Stock Exchange 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 American
Stock
Exchange, 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
with USOF, or a combination of Treasuries and cash, 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.
19
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 American Stock Exchange, 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.
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 American Stock
Exchange, 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 American Stock
Exchange 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 American Stock Exchange.
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 American Stock Exchange 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 New York Mercantile
Exchange
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 the General Partner and Affiliates
On
September 8, 2006, the General Partner formed USNG, but since it has not
begun
trading there is no prior performance for USNG. USOF’s offering began on April
10, 2006 and is a continuous offering. As of December 31, 2006, the total
amount of money raised by USOF from Authorized Purchasers was $1,740,249,722;
the total number of Authorized Purchasers was 9, the number of baskets
purchased
by Authorized Purchasers was 290; and the aggregate amount of units purchased
was 29 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, 2006
|
Dollar
Amount Offered:
|
$
|
2,708,260,000
|
|
|
||
|
Dollar
Amount Raised:
|
$
|
1,740,249,722
|
|
|
||
|
Organizational
Expenses*:
|
||
|
SEC
registration fee**:
|
$
|
111,362
|
|
AMEX
Listing Fee**:
|
$
|
5,000
|
|
Auditor's
fees and expenses**:
|
$
|
44,000
|
|
Legal
fees and expenses**:
|
$
|
1,151,354
|
|
Printing
expenses:
|
$
|
240,000
|
|
|
||
|
Length
of Offering:
|
Continuous
|
——————
*
Amounts are for organizational and offering expenses incurred in connection
with
the initial public offering on April 10, 2006.
21
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, 2006):
|
$
|
1,740,249,722
|
||
|
Total
Net Assets as of December 31, 2006:
|
$
|
803,949,254
|
*
|
|
|
Initial
NAV Per Unit as of Inception:
|
$
|
67.39
|
||
|
NAV
per Unit as of December 31, 2006:
|
$
|
51.87
|
||
|
Worst
Monthly Percentage Draw-down:
|
September
2006 (11.71
|
%)
|
||
|
Worst
Peak-to-Valley Draw-down:
|
June
2006-December 2006 (25.73
|
%)
|
||
|
Total
Rate of Return Since Inception:
|
(23.03
|
%)
|
||
——————
* Inclusive
of transactions recorded on a trade date + 1 basis.
|
Month
|
Rates of Return
For the Year 2006
|
|||
|
April
|
3.47
|
%
|
||
|
May
|
(2.91
|
%)
|
||
|
June
|
3.16
|
%
|
||
|
July
|
(0.50
|
%)
|
||
|
August
|
(6.97
|
%)
|
||
|
September
|
(11.71
|
%)
|
||
|
October
|
(8.46
|
%)
|
||
|
November
|
4.73
|
%
|
||
|
December
|
(5.21
|
%)
|
||
22
Draw-down:
Losses experienced by a pool or trading program 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 a pool or trading program. 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.
In
addition, 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 Advisors Act of 1940
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 that focuses on large cap U.S. equities that has approximately $600
million
in assets.
Investments
The
General Partner applies substantially all of USOF’s assets toward trading in Oil
Futures Contracts and other Oil Interests, Treasuries, cash and 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 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 commodity
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 Commodity Exchange Act and
CFTC
regulations.
23
The
Commodity Interest Markets
General
The
Commodity Exchange Act or 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, or 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.
24
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.
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.
25
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.
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.
26
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
New York Mercantile Exchange. 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, or 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
Speculative
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 New York Mercantile Exchange
is
20,000 contracts. The New York Mercantile Exchange 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 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 New York Mercantile Exchange does not impose daily limits
but
rather limits the amount of price fluctuation for Oil Futures Contracts.
For
example, the New York Mercantile Exchange imposes a $10.00 per barrel
($10,000 per contract) price fluctuation limit for Oil Futures Contracts.
This
limit is initially based off the previous trading day’s settlement price. If any
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 commodity
pool
operators and commodity trading advisors and has adopted regulations with
respect to the activities of those persons and/or entities. Under the CEA,
a
registered commodity pool operator, 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 commodity pool operators. Pursuant to this authority, the CFTC
requires commodity pool operators to keep accurate, current and orderly
records
for each pool that they operate. The CFTC may suspend the registration
of a
commodity pool operator (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 commodity pool operator 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.
|
Risk
Factors.
|
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 financial statements
and the related notes.
32
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 WTI 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:
|
·
|
no
commercially productive crude oil or natural gas reservoirs may
be
found;
|
|
·
|
crude
oil and natural gas drilling and production activities may be shortened,
delayed or canceled;
|
|
·
|
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;
|
·
|
decisions
of the cartel of oil producing countries ( e.g.
,
OPEC, the Organization of the Petroleum Exporting Countries), to
produce
more or less oil;
|
|
·
|
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
|
|
·
|
economic
activity of users, as certain economies’ 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 WTI 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 WTI 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 WTI 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:
|
·
|
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 WTI light, sweet crude oil
and the
underlying investments in Oil Futures Contracts and Other Oil Interests
and Treasuries, cash and cash equivalents; and (iv) is required
to pay
brokerage fees and the management fee, which will have an effect on
the correlation.
|
|
·
|
Short-term
supply and demand for WTI 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 oil and the prices of related futures
contracts.
|
|
·
|
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 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 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 WTI light, sweet crude oil and the price
of the
Benchmark Oil Futures Contract.
|
34
|
·
|
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.
|
|
·
|
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.”
|
|
·
|
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 WTI 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.
|
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
WTI
light, sweet, crude oil and this could cause the price of units to substantially
vary from the spot price of WTI 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
oil-related losses or as a way to indirectly invest in
oil.
When
using the Benchmark Oil Futures Contract as a strategy to track the spot
price
of WTI light, sweet crude oil, at best the correlation between changes
in prices
of such oil interests and the spot price 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 WTI light, sweet, crude
oil,
then the price of units may not accurately track the spot price of WTI
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 WTI 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 cash equivalents that it holds. The
anticipated large value of the positions in certain investments, e.g.,
Oil
Futures Contracts, or in negotiated over-the-counter contracts that the
General
Partner acquires or enters 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 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. In addition, such contracts have limited transferability
that
results from such risks and the contract’s express limitations. USOF from time
to time also invests in Other Oil Interests as a result of the speculative
position limits on the New York Mercantile Exchange or other
exchanges.
If
the nature of hedgors and speculators in futures markets has shifted such
that
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 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, 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
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 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 natural gas 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 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 an
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 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 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.
While
USOF is not currently engaging in hedging strategies, participants in the
oil or
in other industries may use USOF as a vehicle to hedge the risk of losses
in
their 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 oil, gasoline, or other fuels, or electricity) may not correlate
because changes in the spot price of oil may vary from changes in energy
costs
because the spot price of 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 oil prices and 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 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 Investment Company Act of 1940.
USOF
is
not an investment company subject to the Investment Company Act of 1940.
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.
USOF
has a limited operating history so there is no extensive performance history
to
serve as a basis to evaluate an investment in USOF.
USOF
is
new and has a limited operating history. Therefore, it does not have extensive
past performance that could otherwise be used as a basis to evaluate an
investment in USOF. Mr. Nicholas Gerber (discussed below) is the only
principal that has any experience operating a commodity pool. Mr. Gerber
ran the Marc Stevens Futures Index Fund (further discussed below) over
10 years
ago. This fund combined investments in commodity futures and equity stock
index
futures and had under $1 million of assets. Mr. Gerber sold the fund to
Newport Commodities. No other principals of the General Partner have operated
a
public or private commodity pool.
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 Mr. Nicholas Gerber, Mr. John Love
and Mr. John Hyland (all discussed in greater detail below). If
Mr. Gerber, Mr. Love or Mr. 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, Mr. Gerber, Mr. Love and
Mr. Hyland are involved in the management of USNG. USNG is expected to
be a public commodity pool designed to track the price movements of natural
gas.
Mr. Gerber and Mr. Love are also employed by Ameristock Corporation, a
registered investment adviser that manages a public mutual fund. USOF estimates
that Mr. Gerber will spend approximately 50% of his time on USOF and USNG
matters, Mr. Love will spend approximately 70% of his time on USOF and USNG
matters and Mr. Hyland will spend approximately 50% of his time on USOF and
USNG matters.
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 oil-related losses or as a way to indirectly invest in
oil.
U.S.
designated contract markets such as the New York Mercantile Exchange 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 Oil Futures Contracts
(including investments in the Benchmark Oil Futures Contract) is 20,000.
While
this is not a fixed ceiling, it is a threshold above which the New York
Mercantile Exchange may exercise greater scrutiny and control over an investor,
including limiting an investor to holding no more than 20,000 Oil Futures
Contracts. With regard to position limits, the New York Mercantile Exchange
limits an investor from holding more than 2,000 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 New York Mercantile
Exchange also sets daily price fluctuation limits on the Benchmark Oil
Futures
Contract. The daily price fluctuation limit establishes the maximum amount
that
the price of futures contracts 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.
In
addition to accountability levels and position limits, the New York Mercantile
Exchange also limits the amount of price fluctuation for Oil Futures Contracts.
For example, the New York Mercantile Exchange imposes a $10.00 per barrel
($10,000 per contract) price fluctuation limit for Oil Futures Contracts.
This
limit is initially based off of the previous trading day’s settlement price. If
any 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 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 oil contracts on the New York Mercantile Exchange, 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 New York Mercantile Exchange, 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 WTI 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 both USOF and USNG. The General Partner may have
a
conflict to the extent that its trading decisions may be influenced by
the
effect they would have on USNG. These trading decisions may be influenced
since the General Partner also serves as the general partner for USNG and
is required to meet USNG’s investment objective as well as USOF’s. If the
General Partner believes that a trading decision it made on behalf of USOF
might
(i) impede USNG from reaching its investment objective, or (ii) improve
the
likelihood of meeting USNG’s objective, 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
USNG, 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 investors could lose their
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 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 limited partnership
interests. 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
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 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 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.
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 WTI 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.
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
Commodity Exchange Act 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
New York
Mercantile Exchange. 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 (“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
Representatives
of the New York Mercantile Exchange have notified USOF of its belief
that USOF
is engaging in unauthorized use of such Exchange’s service marks and settlement
prices.
