Item 1. Condensed Financial Statements.
Index to Condensed Financial Statements
Documents
|
|
Page
|
Condensed Statements of Financial Condition at March 31, 2013 (Unaudited) and December 31, 2012
|
|
2
|
|
|
|
Condensed Schedule of Investments (Unaudited) at March 31, 2013
|
|
3
|
|
|
|
Condensed Statements of Operations (Unaudited) for the three months ended March 31, 2013 and 2012
|
|
4
|
|
|
|
Condensed Statement of Changes in Partners’ Capital (Unaudited) for the three months ended March 31, 2013
|
|
5
|
|
|
|
Condensed Statements of Cash Flows (Unaudited) for the three months ended March 31, 2013 and 2012
|
|
6
|
|
|
|
Notes to Condensed Financial Statements for the period ended March 31, 2013 (Unaudited)
|
|
7
|
United States Short Oil Fund, LP
Condensed Statements of Financial Condition
At March 31, 2013 (Unaudited) and December 31, 2012
|
|
March 31, 2013
|
|
|
December 31, 2012
|
|
Assets
|
|
|
|
|
|
|
|
|
Cash and cash equivalents (Notes 2 and 5)
|
|
$
|
15,484,644
|
|
|
$
|
12,561,552
|
|
Equity in UBS Securities LLC trading accounts:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
|
1,602,949
|
|
|
|
1,461,676
|
|
Unrealized loss on open commodity futures contracts
|
|
|
(838,750
|
)
|
|
|
(735,330
|
)
|
Receivable from General Partner (Note 3)
|
|
|
25,557
|
|
|
|
107,023
|
|
Directors’ fees receivable
|
|
|
504
|
|
|
|
655
|
|
Dividend receivable
|
|
|
73
|
|
|
|
103
|
|
Other assets
|
|
|
1,366
|
|
|
|
73
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
16,276,343
|
|
|
$
|
13,395,752
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Partners' Capital
|
|
|
|
|
|
|
|
|
Professional fees payable
|
|
$
|
31,240
|
|
|
$
|
125,232
|
|
General Partner management fees payable (Note 3)
|
|
|
8,636
|
|
|
|
7,007
|
|
Brokerage commissions payable
|
|
|
512
|
|
|
|
512
|
|
Other liabilities
|
|
|
575
|
|
|
|
415
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
40,963
|
|
|
|
133,166
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies
(Notes
3, 4 and 5)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Partners' Capital
|
|
|
|
|
|
|
|
|
General Partner
|
|
|
–
|
|
|
|
–
|
|
Limited Partners
|
|
|
16,235,380
|
|
|
|
13,262,586
|
|
Total Partners' Capital
|
|
|
16,235,380
|
|
|
|
13,262,586
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and partners' capital
|
|
$
|
16,276,343
|
|
|
$
|
13,395,752
|
|
|
|
|
|
|
|
|
|
|
Limited Partners' units outstanding
|
|
|
450,000
|
|
|
|
350,000
|
|
Net asset value per unit
|
|
$
|
36.08
|
|
|
$
|
37.89
|
|
Market value per unit
|
|
$
|
36.11
|
|
|
$
|
37.88
|
|
See accompanying notes to condensed financial statements.
United States Short Oil Fund, LP
Condensed Schedule of Investments (Unaudited)
At March 31, 2013
|
|
Number of
Contracts
|
|
|
Unrealized
Loss
on Open
Commodity
Contracts
|
|
|
% of
Partners'
Capital
|
|
Open Futures Contracts - Short
|
|
|
|
|
|
|
|
|
|
|
|
|
United States Contracts
|
|
|
|
|
|
|
|
|
|
|
|
|
NYMEX WTI Crude Oil Futures CL May 2013 contracts, expiring April 2013
|
|
|
167
|
|
|
$
|
(838,750
|
)
|
|
|
(5.17
|
)
|
|
|
Principal
Amount
|
|
|
Market
Value
|
|
|
|
|
Cash Equivalents
|
|
|
|
|
|
|
|
|
|
|
|
|
United States Treasury Obligation
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury Bill, 0.08%, 5/30/2013
|
|
$
|
705,000
|
|
|
$
|
704,913
|
|
|
|
4.34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States - Money Market Funds
|
|
|
|
|
|
|
|
|
|
|
|
|
Fidelity Institutional Government Portfolio - Class I
|
|
|
3,453
|
|
|
|
3,453
|
|
|
|
0.02
|
|
Goldman Sachs Financial Square Funds - Government Fund - Class FS
|
|
|
1,502,673
|
|
|
|
1,502,673
|
|
|
|
9.26
|
|
Morgan Stanley Institutional Liquidity Fund - Government Portfolio
|
|
|
1,003,334
|
|
|
|
1,003,334
|
|
|
|
6.18
|
|
Wells Fargo Advantage Government Money Market Fund - Class I
|
|
|
1,000,055
|
|
|
|
1,000,055
|
|
|
|
6.16
|
|
Total Money Market Funds
|
|
|
|
|
|
|
3,509,515
|
|
|
|
21.62
|
|
Total Cash Equivalents
|
|
|
|
|
|
$
|
4,214,428
|
|
|
|
25.96
|
|
See accompanying notes to condensed financial statements.
United States Short Oil Fund, LP
Condensed Statements of Operations (Unaudited)
For the three months ended March 31, 2013
and
2012
|
|
Three months ended
March 31, 2013
|
|
|
Three months ended
March 31, 2012
|
|
Income
|
|
|
|
|
|
|
|
|
Gain (loss) on trading of commodity futures contracts:
|
|
|
|
|
|
|
|
|
Realized loss on closed positions
|
|
$
|
(530,080
|
)
|
|
$
|
(802,020
|
)
|
Change in unrealized gain (loss) on open positions
|
|
|
(103,420
|
)
|
|
|
610,740
|
|
Dividend income
|
|
|
232
|
|
|
|
255
|
|
Interest income
|
|
|
910
|
|
|
|
387
|
|
Other income
|
|
|
700
|
|
|
|
1,750
|
|
|
|
|
|
|
|
|
|
|
Total loss
|
|
|
(631,658
|
)
|
|
|
(188,888
|
)
|
|
|
|
|
|
|
|
|
|
Expenses
|
|
|
|
|
|
|
|
|
Professional fees
|
|
|
31,240
|
|
|
|
21,554
|
|
General Partner management fees (Note 3)
|
|
|
22,801
|
|
|
|
14,967
|
|
Brokerage commissions
|
|
|
3,777
|
|
|
|
2,867
|
|
Other expenses
|
|
|
1,168
|
|
|
|
699
|
|
|
|
|
|
|
|
|
|
|
Total expenses
|
|
|
58,986
|
|
|
|
40,087
|
|
|
|
|
|
|
|
|
|
|
Expense waiver (Note 3)
|
|
|
(25,557
|
)
|
|
|
(17,810
|
)
|
|
|
|
|
|
|
|
|
|
Net expenses
|
|
|
33,429
|
|
|
|
22,277
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(665,087
|
)
|
|
$
|
(211,165
|
)
|
Net loss per limited partnership unit
|
|
$
|
(1.81
|
)
|
|
$
|
(1.60
|
)
|
Net loss per
weighted average limited partnership unit
|
|
$
|
(1.60
|
)
|
|
$
|
(0.73
|
)
|
Weighted average limited partnership units outstanding
|
|
|
416,111
|
|
|
|
288,462
|
|
See accompanying notes to condensed financial statements.
United States Short Oil Fund, LP
Condensed Statement of Changes in Partners’ Capital
(Unaudited)
For the three months ended March 31, 2013
|
|
General Partner
|
|
|
Limited Partners
|
|
|
Total
|
|
|
|
|
|
|
|
|
|
|
|
Balances, at December 31, 2012
|
|
$
|
–
|
|
|
$
|
13,262,586
|
|
|
$
|
13,262,586
|
|
Addition of 100,000 partnership units
|
|
|
–
|
|
|
|
3,637,881
|
|
|
|
3,637,881
|
|
Net loss
|
|
|
–
|
|
|
|
(665,087
|
)
|
|
|
(665,087
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, at March 31, 2013
|
|
$
|
–
|
|
|
$
|
16,235,380
|
|
|
$
|
16,235,380
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Asset Value Per Unit:
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2012
|
|
|
|
|
|
|
|
|
|
$
|
37.89
|
|
At March 31, 2013
|
|
|
|
|
|
|
|
|
|
$
|
36.08
|
|
See accompanying notes to condensed financial statements.