USOF
invests primarily in Oil Futures Contracts, and particularly in Oil Futures
Contracts traded on the New York Mercantile Exchange. Representatives
of the New
York Mercantile Exchange have at various times asserted varying claims
regarding
USOF’s operations and the Exchange’s service marks and settlement prices of oil
futures contracts traded on the Exchange.
The
New
York Mercantile Exchange initially claimed that USOF’s use of the Exchange’s
service marks would cause confusion as to USOF’s source, origin, sponsorship or
approval, and constitute infringement of the Exchange’s trademark rights and
unfair competition and dilution of the Exchange’s marks. In response to these
claims, the General Partner changed USOF’s name. In addition, USOF expressly
disclaims any association with the Exchange or endorsement of USOF by
the
Exchange and acknowledges that “NYMEX” and “New York Mercantile Exchange” are
registered trademarks of such Exchange.
The
General Partner has also engaged in discussions with the New York Mercantile
Exchange regarding a possible license agreement. In this regard, USOF
received a
letter from the Exchange dated March 29, 2006 (“March 29th Letter”). The March
29th Letter was in response to USOF’s request for additional information in
connection with the negotiation of the possible license agreement. In
the March
29th Letter, the Exchange stated that it would cause the cessation of
any market
data vendor’s provision of New York Mercantile Exchange settlement prices to
USOF and/or take other action to prevent USOF from using any New York
Mercantile
Exchange settlement prices unless USOF enters into a license agreement
with the
Exchange, or has indicated in writing that it will cease from using any
Exchange
settlement prices. USOF will continue to seek an amicable resolution
to this
situation. It is evaluating the current draft of the license agreement
in view
of the March 29th letter but is also taking into account a recent New
York
federal district court decision against the NYMEX that found under similar
circumstances that NYMEX’s intellectual property rights, including those related
to its settlement prices, were significantly limited. USOF and the General
Partner have retained separate counsel to represent them in this
matter.
At
this
time, USOF is unable to determine what the outcome from this matter will
be.
There could be a number of consequences. Under the license agreement
currently
being negotiated, USOF would be required to pay a license fee to the
New York
Mercantile Exchange for the use of its settlement prices. Also, if the
resolution or lack of resolution of this matter results in a material
restriction on, or significant additional expense associated with, the
use of
the New York Mercantile Exchange’s oil futures contract settlement prices, USOF
may be required to invest to a greater degree than currently anticipated
in Oil
Futures Contracts traded on commodity exchanges other than the New York
Mercantile Exchange and Other Oil Interests. These or other consequences
may
adversely affect USOF’s ability to achieve its investment
objective.
47
Others
may also notify USOF of intellectual property rights that could adversely
impact
USOF.
Separately,
Goldman, Sachs & Co. (“Goldman Sachs”) sent USOF a letter on March 17, 2006,
providing USOF 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 interest of the commodity pool to third party investors. USOF
Units are
equity interests in a publicly traded commodity pool. In addition, USOF
will
directly invest in futures contracts and hold other investments to be
used as
margin for its future contract positions. If patents were to be
issued
to Goldman Sachs based upon these patent applications as currently drafted,
and
USOF continued to operate as currently contemplated after the patents
were
issued, claims against USOF and the General Partner for infringement
of the
patents may be made by Goldman Sachs. However, as these patent applications
are
pending and have not been substantively examined by the U.S. Patent and
Trademark Office, it is uncertain at this time what subject matter will
be
covered by the claims of any patent issuing on one of these applications,
should
a patent issue at all.
Under
the
provisions of 35 U.S.C. § 154(d), Goldman Sachs may seek damages in the form of
a reasonable royalty from the date the Units are publicly offered for
sale to
the date one of their cited patent applications issues as a U.S. Patent
if, and
only if, the invention as claimed in the issued patent is substantially
identical to the invention as claimed in the published patent application.
To
obtain a reasonable royalty under 35 U.S.C. § 154(d), one of Goldman Sachs’s
patents must issue and then it must be proved that post-issuance acts
or systems
of USOF infringe a valid claim of the issued patent, and that the infringed
claim is substantially identical to one of the claims in the corresponding
published application. If at the time a Goldman Sachs patent issues,
USOF does
not infringe the claims of the issued patent based on its current design
or
through modifications made prior to issuance, or if any infringed issued
claim
is not substantially identical to a published claim, then Goldman Sachs
will not
be able to obtain a reasonable royalty under 35 U.S.C. § 154(d). At this time
neither of Goldman Sachs’s patent applications have been substantively examined
by an examiner at the U.S. Patent and Trademark Office nor are they currently
being considered for examination on an expedited basis under a Petition
to Make
Special, and considering that both have been placed in Class 705 for
examination, which has an average pendency of approximately 44-45 months
to
issuance (or abandonment) and an issuance rate of approximately 11% in
2004, it
is likely that neither application will issue within the next two years.
Nonetheless, USOF currently is reviewing the Goldman Sachs published
patent
applications, and is engaged in discussions with Goldman Sachs regarding
their
pending applications and USOF’s own pending patent application. At this time,
due in part to the requirements of 35 U.S.C. § 154(d) and the fact that the
Goldman Sachs patent applications are pending and have not been issued
as U.S.
Patents, USOF is unable to determine what the outcome from this matter
will be.
See “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.”
|
Unresolved
Staff Comments.
|
Not
applicable.
|
Properties.
|
Not
applicable.
48
|
Legal
Proceedings.
|
Although
we may, from time to time, be involved in litigation arising out of our
operations in the normal course
of
business or otherwise, we are currently not a party to any pending material
legal proceedings, except for the items noted below.
New
York Mercantile Exchange
Representatives
of the New York Mercantile Exchange have at various times asserted varying
claims regarding USOF’s operations and the Exchange’s service marks and
settlement prices of oil futures contracts traded on the Exchange.
The
New
York Mercantile Exchange initially claimed that USOF’s use of the Exchange’s
service marks would cause confusion as to USOF’s source, origin, sponsorship or
approval, and constitute infringement of the Exchange’s trademark rights and
unfair competition and dilution of the Exchange’s marks. In response to these
claims, the General Partner changed USOF’s name. In addition, USOF expressly
disclaims any association with the Exchange or endorsement of USOF by the
Exchange and acknowledges that “NYMEX” and “New York Mercantile Exchange” are
registered trademarks of such Exchange.
The
General Partner has also engaged in discussions with the New York Mercantile
Exchange regarding a possible license agreement. In this regard, USOF
received the March 29th Letter. The March 29th Letter was in response
to USOF’s request for additional information in connection with the negotiation
of the possible license agreement. In the March 29th Letter, the Exchange
stated
that it would cause the cessation of any market data vendor’s provision of New
York Mercantile Exchange settlement prices to USOF and/or take other action
to
prevent USOF from using any New York Mercantile Exchange settlement prices
unless USOF enters into a license agreement with the Exchange, or has indicated
in writing that it will cease from using any Exchange settlement prices.
USOF
will continue to seek an amicable resolution to this situation. It is evaluating
the current draft of the license agreement in view of the March 29th letter
but
is also taking into account a recent New York federal district court decision
against the NYMEX that found under similar circumstances that NYMEX’s
intellectual property rights, including those related to its settlement
prices,
were significantly limited. USOF and the General Partner have retained
separate
counsel to represent them in this matter.
At
this
time, USOF is unable to determine what the outcome from this matter will
be.
There could be a number of consequences. Under the license agreement currently
being negotiated, USOF would be required to pay a license fee to the New
York
Mercantile Exchange for the use of its settlement prices. Also, if the
resolution or lack of resolution of this matter results in a material
restriction on, or significant additional expense associated with, the
use of
the New York Mercantile Exchange’s oil futures contract settlement prices, USOF
may be required to invest to a greater degree than currently anticipated
in Oil
Futures Contracts traded on commodity exchanges other than the New York
Mercantile Exchange and Other Oil Interests. These or other consequences
may
adversely affect USOF’s ability to achieve its investment
objective.
49
Goldman
Sachs
Goldman,
Sachs & Co. (“Goldman Sachs”) sent USOF a letter on March 17, 2006,
providing USOF 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 interest of the commodity pool to third party investors. USOF Units
are
equity interests in a publicly traded commodity pool. In addition, USOF
directly
invests in futures contracts and hold other investments to be used as margin
for
its future contract positions. If patents were to be issued to Goldman
Sachs
based upon these patent applications as currently drafted, and USOF continued
to
operate as currently contemplated after the patents were issued, claims
against
USOF and the General Partner for infringement of the patents may be made
by
Goldman Sachs. However, as these patent applications are pending and have
not
been substantively examined by the U.S. Patent and Trademark Office, it
is
uncertain at this time what subject matter will be covered by the claims
of any
patent issuing on one of these applications, should a patent issue at
all.
Under
the
provisions of 35 U.S.C. § 154(d), Goldman Sachs may seek damages in the form of
a reasonable royalty from the date the Units are publicly offered for sale
to
the date one of their cited patent applications issues as a U.S. Patent
if, and
only if, the invention as claimed in the issued patent is substantially
identical to the invention as claimed in the published patent application.
To
obtain a reasonable royalty under 35 U.S.C. § 154(d), one of Goldman Sachs’s
patents must issue and then it must be proved that post-issuance acts or
systems
of USOF infringe a valid claim of the issued patent, and that the infringed
claim is substantially identical to one of the claims in the corresponding
published application. If at the time a Goldman Sachs patent issues, USOF
does
not infringe the claims of the issued patent based on its current design
or
through modifications made prior to issuance, or if any infringed issued
claim
is not substantially identical to a published claim, then Goldman Sachs
will not
be able to obtain a reasonable royalty under 35 U.S.C. § 154(d). At this time
neither of Goldman Sachs’s patent applications have been substantively examined
by an examiner at the U.S. Patent and Trademark Office nor are they currently
being considered for examination on an expedited basis under a Petition
to Make
Special, and considering that both have been placed in Class 705 for
examination, which has an average pendency of approximately 44-45 months
to
issuance (or abandonment) and an issuance rate of approximately 11% in
2004, it
is likely that neither application will issue within the next two years.
Nonetheless, USOF currently is reviewing the Goldman Sachs published patent
applications, and is engaged in discussions with Goldman Sachs regarding
their
pending applications and USOF’s own pending patent application. At this time,
due in part to the requirements of 35 U.S.C. § 154(d) and the fact that the
Goldman Sachs patent applications are pending and have not been issued
as U.S.