United States Short Oil Fund, LP
Condensed Statements of Cash Flows (Unaudited)
For the three months ended March 31, 2013
and
2012
|
|
Three months
ended
March 31, 2013
|
|
|
Three months
ended
March 31, 2012
|
|
Cash Flows from Operating Activities:
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(665,087
|
)
|
|
$
|
(211,165
|
)
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
|
|
|
|
|
|
|
|
(Increase) decrease in commodity futures trading account - cash and cash equivalents
|
|
|
(141,273
|
)
|
|
|
81,476
|
|
Unrealized (gain) loss on open futures contracts
|
|
|
103,420
|
|
|
|
(610,740
|
)
|
Decrease in receivable from General Partner
|
|
|
81,466
|
|
|
|
103,213
|
|
Decrease in directors’ fees receivable
|
|
|
151
|
|
|
|
–
|
|
(Increase) decrease in dividend receivable
|
|
|
30
|
|
|
|
(61
|
)
|
Increase in interest receivable
|
|
|
–
|
|
|
|
(8
|
)
|
Increase in other assets
|
|
|
(1,293
|
)
|
|
|
(90
|
)
|
Decrease investment payable
|
|
|
–
|
|
|
|
(5
|
)
|
Decrease in professional fees payable
|
|
|
(93,992
|
)
|
|
|
(109,895
|
)
|
Increase (decrease) in General Partner management fees payable
|
|
|
1,629
|
|
|
|
(692
|
)
|
Increase in brokerage commissions payable
|
|
|
–
|
|
|
|
220
|
|
Increase (decrease) in other liabilities
|
|
|
160
|
|
|
|
(269
|
)
|
Net cash used in operating activities
|
|
|
(714,789
|
)
|
|
|
(748,016
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows from Financing Activities:
|
|
|
|
|
|
|
|
|
Addition of partnership units
|
|
|
3,637,881
|
|
|
|
9,994,741
|
|
Redemption of partnership units
|
|
|
–
|
|
|
|
(3,356,086
|
)
|
Net cash provided by financing activities
|
|
|
3,637,881
|
|
|
|
6,638,655
|
|
|
|
|
|
|
|
|
|
|
Net Increase in Cash and Cash Equivalents
|
|
|
2,923,092
|
|
|
|
5,890,639
|
|
|
|
|
|
|
|
|
|
|
Cash and Cash Equivalents,
beginning
of period
|
|
|
12,561,552
|
|
|
|
9,409,221
|
|
Cash and Cash Equivalents,
end
of period
|
|
$
|
15,484,644
|
|
|
$
|
15,299,860
|
|
See accompanying notes to condensed financial statements.
United States Short Oil Fund, LP
Notes to Condensed Financial Statements
For the period ended March 31, 2013 (Unaudited)
NOTE 1 — ORGANIZATION AND BUSINESS
The United States Short Oil Fund, LP (“USSO”)
was organized as a limited partnership under the laws of the state of Delaware on June 30, 2008. USSO is a commodity pool that
issues limited partnership units (“units”) that may be purchased and sold on the NYSE Arca, Inc. (the “NYSE Arca”). USSO
will continue in perpetuity, unless terminated sooner upon the occurrence of one or more events as described in its Second Amended
and Restated Agreement of Limited Partnership dated as of March 1, 2013 (the “LP Agreement”). The investment objective
of USSO is for the daily changes in percentage terms of its units’ per unit net asset value (“NAV”) to inversely
reflect the daily changes in percentage terms of the spot price of West Texas Intermediate (“WTI”) light, sweet crude
oil delivered to Cushing, Oklahoma, as measured by the daily changes in the price of the futures contract for WTI light, sweet
crude oil traded on the New York Mercantile Exchange (the “NYMEX”) that is the near month contract to expire,
except when the near month contract is within two weeks of expiration, in which case the futures contract will be the next
month contract to expire (the “Benchmark Futures Contract”), less USSO’s expenses. It is not the intent of USSO
to be operated in a fashion such that the per unit NAV will equal, in dollar terms, the inverse of the spot price of WTI light,
sweet crude oil or any particular futures contract based on WTI light, sweet crude oil. It is not the intent of USSO to be operated
in a fashion such that its per unit NAV will reflect the inverse of the percentage change of the price of any particular futures
contract as measured over a time period greater than one day. United States Commodity Funds LLC (“USCF”), the general
partner of USSO, believes that it is not practical to manage the portfolio to achieve such an investment goal when investing in
short positions in Futures Contracts (as defined below) and Other Crude Oil-Related Investments (as defined below). USSO accomplishes
its objective through investments in short positions in futures contracts for WTI light, sweet crude oil and other types of
crude oil, diesel-heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the NYMEX, ICE Futures
Exchange (“ICE Futures”) or other U.S. and foreign exchanges (collectively, “Futures Contracts”) and
other oil-related investments such as cash-settled options on Futures Contracts, forward contracts for oil, cleared swap contracts
and over-the-counter transactions that are based on the price of crude oil, diesel-heating oil, gasoline, natural gas and other
petroleum-based fuels, Futures Contracts and indices based on the foregoing (collectively, “Other Crude Oil-Related Investments”).
As of March 31, 2013, USSO held short positions in 167 WTI Crude Oil Futures CL Contracts traded on the NYMEX. USSO did not hold
short positions on the ICE Futures as of March 31, 2013.
USSO commenced investment operations on
September 24, 2009 and has a fiscal year ending on December 31. USCF is responsible for the management of USSO.