Patents, USOF is unable to determine what the outcome from this matter
will
be.
|
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 American Stock Exchange (“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 period of April 10, 2006 through December 31, 2006
|
|
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, 2006, we had 27,995 holders of units.
50
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 350
baskets (comprising 13,500,000 units) during the period of April 10, 2006
to
December 31, 2006.
|
Selected
Financial Data.
|
Financial
Highlights (for the period from April 10, 2006 to December 31,
2006)
(Dollar
amounts in 000’s except for Loss per unit)
|
Total
assets
|
$
|
804,349
|
||
|
Net
realized and unrealized loss on futures transactions, inclusive
of
commissions
|
$
|
(138,926
|
)
|
|
|
Net
loss
|
$
|
(126,349
|
) | |
|
Weighted-average
limited partnership units
|
7,018,797
|
|||
| Net loss per unit | $ | (15.52 | ) | |
|
Net
loss per weighted average unit
|
$
|
(18.00
|
) | |
|
Net
cash flows
|
$
|
712,884
|
51
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operation.
|
The
following discussion should be read in conjunction with our consolidated
financial statements and the notes thereto included elsewhere in this Form
10-K.
Forward-Looking
Information
This
Form
10-K 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 which may cause our 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
our future plans, strategies and expectations, are generally identifiable
by use
of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,”
“believe,” “intend” or “project” or the negative of these words or other
variations on these words or comparable terminology. These forward-looking
statements are based on assumptions that may be incorrect, and we cannot
assure
investors that these projections included in these forward-looking statements
will come to pass. Our actual results could differ materially from those
expressed or implied by the forward-looking statements as a result of various
factors.
We
have
based the forward-looking statements included in this annual report on Form
10-K
on information available to us on the date of this annual report on Form
10-K,
and we assume no obligation to update any such forward-looking statements.
Although we undertake 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 we may make
directly to them or through reports that we in the future may file with the
SEC,
including annual reports on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K. Except
for historical information contained herein, this “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” contains
forward-looking statements that involve known and unknown risks and
uncertainties that may cause our actual results or outcome to be materially
different from any future results, performance or achievements expressed
or
implied by such forward-looking statements.
Introduction
USOF,
a
Delaware limited partnership, is a commodity pool that issues units that
may be purchased and sold on the American Stock Exchange. 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
WTI light, sweet crude oil delivered to Cushing, Oklahoma, also on a daily
basis, 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 Benchmark Oil Futures Contract, also measured in percentage terms.
USOF’s General Partner believes the Benchmark Oil Futures Contract historically
exhibited a close correlation with the spot price of WTI light, sweet crude
oil.
At
present, on any valuation day the Benchmark Oil Futures Contract is the
near
month futures contract for WTI light, sweet crude oil traded on the New
York
Mercantile Exchange 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 WTI light, sweet crude oil traded on the New York
Mercantile Exchange. “Near month contract” means the next contract traded on the
New York Mercantile Exchange due to expire; “next month contract” means the
first contract traded on the New York Mercantile Exchange due to expire
after
the near month contract.
USOF
may
also invest in futures contracts for other types of crude oil, heating
oil,
gasoline, natural gas, and other petroleum-based fuels that are traded
on the
New York Mercantile Exchange or other U.S. and foreign exchanges (collectively,
“Oil Futures Contracts”) and other oil interests 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 oil, other petroleum-based
fuels,
Oil Futures Contracts and indices based on the foregoing (collectively,
“Other
Oil Interests”). The General Partner of USOF, Victoria Bay Asset Management,
LLC, which is registered as a commodity pool operator, 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 commodities trading advisors or futures commission
merchants.
52
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 New York Stock Exchange 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 American Stock Exchange typically closes at 4:15 p.m. New York time.
USOF uses the New York Mercantile Exchange closing price (determined at
the
earlier of the close of that exchange or 2:30 p.m. New York time) for the
contracts held on the New York Mercantile Exchange, but calculates or determines
the value of all other USOF investments as of the earlier of the close
of the
New York Stock Exchange 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 American Stock Exchange 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. USOF also
commenced
investment operations on that day by purchasing oil futures contracts traded
on
the New York Mercantile Exchange that are based on WTI light, sweet crude
oil.
The total market value of the crude oil futures contracts purchased on
that day
was $13,418,501 at the time of purchase. USOF established cash deposits
equal to
$13,478,000 at the time of the initial sale of Units. The ending NAV on
the
first day of operations was $67.93. The majority of those cash assets were
held
at USOF’s custodian bank while less than 10% of the cash balance was held as
margin deposits with USOF’s futures commission merchant relating to the Oil
Futures Contracts purchased.
Portfolio
Expenses.
USOF’s
expenses consist of investment management fees and commissions. The investment
advisory 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
investment advisory fee is 0.5%. For assets over $1 billion, the investment
advisory 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 the
USOF were approximately $400,799,633. At no time during 2006, did the total
net
assets of USOF exceed $1 billion. The investment advisory fee paid by USOF
amounted to $1,460,448, which was calculated at the 0.50% rate and accrued
daily.
USOF
also
incurs commissions to brokers for the purchase and sale of futures contracts,
other oil interests, or Treasuries. During 2006, total commissions paid
amounted to $478,713. Prior to the initial offering, USOF had estimated
that the
annual level of such commissions for USOF was expected to be 0.35% of total
net
assets. As an annualized percentage of total net assets, the actual figures
for
2006 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.
Expenses
incurred from inception through December 31, 2006 in connection with organizing
USOF and the initial offering costs of the units were borne by the General
Partner, and are not subject to reimbursement by USOF.
Interest
Income.
USOF
seeks to invest its assets such that it holds crude 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 cash deposits or in Treasuries. This includes
both
the amount on deposit with the futures brokerage firms as margin as well
as
unrestricted cash held with USOF’s custodian bank. The cash or Treasuries 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 or cash
equivalents during this time period.
53
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 30-day period,
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. 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 ending December 31, 2006, the simple average daily change
in
the Benchmark Oil Futures Contract was -0.004 %, while the simple average
daily
change in the NAV of USOF over the same time period was -0.021 %. The average
daily difference was 0.017 % (or 1.7 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 3%, meaning
that
over this time period USOF’s tracking error was within the plus or minus 10%
range established as its benchmark tracking goal.
54
Since
the
offering of USOF units to the public on April 10, 2006, the simple average
daily change in the Benchmark Oil Futures Contract was -0.131%, while the
simple
average daily change in the NAV of USOF over the same time period was-
0.138%.
The average daily difference was 0.007% (or .7 basis point, where 1 basis
point
equals 1/100 of 1%). As a percentage of the daily movement of the benchmark
contract, the average error in daily tracking by the NAV was 3%, 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 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. As a point of reference, USOF commenced
operations on April 10,
2006
with the June 2006 crude oil contract as its Benchmark Oil Futures Contract.
USOF ended 2006 with the February 2007 crude oil contract as its Benchmark
Oil
Futures Contract.
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.
Of
the
various factors that could impact USOF’s ability to accurately track its
benchmark, there are currently three factors that have, during the latest
period, or are most likely to impact in the future, these tracking results.
The
first
major factor that could affect tracking results is if USOF buys or sells
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, if such transactions
did
occur, 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 2006, 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 is not always
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.
The
second major factor that could affect tracking results is the interest that
USOF earns on its cash and Treasury holdings. USOF is not required to
distribute any portion of its income to its unit holders and did not
make any
distribution to unitholders in 2006. 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 investment advisory fee and its
brokerage commissions, 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 2006, USOF earned on an annualized
basis approximately 4.77% on its cash holdings. It also incurred cash
expenses
on an annualized basis of .5% for investment advisory fees and approximately
.16% in brokerage commission costs related to the purchase and sale of
futures
contracts. The foregoing fees and expenses resulted in a net yield on
an
annualized basis of approximately 4.1% 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 investment advisory 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 crude oil
futures
contracts.
55
The
third
major factor affecting tracking results is if USOF holds oil related investments
in its portfolios other than the current Benchmark Oil Futures Contract
that
fail to closely track the Benchmark Oil Futures Contract's total return
movements. In that case, the error in tracking the benchmark can 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 2006 USOF did not hold any oil related
investments other than the then current Benchmark Oil Futures Contract.
However,
there can be no assurance that in future quarters USOF will not make use
of such
non-benchmark oil related investments.
Crude
oil market. During the period from April 10, 2006 to December 31, 2006,
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. On the supply
side,
production remained steady despite concerns about the possible negative
impact
of hurricanes in the U.S. Gulf Coast area and violence impacting production
in
Iraq and Nigeria. During the latter part of 2006, the oil producing portions
of
the Gulf Coast were not subject to a repeat of 2005’s disastrous storms. In
addition, although the crude oil market’s concerns about geo-political issues
regarding other key crude oil producing countries, such as Iran and Venezuela,
remained, such concerns appear to have moderated at least in the short
term. As
a result of the foregoing, although crude oil prices trended initially
higher
from April 10 until mid-July 2006, over the course of rest of the third
and
fourth quarters prices fell sharply and showed periods of greater than
usual
volatility. Crude oil prices finished 2006 at lower levels than where they
were
in April 2006 when USOF commenced operations.
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
in
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 next month contract. If the price of 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), than absent any other change there is a
tendency for the price of a next month contract to decline in value as
it
becomes 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 up and down 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 up and down in reaction to a number of market factors.
If
investors seeks 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 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 next month contracts
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 cash),
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 will 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 next month
contracts
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 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 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 $50. Over time if contango remained constant the difference
would
continue to increase.
56
Historically
the futures oil markets have experienced periods of contango and backwardation,
with backwardation being in place more often than contango. During the
past two
years, including 2006, these markets have experienced contango. This
has
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 on April 10 and held to December 31, 2006
decreased, based upon the changes in the closing market prices for USOF
units on
those days, by 23.03%, while the spot price of crude oil for immediate
delivery
during the same period decreased 11.18% (note: this comparison ignores
the
potential costs associated with physically owning and storing crude oil).
However, 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, or
changes in
the price of the Benchmark Contract. This period of contango did not
meaningfully impact USOF’s investment objective of having percentage changes in
its per unit price track percentage changes in the price of the Benchmark
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
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.
Subsequent
Events
On
January 30,
2007, USOF
had a follow-on public offering of its units declared effective by the U.S.
Securities and Exchange Commission. The primary purpose of that filing
was to
register an additional 50,000,000 units for sale. This offering was
combined with the registration statement on Form S-1 dated October 18,
2006 and
included several changes in language and procedure.