USCF is a member of the National Futures Association (the “NFA”) and became a commodity pool operator
registered with the Commodity Futures Trading Commission (the “CFTC”) effective December 1, 2005. USCF is also
the general partner of the United States Oil Fund, LP (“USOF”), the United States Natural Gas Fund, LP (“USNG”), the
United States 12 Month Oil Fund, LP (“US12OF”), the United States Gasoline Fund, LP (“UGA”) and the United
States Diesel-Heating Oil Fund, LP (formerly, the United States Heating Oil Fund, LP), (“USDHO”), which listed their
limited partnership units on the American Stock Exchange (the “AMEX”) under the ticker symbols “USO”
on April 10, 2006, “UNG” on April 18, 2007, “USL” on December 6, 2007, “UGA”
on February 26, 2008 and “UHN” on April 9, 2008, respectively. As a result of the acquisition of the AMEX
by NYSE Euronext, each of USOF’s, USNG’s, US12OF’s, UGA’s and USDHO’s units commenced trading on
the NYSE Arca on November 25, 2008. USCF is also the general partner of the United States 12 Month Natural Gas Fund, LP (“US12NG”)
and the United States Brent Oil Fund, LP (“USBO”), which listed their limited partnership units on the NYSE Arca under
the ticker symbols “UNL” on November 18, 2009 and “BNO” on June 2, 2010, respectively. USCF
is also the sponsor of the United States Commodity Index Fund (“USCI”), the United States Copper Index Fund (“CPER”),
the United States Agriculture Index Fund (“USAG”) and the United States Metals Index Fund (“USMI”), each
a series of the United States Commodity Index Funds Trust. USCI, CPER, USAG and USMI listed their units on the NYSE Arca under
the ticker symbol “USCI” on August 10, 2010, “CPER” on November 15, 2011, “USAG”
on April 13, 2012 and “USMI” on June 19, 2012, respectively. All funds listed previously are referred to
collectively herein as the “Related Public Funds.” USCF has also filed registration statements to register units of
the United States Sugar Fund (“USSF”), the United States Natural Gas Double Inverse Fund (“UNGD”), the
United States Gasoil Fund (“USGO”) and the United States Asian Commodities Basket Fund (“UAC”), each a
series of the United States Commodity Funds Trust I, and the US Golden Currency Fund (“HARD”), a series of the United
States Currency Funds Trust. USSF, UNGD, USGO and HARD are currently not available to the public, as such funds are still in the
process of review by various regulatory agencies which have regulatory authority over USCF and such funds. UAC has been declared
effective by the regulatory agencies, which have regulatory authority over USCF and UAC, but at the time of the filing of this
quarterly report on Form 10-Q, UAC has not been made available to the public.
Effective February 29, 2012, USSO
issues units to certain authorized purchasers (“Authorized Purchasers”) by offering baskets consisting of 50,000 units
(“Creation Baskets”) through ALPS Distributors, Inc., as the marketing agent (the “Marketing Agent”).
Prior to February 29, 2012, USSO issued units to Authorized Purchasers by offering baskets consisting of 100,000 units through
the Marketing Agent. The purchase price for a Creation Basket is based upon the NAV of a unit calculated shortly after the
close of the core trading session on the NYSE Arca on the day the order to create the basket is properly received.
From July 1, 2011 through March 31,
2013 (and continuing at least through May 1, 2014), the applicable transaction fee paid by Authorized Purchasers is $350 to USSO
for each order they place to create or redeem one or more baskets (“Redemption Baskets”); prior to July 1, 2011,
this fee was $1,000. Units may be purchased or sold on a nationally recognized securities exchange in smaller increments than a
Creation Basket or Redemption Basket. Units purchased or sold on a nationally recognized securities exchange are not purchased
or sold at the per unit NAV of USSO but rather at market prices quoted on such exchange.
In September 2009, USSO initially registered
25,000,000 units on Form S-1 with the U.S. Securities and Exchange Commission (the “SEC”). On September 24, 2009,
USSO listed its units on the NYSE Arca under the ticker symbol “DNO”. On that day, USSO established its initial
per unit NAV by setting the price at $50.00 and issued 200,000 units in exchange for $10,000,000. USSO also commenced investment
operations on September 24, 2009, by taking short positions in Futures Contracts traded on the NYMEX based on WTI
light, sweet crude oil. As of March 31, 2013, USSO had registered a total of 25,000,000 units.
The accompanying unaudited condensed financial
statements have been prepared in accordance with Rule 10-01 of Regulation S-X promulgated by the SEC and, therefore, do not include
all information and footnote disclosure required under generally accepted accounting principles (“GAAP”) in the United
States of America. The financial information included herein is unaudited; however, such financial information reflects all adjustments,
consisting only of normal recurring adjustments, which are, in the opinion of USCF, necessary for the fair presentation of the
condensed financial statements for the interim period.