Critical
Accounting Policies
Preparation
of the 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 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. While
not
currently applicable given the fact that during the time period covered
by this
report, USOF was not investing in futures contracts not traded on a United
States futures exchange to the extent USOF makes such investments in the
future,
the values used by USOF for its forward contracts will be provided by its
commodity broker who uses market prices when available, while over-the-counter
contracts will be valued based on the present value of estimated future
cash
flows that would be received from or paid to a third party in settlement
of
these derivative contracts prior to their delivery date and valued on a
daily
basis.
Liquidity
and Capital Resources
USOF
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 cash and/or short-term Treasuries 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 cash. USOF has allocated substantially all of its
nets
assets to trading in oil interests. A significant portion of the NAV was
held in
cash that was used as margin for USOF's trading in oil interests. Cash
or Treasuries 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.
57
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
limit. Such market conditions could prevent USOF from promptly liquidating
its
positions in Oil Futures Contracts. During 2006, USOF was not forced to
liquidate any of its positions as a result of daily limits; however, USOF
cannot
predict whether such an event may occur in the future. To date, all of
USOF's
and the General Partner's expenses have been funded by their affiliates.
Neither
USOF nor the General Partner have any obligation or intention to refund
such
payments by their affiliates. These affiliates are under no obligation
to
continue payment of USOF's or the General Partner's expenses. If such affiliates
were to discontinue the payment of these expenses and 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 oil, as
well as
drastic market occurrences, could ultimately lead to the loss of all or
substantially all of an investor’s capital.
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 New York Mercantile
Exchange and on most other 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. During the period ended December 31, 2006, the only foreign
exchange we made on investments of oil interests was the ICE Futures. There
can
be no assurance that any counterparty, clearinghouse, or their members
or
financial backers would 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. These commodity brokers are not allowed to commingle
USOF's assets with their 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.
Off
Balance Sheet Financing
As
of
December 31, 2006, 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 that 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.
58
Redemption
Basket Obligation
In
order
to meet its investment objective and pay its contractual obligations described
below, USOF requires liquidity to redeem Redemption Baskets. USOF has
satisfied this obligation through the sale of its Treasuries or cash 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 .50% for an NAV of $1 billion
or less,
and thereafter .20% of the NAV above $1 billion. The General Partner or
its
affiliate has agreed to pay the start-up costs associated with the formation
of
USOF, primarily its legal, accounting and other costs in connection with
its
registration with the CFTC as a commodity pool operator and the registration
and
listing of USOF with the SEC and the American Stock Exchange, respectively.
However, certain costs of registering and listing additional shares of
USOF with
the SEC may be directly borne in the future by USOF, and not by the General
Partner, if the General Partner determines that such costs are no longer
part of
the start-up costs of USOF and instead are part of the ordinary on-going
costs
of USOF.
The
General Partner has agreed to pay the fees of the custodian and transfer
agent,
Brown Brothers Harriman & Co., as well as Brown Brothers Harriman &
Co.'s fees for performing administrative services, including in connection
with
USOF's preparation of its financial statements and its SEC and CFTC reports.
The
General Partner will also pay the fees of USOF's accountants and a separate
firm
for providing tax related services, as well as those of USOF's marketing
agent,
ALPS Distributors, Inc. The General Partner is also in the process of
negotiating a licensing agreement with the New York Mercantile Exchange
under
which certain licensing fees will be paid to the exchange by USOF.
In
addition to the General Partner's management fee, USOF pays its brokerage
fees,
over-the-counter dealer spreads, fees to the Broker (or any other Futures
Clearing Merchant that the General Partner may elect to use for execution
or
clearing of futures trades), and extraordinary expenses. The latter are
expenses
not in the ordinary course of its business, including 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 the Broker
or any
other Futures Clearing Merchant are on a contract-by-contract, or round
turn,
basis.
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
with an
option to renew, or, in some cases, are in effect for the duration of USOF's
existence. The parties may terminate these agreements earlier for certain
reasons listed in the agreements.
59
Item
7A. Quantitative
and Qualitative Disclosure About Market Risk
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 such 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 price
of the
crude oil spot, or 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 WTI spot price, the
price
of Oil Futures Contract traded on New York Mercantile Exchange 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.
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 period ended December 31, 2006, 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.
60
|
Financial
Statements and Supplementary
Data.
|
Index
to Financial Statements
61
Report
of Independent Registered Public Accounting
Firm
To
the
Partners of
United
States Oil Fund, LP (formerly New York Oil ETF, LP)
We
have
audited the accompanying statements of financial condition of United
States Oil
Fund, LP, (formerly New York Oil ETF, LP) (the “Fund”) as of December 31, 2006
and 2005, including the schedule of investments as of December 31, 2006,
and the
related statements of operations, changes in partners’ capital and cash flows
for the year ended December 31, 2006 and the period from inception (May
12,
2005) through 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
(formerly New York Oil ETF, LP) as of December 31, 2006 and 2005, and the
results of its operations and its cash flows for the year ended December
31,
2006 and the period from inception (May 12, 2005) through December 31,
2005 in
conformity with accounting principles generally accepted in the United
States of
America.
/s/
SPICER JEFFRIES LLP
Greenwood
Village, Colorado
March
15,
2007
62
|
United
States Oil Fund, LP
|
|||||||
|
Statements
of Financial Condition
|
|||||||
|
December
31, 2006 and 2005
|
|||||||
|
|
|||||||
|
2006
|
2005
|
||||||
|
Assets
|
|||||||
|
Cash
and cash equivalents
|
$
|
712,883,812
|
$
|
1,000
|
|||
|
Equity
in UBS Securities LLC trading accounts:
|
|||||||
|
Cash
|
87,123,636
|
-
|
|||||
|
Unrealized
loss on open commodity futures contracts
|
(34,383,000
|
)
|
-
|
||||
|
Receivable
for units sold
|
36,080,896
|
-
|
|||||
|
Interest
receivable
|
2,626,230
|
-
|
|||||
|
Other
assets
|
17,000
|
-
|
|||||
|
Total
assets
|
$
|
804,348,574
|
$
|
1,000
|
|||
|
Liabilities
and Partners' Capital
|
|||||||
|
General
Partner management fees (Note 3)
|
$
|
332,736
|
$
|
-
|
|||
|
Commissions
payable
|
44,386
|
-
|
|||||
|
Other
liabilities
|
22,198
|
-
|
|||||
|
Total
liabilities
|
399,320
|
-
|
|||||
|
Commitments
and Contingencies (Notes 3,
4 and 5)
|
|||||||
|
Partners'
Capital
|
|||||||
|
General
Partner
|
-
|
20
|
|||||
|
Limited
Partners
|
803,949,254
|
980
|
|||||
|
Total
Partners' Capital
|
803,949,254
|
1,000
|
|||||
|
Total
liabilities and partners' capital
|
$
|
804,348,574
|
$
|
1,000
|
|||
|
Limited
Partners' units outstanding, December 31, 2006
|
15,500,000
|
-
|
|||||
|
Net
asset value per unit (commencement of operations, April 10,
2006)
|
$
|
67.39
|
$ |
-
|
|||
|
Net
asset value per unit, December 31, 2006
|
$
|
51.87
|
$
|
-
|
|||
|
Market
value per unit, December 31, 2006
|
$
|
51.60
|
$
|
-
|
|||
|
See
accompanying notes to financial statements.
|
|||||||
63
|
United
States Oil Fund, LP
|
||||||||||
|
Schedule
of Investments
|
||||||||||
|
December
31, 2006
|
||||||||||
|
Open
Futures Contracts
|
||||||||||
|
Loss
on Open
|
||||||||||
|
Number
of
|
Commodity
|
%
of Partners'
|
||||||||
|
|
Contracts
|
Contracts
|
Capital
|
|||||||
|
United
States Contracts
|
||||||||||
|
Crude
Oil Future contracts, expires February 2007
|
13,171
|
$
|
(34,383,000
|
)
|
(4.28
|
)
|
||||
|
Cash
Equivalents
|
||||||||||
|
|
Cost
|
Market
Value
|
||||||||
|
United
States - Money Market Funds
|
||||||||||
|
AIM
STIT- Liquid Assets Portfolio
|
$
|
171,344,554
|
$
|
171,344,554
|
21.31
|
|||||
|
AIM
STIT- STIC Prime Portfolio
|
171,230,961
|
171,230,961
|
21.30
|
|||||||
|
Goldman
Sachs Financial Square Funds - Prime Obligations Fund
|
190,268,507
|
190,268,507
|
23.67
|
|||||||
|
$
|
532,844,022
|
|
532,844,022
|
66.28
|
||||||
| Cash |
180,039,790
|
22.39
|
|||||
| Total cash and cash equivalents |
712,883,812
|
88.67
|
|||||
|
Cash
on deposit with broker
|
|
87,123,636
|
10.84
|
||||
|
Other
assets in excess of liabilities
|
38,324,806
|
4.77
|
|||||
|
Total
Partners' Capital
|
$
|
803,949,254
|
100.00
|
||||
|
See
accompanying notes to financial statements.
|
64
|
Statements
of Operations
|
|||||||
|
For
the period from (April 10, 2006) commencement of operations
to December
31, 2006
|
|||||||
|
and
the period from (May 12, 2005) inception to December
31,
2005
|
|||||||
|
2006
|
2005
|
||||||
|
Income
|
|||||||
|
Gains
(losses) on trading of commodity futures contracts:
|
|||||||
|
Realized
losses on closed positions
|
$
|
(104,063,960
|
)
|
$
|
-
|
||
|
Change
in unrealized losses on open positions
|
(34,383,000
|
)
|
-
|
||||
|
Interest
income
|
13,930,431
|
-
|
|||||
|
Other
income
|
129,000
|
-
|
|||||
|
Total
loss
|
(124,387,529
|
)
|
-
|
||||
|
Expenses
|
|||||||
|
General
Partner management fees (Note 3)
|
1,460,448
|
-
|
|||||
|
Brokerage
commissions
|
478,713
|
-
|
|||||
|
Other
expenses
|
22,198
|
-
|
|||||
|
Total
expenses
|
1,961,359
|
-
|
|||||
|
Net
loss
|
$
|
(126,348,888
|
)
|
$
|
-
|
||
|
Net
loss per limited partnership unit
|
$
|
(15.52
|
)
|
$
|
-
|
|
|
|
Net
loss per weighted average limited partnership
unit
|
$
|
(18.00
|
)
|
$
|
-
|
||
|
Weighted
average limited partnership units outstanding
|
7,018,797
|
-
|
|||||
|
See
accompanying notes to financial statements.
|
|||||||
65
|
Statements
of Changes in Partners' Capital
|
||||||||||
|
For
the period from (April 10, 2006) commencement of operations
to December
31, 2006
|
||||||||||
|
and
the period from (May 12, 2005) inception to December 31,
2005
|
||||||||||
|
General
Partner
|
Limited
Partners
|
Total
|
||||||||
|
Balances,
at Inception
|
$
|
-
|
$
|
-
|
$
|
-
|
||||
|
Initial
contribution of capital
|
20
|
980
|
1,000
|
|||||||
|
Balances,
at December 31, 2005
|
20
|
980
|
1,000
|
|||||||
|
Addition
of 29,000,000 partnership units
|
-
|
1,740,249,722
|
1,740,249,722
|
|||||||
|
Redemption
of 13,500,000 partnership units
|
(20
|
)
|
(809,952,560
|
)
|
(809,952,580
|
)
|
||||
|
Net
loss
|
-
|
(126,348,888
|
)
|
(126,348,888
|
)
|
|||||
|
Balances,
at December 31, 2006
|
$
|
-
|
$
|
803,949,254
|
$
|
803,949,254
|
||||
|
Net
Asset Value Per Unit
|
||||||||||
|
At
December 31, 2005
|
$
|
-
|
||||||||
|
At
April 10, 2006 (commencement of operations)
|
$ |
67.39
|
||||||||
|
At
December 31, 2006
|
$
|
51.87
|
||||||||
|
See
accompanying notes to financial statements.
|
||||||||||
66
|
Statements
of Cash Flows
|
|||||||
|
Period
from (April 10, 2006) commencement of operations to December
31,
2006
|
|||||||
|
and
the period from (May 12, 2005) inception to December 31,
2005
|
|||||||
|
2006
|
2005
|
||||||
|
Cash
Flows from Operating Activities:
|
|||||||
|
Net
loss
|
$
|
(126,348,888
|
)
|
$
|
-
|
||
|
Adjustments
to reconcile net loss to net cash
|
|||||||
|
used
in operating activities:
|
|||||||
|
Increase
in commodity futures trading account - cash
|
(87,123,636
|
)
|
-
|
||||
|
Increase
in unrealized loss on futures contracts
|
34,383,000
|
-
|
|||||
|
Increase
in interest receivable and other assets
|
(2,643,230
|
)
|
-
|
||||
|
Increase
in management fees payable
|
332,736
|
- | |||||
|
Increase
in commissions payable
|
44,386
|
-
|
|||||
|
Increase
in other liabilities
|
22,198
|
-
|
|||||
|
Net
cash used in operating activities
|
(181,333,434
|
)
|
-
|
||||
|
Cash
Flows from Financing Activities:
|
|||||||
|
Subscription
of partnership units
|
1,704,168,826
|
1,000
|
|||||
|
Redemption
of partnership units
|
(809,952,580
|
)
|
-
|
||||
|
Net
cash provided by financing activities
|
894,216,246
|
1,000
|
|||||
|
Net
Increase in Cash and Cash Equivalents
|
712,882,812
|
1,000
|
|||||
|
Cash
and Cash Equivalents,
beginning of period
|
1,000
|
-
|
|||||
|
Cash
and Cash Equivalents,
end of period
|
$
|
712,883,812
|
$
|
1,000
|
|||
|
See
accompanying notes to financial statements.
|
|||||||
67
United
States Oil Fund, LP
(formerly
New York Oil ETF, LP)
Notes
to Financial Statements
December
31, 2006
NOTE
1 - ORGANIZATION AND BUSINESS
United
States Oil Fund, LP (formerly New York Oil ETF, LP) (the “Fund”), was organized
as a limited partnership under the laws of the state of Delaware on May
12, 2005
and changed its name on September 30, 2005. The Fund is a commodity pool
that
issues units that may be purchased and sold on the American Stock Exchange.
The
Fund will continue in perpetuity, unless terminated sooner upon the occurrence
of one or more events as described in its First Amended and Restated Limited
Partnership Agreement (the “Limited Partnership Agreement”). The investment
objective of the Fund is for its net asset value to reflect the performance
of
the price of light, sweet crude oil, less the Fund’s expenses. The Fund will
accomplish its objectives through investments in futures contracts for
light,
sweet crude oil, other types of crude oil, heating oil, gasoline, natural
gas
and other petroleum-based fuels that are traded on the New York Mercantile
Exchange and other U.S. and foreign exchanges (“Oil Futures Contracts”) and
other oil interests 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 oil. Victoria Bay Asset Management, LLC is the general partner
of
the Fund (the “General Partner”) and is also responsible for the management of
the Fund. The
Fund
commenced operations on April 10, 2006. The
General Partner is a member of the National Futures Association (“NFA”) and is a
commodity pool operator effective December 1, 2005. The
Fund
has a fiscal year ending on December 31.
The
Fund
issues limited partnership interests (“Units”) to authorized purchasers by
offering creation baskets consisting of 100,000 Units (“Creation Baskets”)
through a marketing agent. The purchase price for a Creation Basket is
based
upon the net asset value of a Fund Unit. In addition, authorized purchasers
pay
the Fund a $1,000 fee for the creation of each Creation Basket. The initial
offering price of the initial creation basket was based on the closing
price of
the near month oil futures contracts as traded and reported on the New
York
Mercantile Exchange on the last business day prior to the effective date.
Additionally, subsequent to the sale of the initial Creation Basket, Units
can
be purchased or sold on a nationally recognized securities exchange in
smaller
increments. Units purchased or sold on a nationally recognized securities
exchange are not made at the net asset value of the Fund but rather at
market
prices quoted on the stock exchange.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue
Recognition
Commodity
futures contracts, forward contracts, physical commodities, and related
options
are recorded on the trade date. All such transactions are recorded on the
identified cost basis and marked to market daily. Unrealized gains or losses
on
open contracts are reflected in the statement of financial condition and
the
difference between original contract amount and market value (as determined
by
exchange settlement prices for futures contracts and related options and
cash
dealer prices at a predetermined time for forward contracts, physical
commodities, and their related options) as of the last business day of
the year
or as of the last date of the financial statements. Changes in the unrealized
gains or losses between periods are reflected in the statement of operations.
The Fund earns interest on its assets on deposit at the Broker at the 90-day
Treasury bill rate less fifty basis points for deposits denominated in
U.S.
dollars.
Brokerage
Commissions
Brokerage
commissions on all open commodity futures contracts are accrued on a full-turn
basis.
68
Income
Taxes
The
Fund
is not subject to federal income taxes; each partner reports his/her allocable
share of income, gain, loss deductions or credits on his/her own income
tax
return.
Redemptions
Authorized
persons may redeem Units from the Fund only in blocks of 100,000 Units
called
“Redemption Baskets”. The amount of the redemption proceeds for a Redemption
Basket will be equal to the net asset value of the Fund Units in the Redemption
Basket.
Partnership
Capital and Allocation of Partnership Income and Losses
Profit
or
loss shall be allocated among the partners of the Fund in proportion to
the
number of Units each partner holds as of the close of each month. The General
Partner may revise, alter or otherwise modify this method of allocation
as
described in the Limited Partnership Agreement.
Calculation
of Net Asset Value
The
Fund
calculates net asset value on each trading day by taking the current market
value of its total assets, subtracting any liabilities and dividing the
amount
by the total number of Units issued and outstanding. The Fund uses the
New York
Mercantile Exchange closing price on that day for contracts held on the
New York
Mercantile Exchange.
Loss
per Limited Partnership Unit
Net
loss
per limited partnership Unit is the difference between the net asset value
per
Unit at the beginning and end of each period. The weighted average number
of
limited partnership Units outstanding was computed for purposes of disclosing
net loss per weighted average limited partnership Unit. The weighted average
limited partnership Units are equal to the number of Units outstanding
at period
end, adjusted proportionately for Units redeemed based on their respective
time
outstanding during such period. There were no Units held by the General
Partner at December 31, 2006.
Cash
Equivalents
As
of
December 31, 2006, cash and cash equivalents included money market portfolios
and overnight time deposits with original maturity dates of three months
or
less.
Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires the Fund’s
management to make estimates and assumptions that affect the reported amount
of
assets and liabilities and disclosure of contingent assets and liabilities
at
the date of the financial statement, and the reported amounts of the revenue
and
expenses during the reporting period. Actual results could differ from
those
estimates.
NOTE 3
- GENERAL PARTNER MANAGEMENT FEE AND RELATED PARTY
TRANSACTIONS
Under
the
Limited Partnership Agreement, the General Partner is responsible for
investing
the assets of the Fund in accordance with the objectives and policies
of the
Fund. In addition, the General Partner has arranged for one or more third
parties to provide administrative, custody, accounting, transfer agency
and
other necessary services to the Fund. For these services, the Fund is
contractually obligated to pay the General Partner a fee, which is paid
monthly,
based on average daily net assets that are equal to .50% per annum on
average
net assets of $1,000,000,000 or less and .20% per annum of average daily
net
assets that are greater than $1,000,000,000. The Fund will pay for all
brokerage
fees, taxes and
other
expenses, including licensing fees for the use of intellectual property,
registration or other fees paid to the Securities and Exchange Commission,
the
National Association of Securities Dealers, or any other regulatory agency
in
connection with the offer and sale of subsequent Units after its initial
registration and all legal, accounting, printing and other expenses
associated therewith. The Fund also pays the fees and expenses, including
the
directors and officers’ liability insurance, of the independent
directors.
For
the period ended December 31, 2006, all of the
Fund's offering and organizational expenses have been funded by an affiliate
of
the General Partner. The Fund does not have any obligation or intention to
reimburse such payments. The Fund incurred offering and organizational
costs in the amount of $1,571,318.
69
NOTE
4 - CONTRACTS AND AGREEMENTS
The
Fund
is party to a marketing agent agreement dated March 13, 2006 with ALPS
Distributors Inc. (“ALPS”), a Colorado corporation, whereby ALPS provides
certain marketing services for the Fund as outlined in the agreement. The
fees
of the marketing agent, which are borne by the General Partner, include
a
marketing fee of $425,000 per annum plus the following incentive fee: zero
basis
points on Fund assets from $0 - $500 million; 4 basis points on Fund assets
from
$500 million - $4 billion; and 3 basis points on Fund assets in excess
of $4
billion.