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 condensed statements
of financial condition and represent the difference between the original contract amount and the 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
condensed financial statements. Changes in the unrealized gains or losses between periods are reflected in the condensed
statements of operations. USSO earns interest on its assets denominated in U.S. dollars on deposit with the futures commission
merchant at the 90-day Treasury bill rate. In addition, USSO earns income on funds held at the custodian or futures commission
merchant at prevailing market rates earned on such investments.
Brokerage Commissions
Brokerage commissions on all open commodity
futures contracts are accrued on a full-turn basis.
Income Taxes
USSO 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.
In accordance with GAAP, USSO is required
to determine whether a tax position is more likely than not to be sustained upon examination by the applicable taxing authority,
including resolution of any tax related appeals or litigation processes, based on the technical merits of the position. USSO files
an income tax return in the U.S. federal jurisdiction, and may file income tax returns in various U.S. states. USSO is not subject
to income tax return examinations by major taxing authorities for years before 2009. The tax benefit recognized is measured as
the largest amount of benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. De-recognition
of a tax benefit previously recognized results in USSO recording a tax liability that reduces net assets. However, USSO’s
conclusions regarding this policy may be subject to review and adjustment at a later date based on factors including, but not limited
to, on-going analysis of and changes to tax laws, regulations and interpretations thereof. USSO recognizes interest accrued related
to unrecognized tax benefits and penalties related to unrecognized tax benefits in income tax fees payable, if assessed. No interest
expense or penalties have been recognized as of and for the period ended March 31, 2013.
Creations and Redemptions
Effective February 29, 2012, Authorized
Purchasers may purchase Creation Baskets or redeem Redemption Baskets only in blocks of 50,000 units at a price equal to the NAV
of the units calculated shortly after the close of the core trading session on the NYSE Arca on the day the order is placed. Prior
to February 29, 2012, Authorized Purchasers could only purchase Creation Baskets or redeem Redemption Baskets in blocks of
100,000 units.
USSO receives or pays the proceeds from
units sold or redeemed within three business days after the trade date of the purchase or redemption. The amounts due from Authorized
Purchasers are reflected in USSO’s condensed statements of financial condition as receivable for units sold, and amounts
payable to Authorized Purchasers upon redemption are reflected as payable for units redeemed.
Partnership Capital and Allocation of
Partnership Income and Losses
Profit or loss shall be allocated among
the partners of USSO in proportion to the number of units each partner holds as of the close of each month. USCF may revise, alter
or otherwise modify this method of allocation as described in the LP Agreement.
Calculation of Per Unit Net Asset Value
USSO’s per unit NAV is calculated
on each NYSE Arca trading day by taking the current market value of its total assets, subtracting any liabilities and dividing
that amount by the total number of units outstanding. USSO uses the closing price for the contracts on the relevant exchange
on that day to determine the value of contracts held on such exchange.
Net Income (Loss) Per Unit
Net income (loss) per unit is the
difference between the per unit NAV at the beginning of each period and at the end of each period. The weighted average number
of units outstanding was computed for purposes of disclosing net income (loss) per weighted average unit. The weighted average
units are equal to the number of units outstanding at the end of the period, adjusted proportionately for units added and redeemed
based on the amount of time the units were outstanding during such period. There were no units held by USCF at March 31, 2013.
Offering Costs
Offering costs incurred in connection with
the registration of additional units after the initial registration of units are borne by USSO. These costs include registration
fees paid to regulatory agencies and all legal, accounting, printing and other expenses associated with such offerings. These costs
are accounted for as a deferred charge and thereafter amortized to expense over twelve months on a straight-line basis or a shorter
period if warranted.
Cash Equivalents
Cash equivalents include money market funds
and overnight deposits or time deposits with original maturity dates of six months or less.
Reclassification
Certain amounts in the accompanying condensed
financial statements were reclassified to conform to the current presentation.
Use of Estimates
The preparation of condensed financial
statements in conformity with GAAP requires USCF 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 condensed financial statements, and the reported
amounts of the revenue and expenses during the reporting period. Actual results may differ from those estimates and assumptions.
NOTE 3 — FEES PAID BY THE
FUND AND RELATED PARTY TRANSACTIONS
USCF Management Fee
Under the LP Agreement, USCF is responsible
for investing the assets of USSO in accordance with the objectives and policies of USSO. In addition, USCF has arranged for one
or more third parties to provide administrative, custody, accounting, transfer agency and other necessary services to USSO. For
these services, USSO is contractually obligated to pay USCF a fee, which is paid monthly, equal to 0.60% per annum of average
daily total net assets.