The
above
fees do not include the following expenses, which are also borne by the
General
Partner: the cost of placing advertisements in various periodicals; web
construction and development; or the printing and production of various
marketing materials.
The
Fund
is also party to a custodian agreement dated March 13, 2006, with Brown
Brothers
Harriman & Co. (“Brown Brothers”), whereby Brown Brothers holds investments
on behalf of the Fund. The General Partner of the Fund pays the fees of
the
custodian, which shall be agreed to from time to time between the parties.
In
addition, the Fund is party to an administrative agency agreement dated
March
13, 2006, also with Brown Brothers, whereby Brown Brothers acts as the
administrative agent, transfer agent and registrar for the Fund. The General
Partner also pays the fees of Brown Brothers for its services under this
agreement and such fees will be determined by the parties from time to
time.
Currently,
the General Partner pays Brown Brothers for its services in the foregoing
capacity a minimum amount of $300,000 annually and, once the Fund’s net assets
are above $500 million, an asset charge, which is not reflected in either
agreement, ranging between 0.035% and 0.06%, plus a $50,000 transfer agency
fee,
and transaction charges of $7.00 to $15.00 per transaction.
The
Fund
invests primarily in oil futures contracts traded on the New York Mercantile
Exchange (the “Exchange”). The Fund and the Exchange are discussing entering
into and in the process of finalizing a License Agreement whereby the Fund
will
be granted a non-exclusive license to use certain of the Exchange’s settlement
prices and service marks. Under the proposed License Agreement, the Exchange
would receive an asset-based fee for the license, which will be paid by
the
Fund.
The
Fund
expressly disclaims any association with the Exchange or endorsement of
the Fund
by the Exchange and acknowledges that “NYMEX” and “New York Mercantile Exchange”
are registered trademarks of such Exchange.
The
Fund
has entered into a brokerage agreement with UBS Securities LLC, formerly
ABN
AMRO Incorporated, Futures Commission Merchant (the “Broker”). The agreement
provides that the Broker charge the Fund commissions of approximately $7
per
round-turn trade plus applicable exchange and NFA fees for futures contracts
and
options on futures contracts.
NOTE
5 - FINANCIAL INSTRUMENTS, OFF-BALANCE SHEET RISKS AND
CONTINGENCIES
The
Fund
engages in the speculative trading of U.S. futures contracts and options
on U.S.
futures contracts (collectively “derivatives”). The Fund is exposed to both
market risk, which is the risk arising from changes in the market value
of the
contracts; and credit risk, which is the risk of failure by another party
to
perform according to the terms of a contract.
All
of
the contracts currently traded by the Fund are exchange traded. The risks
associated with exchange-traded contracts are generally perceived to be
less
than those associated with over-the-counter transactions since, in
over-the-counter transactions, the Fund must rely solely on the credit
of their
respective individual counterparties. However, in the future, if the Fund
were
to enter into non-exchange traded contracts, it would be subject to the
credit
risk associated with counterparty non-performance. The credit risk from
counterparty non-performance associated with such instruments is the net
unrealized gain, if any. The Company also has credit risk since the sole
counterparty to all domestic futures contracts is the exchange clearing
corporation. In addition, the Fund bears the risk of financial failure
by the
clearing broker.
70
The
purchase and sale of futures and options on futures contracts requires
margin
deposits with a Futures Commission Merchant (“FCM”). Additional deposits may be
necessary for any loss on contract value. The Commodity Exchange Act requires
an
FCM to segregate all customer transactions and assets from the FCM’s proprietary
activities.
The
Fund’s cash and other property such as U.S. Treasury Bills, deposited with an
FCM are considered commingled with all other customer funds subject to
the FCM’s
segregation requirements. In the event of an FCM’s insolvency, recovery may be
limited to a pro rata share of segregated funds available. It is possible
that
the recovered amount could be less than the total of cash and other property
deposited.
For
derivatives, risks arise from changes in the market value of the contracts.
Theoretically, the Fund is exposed to a market risk equal to the value
of
futures contracts purchased and unlimited liability on such contracts sold
short. As both a buyer and a seller of options, the Fund pays or receives
a
premium at the outset and then bears the risk of unfavorable changes in
the
price of the contract underlying the option.
The
Fund’s policy is to continuously monitor its exposure to market and counterparty
risk through the use of a variety of financial, position and credit exposure
reporting controls and procedures. In addition, the Fund has a policy of
reviewing the credit standing of each broker of counterparty with which
it
conducts business.
The
financial instruments held by the Fund are reported in the statement of
financial condition at market or fair value, or at carrying amounts that
approximate fair value, because of their highly liquid nature and short-term
maturity.
The
Fund
received a letter from Goldman, Sachs & Co. (“Goldman Sachs”) on March 17,
2006, providing the Fund notice under 35 U.S.C. Section 154(d) of two pending
United States patent applications, Publication Nos. 2004/0225593A1 and
2006/0036533A1. The Fund is currently reviewing the Goldman Sachs published
patent applications, and has engaged in discussions with Goldman Sachs
regarding
their pending applications and the Fund’s own pending patent application. At
this time, due in part to the fact that the Goldman Sachs patent applications
are pending and have not been issued as U.S. Patents, the Fund is unable
to
determine what the outcome of this matter will be.
NOTE 6
- FINANCIAL HIGHLIGHTS
The
following table presents per Unit performance data and other supplemental
financial data for the period April 10, 2006 (commencement of operations)
to
December 31, 2006 for the limited partners. This information has been derived
from information presented in the financial statements.
|
April
10, 2006
|
||||
|
(commencement
of
|
||||
|
operations)
to
|
||||
|
December
31, 2006
|
||||
|
Per
Unit Operating Performance:
|
||||
|
Net
asset value, beginning of period
|
$
|
67.39
|
||
|
Total loss
|
(15.24
|
)
|
||
|
Total
expenses
|
(0.28
|
)
|
||
|
Net
decrease in net asset value
|
(15.52
|
)
|
||
|
Net
asset value, end of period
|
$
|
51.87
|
||
|
Total
Return
|
(23.03
|
)%
|
||
|
Ratios
to Average Net Assets (annualized)
|
||||
|
Total loss
|
(42.59
|
)%
|
||
|
Expenses
excluding management fees
|
(0.17
|
)%
|
||
|
Management
fees
|
(0.50
|
)%
|
||
|
Net loss
|
(43.26
|
)%
|
||
Total
returns are calculated based on the change in value during the period.
An
individual limited partner’s total return and ratio may vary from the above
total returns and ratios based on the timing of contributions and
withdrawals.
71
|
Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure.
|
Not
applicable.
|
Controls
and Procedures.
|
Disclosure
Controls and Procedures.
The
Fund
maintains disclosure controls and procedures that are designed to ensure
that
material information required to be disclosed in the Fund’s periodic reports
filed or submitted under the Securities Exchange Act of 1934, as amended
(the
“Exchange Act”), is recorded, processed, summarized and reported within the time
period specified in the SEC’s rules and forms.
The
duly
appointed officers of Victoria Bay Asset Management, LLC, USOF's General
Partner, including its chief executive officer and the chief financial
officer, who perform functions equivalent to those a principal executive
officer and principal financial officer of USOF would perform if USOF had
any
officers, have evaluated the effectiveness of USOF’s disclosure and control
procedures and have concluded that the disclosure controls and procedures
of
USOF have been effective as of the end of the period covered by this
report.
Management’s
Annual Report on Internal Control Over Financial
Reporting.
Since
USOF is not an accelerated filer or large accelerated filer, as such terms
are
defined in Rule 405 of the Securities Act of 1933, management of the General
Partner is not required to, and has not, evaluated the effectiveness of USOF’s
internal control over financial reporting as of December 31, 2006. Beginning
with USOF’s annual report on Form 10-K filed for the year ending December 31,
2007, management of the General Partner will be required to make such an
assessment.
Attestation
Report of Registered Public Accounting Firm.
Not
applicable.
Change
in Internal Control Over Financial Reporting.
There
were no changes in USOF’s internal control over financial reporting during
USOF’s last fiscal quarter that have materially affected, or are reasonably
likely to materially affect USOF’s internal control over financial
reporting.
|
Other
Information.
|
None.
72
|
Directors,
Executive Officers and Corporate
Governance.
|
Messrs.
Gerber and Mah also serve as executive officers of the General Partner. USOF
has
no executive officers. Its affairs are generally managed by the General Partner.
The following individuals serve as Management Directors of the General
Partner.
Nicholas
Gerber
has been
the President and CEO of the General Partner since June 9, 2005 and a Management
Director of the General Partner since May 10, 2005. He maintains his main
business office at 1320 Harbor Bay Parkway, Suite 145, Alameda, California
94502. Mr. Gerber will act as a portfolio manager for USOF. He registered
with the NFA as a Principal of the General Partner in November 2005, and
as an
Associated Person of the General Partner in December 2005. Currently, Mr.
Gerber
manages USNG. Mr. Gerber has an extensive background in securities
portfolio management and in developing investment funds that make use of
indexing and futures contracts. He is also the founder of Ameristock
Corporation, a California-based investment adviser registered under the
Investment Advisers Act of 1940, that has been sponsoring and providing
portfolio management services to mutual funds since 1995. Since 1995,
Mr. Gerber has been the portfolio manager of the Ameristock Mutual Fund,
Inc. a mutual fund registered under the Investment Company Act of 1940, focused
on large cap U.S. equities that currently has approximately $800 million
in
assets. In these roles, Mr. Gerber has gained extensive experience in
evaluating and retaining third-party service providers, including custodians,
accountants, transfer agents, and distributors. Prior to managing Ameristock
Mutual Fund Inc., Mr. Gerber served as a portfolio manager with Bank of
America Capital Management. While there he was responsible for the daily
stewardship of four funds with a combined value in excess of $240 million.