Ongoing Registration Fees and Other
Offering Expenses
USSO pays all costs and expenses associated
with the ongoing registration of its units subsequent to the initial offering. These costs include registration or other fees paid
to regulatory agencies in connection with the offer and sale of units, and all legal, accounting, printing and other expenses associated
with such offer and sale. For the three months ended March 31, 2013 and 2012, USSO did not incur any registration fees or
other offering expenses.
Directors’ Fees and Expenses
USSO is responsible for paying its portion
of the directors’ and officers’ liability insurance for USSO and the Related Public Funds and the fees and expenses
of the independent directors who also serve as audit committee members of USSO and the Related Public Funds organized as limited
partnerships and, as of July 8, 2011, the Related Public Funds organized as a series of a Delaware statutory trust. USSO shares
the fees and expenses on a pro rata basis with each Related Public Fund, as described above, based on the relative assets of each
fund computed on a daily basis. These fees and expenses for the year ending December 31, 2013 are estimated to be a total
of $560,625 for USSO and the Related Public Funds.
Licensing Fees
As discussed in
Note 4
below, USSO
entered into a licensing agreement with the NYMEX on May 22, 2009, as amended on October 20, 2011. Pursuant to the
agreement, through October 19, 2011, USSO and the Related Public Funds, other than USBO, USCI, CPER, USAG and USMI, paid a
licensing fee that was equal to 0.04% for the first $1,000,000,000 of combined net assets of the funds and 0.02% for combined
net assets above $1,000,000,000. On and after October 20, 2011, USSO and the Related Public Funds, other than USBO, USCI,
CPER, USAG and USMI, pay a licensing fee that is equal to 0.015% on all net assets. During the three months ended March 31, 2013
and 2012, USSO incurred $570 and $374, respectively, under this arrangement.
Investor Tax Reporting Cost
The fees and expenses associated with USSO’s
audit expenses and tax accounting and reporting requirements are paid by USSO. These costs are estimated to be $85,000 for the
year ending December 31, 2013.
Other Expenses and Fees and Expense
Waivers
In addition to the fees described above,
USSO pays all brokerage fees and other expenses in connection with the operation of USSO, excluding costs and expenses paid
by USCF as outlined in
Note 4
below. USCF has voluntarily agreed to pay certain expenses normally borne by USSO to the
extent that such expenses exceed 0.15% (15 basis points) of USSO’s NAV, on an annualized basis, through at least June 30,
2013. USCF has no obligation to continue such payments into subsequent periods. For the three months ended March 31, 2013, USCF
waived $25,557 of USSO’s expenses. This voluntary expense waiver is in addition to those amounts USCF is contractually obligated
to pay as described in
Note 4
.
NOTE 4 — CONTRACTS AND AGREEMENTS
USSO is party to a marketing agent agreement,
dated as of June 8, 2009, as amended from time to time, with the Marketing Agent and USCF, whereby the Marketing Agent
provides certain marketing services for USSO as outlined in the agreement. The fee of the Marketing Agent, which is borne
by USCF, is equal to 0.06% on USSO’s assets up to $3 billion; and 0.04% on USSO’s assets in excess of $3 billion. In
no event may the aggregate compensation paid to the Marketing Agent and any affiliate of USCF for distribution related services
exceed 10% of the gross proceeds of USSO’s offering.
The above fee does not include the following
expenses, which are also borne by USCF: the cost of placing advertisements in various periodicals; web construction and development;
or the printing and production of various marketing materials.
USSO is also party to a custodian agreement,
dated October 7, 2008, as amended from time to time, with Brown Brothers Harriman & Co. (“BBH&Co.”)
and USCF, whereby BBH&Co. holds investments on behalf of USSO. USCF pays the fees of the custodian, which are determined
by the parties from time to time. In addition, USSO is party to an administrative agency agreement, dated October 7, 2008,
as amended from time to time, with USCF and BBH&Co., whereby BBH&Co. acts as the administrative agent, transfer agent and
registrar for USSO. USCF also pays the fees of BBH&Co. for its services under such agreement and such fees are determined
by the parties from time to time.
Currently, USCF pays BBH&Co. for its
services, in the foregoing capacities, a minimum amount of $75,000 annually for its custody, fund accounting and fund administration
services rendered to USSO and each of the Related Public Funds, as well as a $20,000 annual fee for its transfer agency services. In
addition, USCF pays BBH&Co. an asset-based charge of: (a) 0.06% for the first $500 million of USSO’s, USOF’s,
USNG’s, US12OF’s, UGA’s, USDHO’s, US12NG’s, USBO’s, USCI’s, CPER’s, USAG’s
and USMI’s combined net assets, (b) 0.0465% for USSO’s, USOF’s, USNG’s, US12OF’s, UGA’s,
USDHO’s, US12NG’s, USBO’s, USCI’s, CPER’s, USAG’s and USMI’s combined net assets greater
than $500 million but less than $1 billion, and (c) 0.035% once USSO’s, USOF’s, USNG’s, US12OF’s,
UGA’s, USDHO’s, US12NG’s, USBO’s, USCI’s, CPER’s, USAG’s and USMI’s combined net
assets exceed $1 billion. The annual minimum amount will not apply if the asset-based charge for all accounts in the aggregate
exceeds $75,000. USCF also pays transaction fees ranging from $7 to $15 per transaction.
USSO has entered into a brokerage agreement
with UBS Securities LLC (“UBS Securities”). The agreement requires UBS Securities to provide services to USSO
in connection with the purchase and sale of Futures Contracts and Other Crude Oil-Related Investments that may be purchased and
sold by or through UBS Securities for USSO’s account. In accordance with the agreement, UBS Securities charges USSO commissions
of approximately $7 to $15 per round-turn trade, including applicable exchange and NFA fees for Futures Contracts and options on
Futures Contracts. Such fees include those incurred when purchasing Futures Contracts and options on Futures Contracts when USSO
issues units as a result of a Creation Basket, as well as fees incurred when selling Futures Contracts and options on Futures Contracts
when USSO redeems units as a result of a Redemption Basket. Such fees are also incurred when Futures Contracts and options on Futures
Contracts are purchased or redeemed for the purpose of rebalancing the portfolio. USSO also incurs commissions to brokers for the
purchase and sale of Futures Contracts, Other Crude Oil-Related Investments or short-term obligations of the United States of two
years or less (“Treasuries”). During the three months ended March 31, 2013, total commissions accrued to brokers amounted
to $3,777. Of this amount, approximately $2,130 was a result of rebalancing costs and approximately $1,647 was the result of trades
necessitated by creation and redemption activity. By comparison, during the three months ended March 31, 2012, total commissions
accrued to brokers amounted to $2,867. Of this amount, approximately $1,420 was a result of rebalancing costs and approximately
$1,447 was the result of trades necessitated by creation and redemption activity. The increase in the total commissions accrued
to brokers for the three months ended March 31, 2013, as compared to the three months ended March 31, 2012, was primarily a function
of increased brokerage fees due to a higher number of futures contracts being held and traded as a result of the increase in USSO’s
total net assets during the three months ended March 31, 2013. As an annualized percentage of average daily total net assets,
the figure for the three months ended March 31, 2013 represents approximately 0.10% of average daily total net assets. By
comparison, the figure for the three months ended March 31, 2012 represented approximately 0.11% of average daily 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.
USSO and the NYMEX entered into a licensing
agreement on May 22, 2009, as amended on October 20, 2011, whereby USSO was granted a non-exclusive license to use certain
of the NYMEX’s settlement prices and service marks. Under the licensing agreement, USSO and the Related Public Funds,
other than USBO, USCI, CPER, USAG and USMI, pay the NYMEX an asset-based fee for the license, the terms of which are described
in
Note 3.
USSO expressly disclaims any association with the NYMEX or endorsement of USSO by the NYMEX and acknowledges
that “NYMEX” and “New York Mercantile Exchange” are registered trademarks of the NYMEX.
NOTE 5 — FINANCIAL INSTRUMENTS, OFF-BALANCE SHEET RISKS
AND CONTINGENCIES
USSO engages in the trading of futures
contracts and options on futures contracts and may engage in cleared swaps (collectively, “derivatives”). USSO 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.
USSO may enter into futures contracts,
options on futures contracts and cleared swaps to gain exposure to changes in the value of an underlying commodity. A futures contract
obligates the seller to deliver (and the purchaser to accept) the future delivery of a specified quantity and type of a commodity
at a specified time and place. Some futures contracts may call for physical delivery of the asset, while others are settled in
cash. The contractual obligations of a buyer or seller may generally be satisfied by taking or making physical delivery of the
underlying 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 purchase and sale of futures contracts,
options on futures contracts and cleared swaps require margin deposits with a futures commission merchant. Additional deposits
may be necessary for any loss on contract value. The Commodity Exchange Act requires a futures commission merchant to segregate
all customer transactions and assets from the futures commission merchant’s proprietary activities.
Futures contracts and cleared swaps involve,
to varying degrees, elements of market risk (specifically commodity price risk) and exposure to loss in excess of the amount of
variation margin. The face or contract amounts reflect the extent of the total exposure USSO has in the particular classes of instruments.
Additional risks associated with the use of futures contracts are an imperfect correlation between movements in the price of the
futures contracts and the market value of the underlying securities and the possibility of an illiquid market for a futures contract.
All of the futures contracts held by USSO
were exchange-traded through March 31, 2013. 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, a party must rely solely
on the credit of its respective individual counterparties. However, in the future, if USSO 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, on the transaction. USSO has credit risk under
its futures contracts since the sole counterparty to all domestic and foreign futures contracts is the clearinghouse for the
exchange on which the relevant contracts are traded. In addition, USSO bears the risk of financial failure by the clearing broker.