At
Bank of America Capital Management, Mr. Gerber worked extensively in the
development and managing of mutual funds and institutional accounts that
were
designed to track assorted equity market indices such as the Standard &
Poor’s 500 and the Standard & Poor’s Midcap 400. Before joining Bank of
America, he was managing director and founder of the Marc Stevens Futures
Index
Fund, a fund that combined the use of commodity futures with equity stock
index
futures. The futures index fund was a commodity pool and Mr. Gerber was the
CPO. It was ultimately purchased by Newport Commodities. Mr. Gerber’s two
decades of experience in institutional investment include a period of employment
as a floor trader on the New York Futures Exchange. Mr. Gerber has passed
the Series 3 examination for associated persons. He holds an MBA in finance
from
the University of San Francisco and a BA from Skidmore College. Mr. Gerber
is 44 years old.
Howard
Mah
has been
a Management Director of the General Partner since May 10, 2005, Secretary
of
the General Partner since June 9, 2005, and Chief Financial Officer of
the
General Partner since May 23, 2006. In these roles, Mr. Mah is involved
in the
management of both USOF and USNG. Mr. Mah also serves as the General
Partner’s Chief Compliance Officer. He received a Bachelor of Education from the
University of Alberta, in 1986 and an MBA from the University of San Francisco
in 1988. He has been the Compliance Officer of Ameristock Corporation since
2001; a tax & finance consultant in private practice since 1995, Secretary
of Ameristock Mutual Fund since 1995 and Ameristock Focused Value Fund
from
December 2000 to January 2005; Chief Compliance Officer of Ameristock Mutual
Fund since 2004 and the Co-Portfolio Manager of the Ameristock Focused
Value
Fund from December 2000 to January 2005. Mr. Mah is 42 years
old.
Andrew
F. Ngim
has been
a Management Director of the General Partner since May 10, 2005 and Treasurer
of
the General Partner since June 9, 2005. As Treasurer of the General Partner,
Mr.
Ngim is involved in the management of both USOF and USNG. He received a Bachelor
of Arts from the University of California at Berkeley in 1983. Mr. Ngim has
been the Managing Director of Ameristock Corporation since 1999. He was the
co-portfolio manager of the Ameristock Large Company Growth Fund from December
2000 to June 2002 and a Benefits Consultant with PriceWaterhouseCoopers from
1994 to 1999. Mr. Ngim is 46 years old.
Robert
L. Nguyen
has been
a Management Director of the General Partner since May 10, 2005. As a Management
Director of the General Partner, Mr. Nguyen is involved on the management
of
both USOF and USNG. He received a Bachelor of Science from California State
University Sacramento in 1981. Mr. Nguyen has been the Managing Principal
of Ameristock Corporation since 2000. He was Co-Portfolio Manager of the
Ameristock Large Company Growth Fund from December 2000 to June 2002 and
Institutional Specialist with Charles Schwab & Company Inc. from 1995 to
1999. Mr. Nguyen is 47 years old.
73
The
following individuals provide significant services to USOF but are employed
by
the entities noted below.
John
Love
acts as
the Operations Manager and is employed by Ameristock. Mr. Love has served
as the operations manager of Ameristock Corporation since 2002, where he
is
responsible for marketing the Ameristock Mutual Fund. From April 2001 to
September 2002, Mr. Love was the project manager for TouchVision
Interactive where he provided leadership to project teams while assisting
with
business and process development. From January 1996 to November 2000,
Mr. Love was the managing director of Jamison/Gold (Keane Inc.) where he
provided leadership to all departments including operations, production,
technology, sales, marketing, administration, recruiting, and finance. From
December 2000 to February 2001, Mr. Love was employed by Digital Boardwalk
Inc. Mr. Love’s experience also includes leading a group of multimedia
producers who controlled web and kiosk projects from pre-contract to deployment.
He holds a BFA in cinema-television from the University of Southern California.
Mr. Love does not have any experience operating a commodity pool.
Mr. Love is 35 years old.
John
T. Hyland, CFA
acts as
a Portfolio Manager and as the Director of Portfolio Research and is employed
by
the General Partner. He registered with the NFA as an Associated Person of
the
General Partner in December 2005, and as a Principal of the General Partner
in
January 2006. In April 2006, Mr. Hyland became the Portfolio Manager and
Director of Portfolio Research for USOF. As part of his responsibilities
for
USOF, Mr. Hyland handles day-to-day trading, helps set investment policies,
and
oversees USOF’s activities with its futures commission brokers,
custodian-administrator, and marketing agent. Mr. Hyland has an extensive
background in portfolio management and research with both equity and fixed
income securities, as well as in the development of new types of complex
investment funds. In July 2001, Mr. Hyland founded Towerhouse Capital
Management, LLC, a firm that provides portfolio management and new fund
development expertise to non-U.S. institutional investors. Mr. Hyland has
been, and remains, a Principal and Portfolio Manager for Towerhouse. From
July 2001 to January 2002, Mr. Hyland was the Director of Global Property
Securities Research for Roulac International, where he worked on the development
of a hedge fund focused on global real estate stocks. From 1996 through 2001,
Mr. Hyland was the Director of Securities Research and Portfolio Manager
for the capital markets division of CB Richard Ellis, a global commercial
real
estate services firm. His division provided portfolio management of equities
as
an advisor or sub-advisor for mutual funds and separate accounts focused
on real
estate investment trusts. In addition, his group conducted research in the
area
of structured commercial real estate debt (including Commercial Mortgage-Back
Securities, or “CMBS”), and lead the creation of one of the earliest
re-securitizations of multiple CMBS pool tranches into a Collateralized Debt
Obligation (“CDO”) vehicle. In the ten years prior to working at CB Richard
Ellis, Mr. Hyland had worked as a portfolio manager or financial
representative for several other investment firms and mutual funds.
Mr. Hyland received his Chartered Financial Analyst (“CFA”) designation in
1994. From 1993 until 2003, Mr. Hyland was on the Board of Directors of the
Security Analysts of San Francisco (“SASF”), a not-for-profit organization of
investment management professionals. He served as the president of the SASF
from
2001-2002. Mr. Hyland is a member of the CFA Institute (formerly AIMR). He
is also a member of the National Association of Petroleum Investment Analysts
(NAPIA), a not-for-profit organization of investment professionals focused
on
the oil industry. He serves as an arbitrator for the National Association
of
Securities Dealers (“NASD”), as part of their dispute resolution program. He is
a graduate of the University of California, Berkeley and received a BA in
political science/international relations in 1982. Mr. Hyland is 47 years
old.
Kathryn
D. Rooney
acts as
a Marketing Manager and is employed by Ameristock and ALPS. Her primary
responsibilities include soliciting orders, customers and customer funds.
Currently, Ms. Rooney is the Director of Business Development for
Ameristock Mutual Fund. She has held this position since September of 2003.
Prior to working for Ameristock Mutual Fund, Ms. Rooney was the Regional
Director for Accessor Capital Management from November of 2002 to September
of
2003. Before working at Accessor Capital Management, Ms. Rooney worked at
ALPS Mutual Fund Services, Inc. as a National Sales Director. She held this
position from May of 1999 through November of 2002. Before working at ALPS
Mutual Fund Services, Inc., Ms. Rooney worked as a Trust Officer for Fifth
Third Bank from June of 1994 through May of 1999. Ms. Rooney is 34 years
old.
74
The
following individuals serve as independent directors of the General
Partner:
Peter
M. Robinson
has been
an Independent Director of the General Partner since September 30, 2005.
Mr. Robinson has been employed with the Hoover Institution since 1993.
Mr. Robinson graduated from Dartmouth College in 1979 and Oxford University
in 1982. Mr. Robinson spent six years in the White House, serving from 1982
to 1983 as chief speechwriter to Vice President George Bush and from 1983
to
1988 as special assistant and speechwriter to President Ronald Reagan. After
the
White House, Mr. Robinson received an MBA from the Stanford University
Graduate School of Business. Mr. Robinson then spent a year in New York
City with Fox Television. He spent a second year in Washington, D.C., with
the
Securities and Exchange Commission, where he served as the director of the
Office of Public Affairs, Policy Evaluation, and Research. Mr. Robinson has
also written three books and has been published in the New
York Times, Red Herring
, and
Forbes
ASAP
and he
is the editor of Can
Congress Be Fixed?: Five Essays on Congressional Reform
(Hoover
Institution Press, 1995). Mr. Robinson is 48 years old.
Gordon
L. Ellis
has been
an Independent Director of the General Partner since September 30, 2005.
Mr. Ellis has been Chairman of International Absorbents, Inc. since July
1988, President and Chief Executive Officer since November 1996 and a Class
I
Director of the company since July 1985. Mr. Ellis is also a director of
Absorption Corp., International Absorbents, Inc.’s wholly-owned subsidiary.
Mr. Ellis is a director/trustee of Polymer Solutions, Inc., a former
publicly-held company that sold all of its assets effective as of February
3,
2004 and is currently winding
down its operations and liquidating following such sale. Mr. Ellis is a
professional engineer with an MBA in international finance. Mr. Ellis is 59
years old.
Malcolm
R. Fobes III
has been
an Independent Director of the General Partner since September 30, 2005.
Mr. Fobes is the founder, Chairman and Chief Executive Officer of
Berkshire Capital Holdings, Inc., a California-based investment adviser
registered under the Investment Advisers Act of 1940, that has been sponsoring
and providing portfolio management services to mutual funds since 1997. Since
1997, Mr. Fobes has been the Chairman and President of The Berkshire Funds,
a
mutual fund investment company registered under the Investment Company Act
of
1940. Mr. Fobes also serves as portfolio manager of the Berkshire Focus Fund,
a
mutual fund registered under the Investment Company Act of 1940, which
concentrates its investments in the electronic technology industry. From
April
2000 to July 2006, Mr. Fobes also served as co-portfolio manager of The Wireless
Fund, a mutual fund registered under the Investment Company Act of 1940,
which
concentrates its investments in companies engaged in the development,
production, or distribution of wireless-related products or services. In
these
roles, Mr. Fobes has gained extensive experience in evaluating and retaining
third-party service providers, including custodians, accountants, transfer
agents, and distributors. Mr. Fobes was also contributing editor of Start
a
Successful
Mutual Fund: The Step-by-Step Reference Guide to Make It Happen
(JV
Books, 1995). Prior to forming Berkshire Capital Holdings, Inc., Mr. Fobes
was
employed by various technology-related companies, including Adobe Systems,
Inc.,
a leading provider of digital publishing and imaging software technologies.
Mr.
Fobes holds a B.S. degree in Finance and Economics from San Jose State
University in California. Mr. Fobes is 42 years old.
The
following are individual Principals, as that term is defined in CFTC Rule
3.1,
for USOF: Melinda Gerber, Howard Mah, Andrew Ngim, Robert Nguyen, Peter
Robinson, Gordon Ellis, Malcolm Fobes, John Love, and John Hyland. These
individuals are principals due to their positions, however, Nicholas Gerber
and
Melinda Gerber are also principals due to their controlling stake in Wainwright.
Neither the General Partner, nor the principals own or have any other beneficial
interest in USOF. Nicholas Gerber and John Hyland make trading and investment
decisions for USOF. Nicholas Gerber, John Love, and John Hyland execute trades
on behalf of USOF. In addition, Nicholas Gerber, John Love, John Hyland and
Kathryn Rooney are registered with the CFTC as Associated Persons of the
General
Partner and are members of the NFA.
Audit
Committee
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. Mr. Fobes and Mr. Ellis meet the financial
sophistication requirements of the American Stock Exchange and the audit
committee charter and the Board has determined that each is considered
to be an
“Audit Committee Financial Expert” as defined by the federal securities
laws.
Other
Committees
Since
the
individuals who perform work on behalf of USOF are not compensated by USOF,
but
instead by the General Partner, Ameristock or ALPS, USOF does not have
a
Compensation Committee. Similarly, since the Directors noted above serve
on the
Board of Directors of the General Partner, USOF does not have a Nominating
Committee.
75
Code
of Ethics
USOF
has
not adopted a Code of Ethics that would apply to its principal executive,
financial and accounting officers since USOF is managed by the General
Partner,
and the individuals who perform the duties of principal executive, principal
financial and principal accounting officers are employed and compensated
by the
General Partner. We may adopt such policies in the future and, to the
extent we
do, we will announce such policies by the filing of a Form 8-K that would
include the text of the Code of Ethics and will include the Code of Ethics
on
our website.
|
Executive
Compensation.
|
Compensation
to the General Partner and Other Compensation.
USOF
does
not directly compensate any of the executive officers noted above. The
executive officers noted above are compensated by the General Partner for
the work they perform on behalf of USOF and other entities controlled by
the
General Partner. USOF does not reimburse the General Partner, nor does it
set
the amount or form of any portion of the compensation paid to the executive
officers by the General Partner. USOF pays fees to the General Partner pursuant
to the LP Agreement under which the fund is obligated to pay the General
Partner an annualized fee of 0.50% of average daily net assets of the fund
for
the first $1,000,000,000 and 0.20% of average daily net assets of the fund
for
amounts above $1,000,000,000. For 2006 USOF paid the General Partner aggregate
fees of $1,460,448.
Director
Compensation
The
following table sets forth compensation earned during the year ended
December 31, 2006, by the Directors of the General Partner.
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|
|
|
|
|
|
|
|
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Change
in
|
|
|
|
|
|
|||||||
|
|
|
|
|
|
|
|
|
|
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Pension
|
|
|
|
|
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|||||||
|
|
|
|
|
|
|
|
|
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Value
and
|
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|
|
|
|
|||||||
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|
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Fees
|
|
|
|
|
|
|
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Nonqualified
|
||||||||||||
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Earned
or
|
|
|
|
|
|
Non-Equity
|
|
Deferred
|
|
|
|
|
|
|||||||||
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|
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Paid
in
|
|
Stock
|
|
Option
|
|
Incentive
Plan
|
|
Compensation
|
|
All
Other
|
|
|
|
|||||||
|
Name
|
|
Cash
|
|
Awards
|
|
Awards
|
|
Compensation
|
|
Plan
|
|
Compensation
(1)
|
|
Total
|
||||||||
|
Management
Directors
|
||||||||||||||||||||||
|
Nicholas
Gerber
|
$
|
0
|
NA
|
NA
|
NA
|
$
|
0
|
$
|
0
|
$
|
0
|
|||||||||||
|
Andrew
F. Ngim
|
$
|
0
|
NA
|
NA
|
NA
|
$
|
0
|
$
|
0
|
$
|
0
|
|||||||||||
|
Howard
Mah
|
$
|
0
|
NA
|
NA
|
NA
|
$
|
0
|
$
|
0
|
$
|
0
|
|||||||||||
|
Robert
L. Nguyen
|
$
|
0
|
NA
|
NA
|
NA
|
$
|
0
|
$
|
0
|
$
|
0
|
|||||||||||
|
Independent
Directors
|
||||||||||||||||||||||
|
Peter
M. Robinson
|
$
|
0
|
NA
|
NA
|
NA
|
$
|
0
|
$
|
17,500
|
$
|
17,500
|
|||||||||||
|
Gordon
L. Ellis
|
$
|
0
|
NA
|
NA
|
NA
|
$
|
0
|
$
|
17,500
|
$
|
17,500
|
|||||||||||
|
Malcolm
R. Fobes III
|
$
|
0
|
NA
|
NA
|
NA
|
$
|
0
|
$
|
17,500
|
$
|
17,500
|
|||||||||||
(1)
Payments made under this column represent cash payments made in lieu of
directors’ and officers’ insurance coverage. Such payments were made only to the
Independent Directors of the General Partner.
76
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.
|
None
of
the directors or executive officers of the General Partner, nor the employees
of
USOF own any units of USOF. In addition, USOF is not aware of any 5% holder
of its units.
|
Certain
Relationships and Related Transactions, and Director
Independence.
|
USOF
has and will continue to have certain
relationships with the General Partner and its affiliates. However, there
have been no direct financial transactions between the Registrant and the
directors or officers of the General Partner that have not been disclosed
herein. See "Item 11. Executive Compensation" and "Item 12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters." Any transaction with a related person that must be disclosed in
accordance with SEC Regulation S-K item 404(a), including financial transactions
by USOF with directors or executive officers of the General Partner or holders
of beneficial interests in the General Partner or USOF of more than 5%, will
be
subject to the provisions regarding "Resolutions of Conflicts of Interest;
Standard of Care" as set forth in Section 7.7 of the LP Agreement and will
be
reviewed and approved by the Audit Committee of the General
Partner.
|
Principal
Accounting Fees and
Services.
|
During
the year ended December 31, 2006, the General Partner made the following
payments to its independent auditors:
|
2006
|
2005
|
|||||
|
Audit
fees
|
$
|
109,000
|
$ |
-
|
||
|
Audit-related
fees
|
|
50,000
|
-
|
|||
|
Tax
fees
|
|
-
|
-
|
|||
|
All
other fees
|
|
-
|
-
|
|||
|
$
|
159,000
|
$ |
-
|
Audit
Fees consist of fees paid to Eisner LLP and Spicer Jeffries LLP for (i) the
audit of USOF’s annual financial statements included in the Annual Report on
Form 10-K, review of financial statements included in the Quarterly Reports
on
Form 10-Q and filed on its current reports on Form 8-K; and
(ii) services
that are normally provided by the Independent Registered Public Accountants
in
connection with statutory and regulatory filings or engagements.
Audit-Related
Fees consist of fees for assurance and related services that are reasonably
related to the performance of audit or review of USOF’s financial statements and
are not reported under Audit Fees. This category includes fees related to
audit and attest services not required by statute or regulations, due diligence
related to mergers, acquisitions and investments and consultations concerning
financial accounting and reporting standards. The Audit Committee and Board
of
Directors of the General Partner approved all of these
services.
77
|
Exhibits,
Financial Statement
Schedules.
|
|
1.
|
See
Index to Financial Statements on page 61.
|
|
2.
|
No
financial statement schedules are filed herewith because (i) such
schedules are not required or (ii) the information required has
been
presented in the aforementioned financial statements.
|
|
3.
|
Exhibits
required to be filed by Item 601 of Regulation
S-K.
|
Listed
below are the exhibits which are filed as part of this report (according
to the
number assigned to them in Item 601 of Regulation S-K):
|
Exhibit
Number
|
Description
of Document
|
|
|
3.1*****
|
Form
of the Third Amended and Restated Agreement of Limited
Partnership.
|
|
|
3.2**
|
Certificate
of Limited Partnership of the Registrant.
|
|
|
10.1***
|
Form
of Initial Authorized Purchaser Agreement.
|
|
|
10.2****
|
Marketing
Agent Agreement.
|
|
|
10.3***
|
Custodian
Agreement.
|
|
|
10.4***
|
Administrative
Agency Agreement.
|
|
|
|
||
|
|
||
|
|
||
|
|
||
* Filed
Herewith
** Incorporated
by reference to
Registrant's Registration Statement on Form S-1 (File No. 333- 124950)
filed on
May 16, 2005.
***
Incorporated
by reference
to Registrant's Pre-Effective Amendment No. 5 to the Registration Statement
on
Form S-1 (File No. 333- 124950) filed on March 13, 2006.
**** Incorporated
by reference to
Registrant's Pre-Effective Amendment No. 7 to the Registration Statement
on Form
S-1 (File No. 333- 124950) filed on April 6, 2006.
***** Incorporated
by reference to
Registrant's Registration Statement on Form S-1 (File No. 333- 140117)
filed on January 19, 2007.
78
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf
by
the undersigned thereunto duly authorized on March 26, 2007.
|
United
States Oil Fund, LP (Registrant)
By:
Victoria Bay Asset Management, LLC, its general partner
|
|
/S/
Nicholas D. Gerber
|
|
Nicholas
D. Gerber
|
|
Chief
Executive Officer of Victoria Bay Asset Management,
LLC
(Principal
executive officer)
|
|
DateDate:
March 26, 2007
|
| /S/ Howard Mah |
|
Howard
Mah
|
|
Chief
Financial Officer of Victoria Bay Asset Management,
LLC
(Principal
financial and accounting
officer)
|
|
DateDate:
March 26, 2007
|
79
Pursuant
to the requirements of
the Securities Exchange Act of 1934, this Report has been signed below by the
following persons on behalf of the Registrant in the capacities and on the
dates
indicated.
|
Signature
|
Title
(Capacity)
|
Date
|
|
/S/
Peter M. Robinson
|
Independent
Director
|
March
29, 2007
|
|
Peter
M. Robinson
|
||
|
/S/
Gordon L. Ellis
|
Independent
Director
|
March
29, 2007
|
|
Gordon
L. Ellis
|
||
|
/S/
Malcolm R. Fobes III
|
Independent
Director
|
March
29, 2007
|
|
Malcolm
R. Fobes III
|
80