USSO’s cash and other property, such
as Treasuries, deposited with a futures commission merchant are considered commingled with all other customer funds, subject to
the futures commission merchant’s segregation requirements. In the event of a futures commission merchant’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. The insolvency of a futures commission merchant could result in the complete
loss of USSO’s assets posted with that futures commission merchant; however, the majority of USSO’s assets are held
in Treasuries, cash and/or cash equivalents with USSO’s custodian and would not be impacted by the insolvency of a futures
commission merchant. The failure or insolvency of USSO’s custodian, however, could result in a substantial loss of USSO’s
assets.
USCF invests a portion of USSO’s
cash in money market funds that seek to maintain a stable per unit NAV. USSO is exposed to any risk of loss associated with an
investment in such money market funds. As of March 31, 2013 and December 31, 2012, USSO held investments in money market funds
in the amounts of $3,509,515 and $3,509,515, respectively. USSO also holds cash deposits with its custodian. Pursuant to a written
agreement with BBH&Co., uninvested overnight cash balances are swept to offshore branches of U.S. regulated and domiciled banks
located in Toronto, Canada, London, United Kingdom, Grand Cayman, Cayman Islands and Nassau, Bahamas, which are subject to U.S.
regulation and regulatory oversight. As of March 31, 2013 and December 31, 2012, USSO held cash deposits and investments in Treasuries
in the amounts of $13,578,078 and $10,513,713, respectively, with the custodian and futures commission merchant. Some or all of
these amounts may be subject to loss should USSO’s custodian and/or futures commission merchant cease operations.
For derivatives, risks arise from changes
in the market value of the contracts. Theoretically, USSO is exposed to 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, USSO 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.
USSO’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, USSO has a policy of requiring review of the credit standing of each broker or counterparty
with which it conducts business.
The financial instruments held by USSO
are reported in its condensed statements 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.
NOTE 6 — FINANCIAL HIGHLIGHTS
The following table presents per unit performance
data and other supplemental financial data for the three months ended March 31, 2013 and 2012 for the unitholders. This information
has been derived from information presented in the condensed financial statements.
|
|
For the three months ended
|
|
|
For the three months ended
|
|
|
|
March 31, 2013
|
|
|
March 31, 2012
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
Per Unit Operating Performance:
|
|
|
|
|
|
|
|
|
Net asset value, beginning of period
|
|
$
|
37.89
|
|
|
$
|
36.16
|
|
Total income (loss)
|
|
|
(1.73
|
)
|
|
|
(1.52
|
)
|
Total expenses
|
|
|
(0.08
|
)
|
|
|
(0.08
|
)
|
Net decrease in net asset value
|
|
|
(1.81
|
)
|
|
|
(1.60
|
)
|
Net asset value, end of period
|
|
$
|
36.08
|
|
|
$
|
34.56
|
|
|
|
|
|
|
|
|
|
|
Total Return
|
|
|
(4.78
|
)%
|
|
|
(4.42
|
)%
|
|
|
|
|
|
|
|
|
|
Ratios to Average Net Assets
|
|
|
|
|
|
|
|
|
Total income (loss)
|
|
|
(4.10
|
)%
|
|
|
(1.88
|
)%
|
Management fees*
|
|
|
0.60
|
%
|
|
|
0.60
|
%
|
Total expenses excluding management fees*
|
|
|
0.95
|
%
|
|
|
1.01
|
%
|
Expenses waived*
|
|
|
(0.67
|
)%
|
|
|
(0.72
|
)%
|
Net expenses excluding management fees*
|
|
|
0.28
|
%
|
|
|
0.29
|
%
|
Net income (loss)
|
|
|
(4.32
|
)%
|
|
|
(2.10
|
)%
|
* Annualized
Total returns are calculated based on the
change in value during the period. An individual unitholder’s total return and ratio may vary from the above total returns
and ratios based on the timing of contributions to and withdrawals from USSO.
NOTE 7 — FAIR VALUE OF FINANCIAL
INSTRUMENTS
USSO values its investments in accordance
with Accounting Standards Codification 820 – Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines
fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures
about fair value measurement. The changes to past practice resulting from the application of ASC 820 relate to the definition of
fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurement. ASC 820 establishes
a fair value hierarchy that distinguishes between: (1) market participant assumptions developed based on market data obtained
from sources independent of USSO (observable inputs) and (2) USSO’s own assumptions about market participant assumptions
developed based on the best information available under the circumstances (unobservable inputs). The three levels defined by the
ASC 820 hierarchy are as follows:
Level I – Quoted prices (unadjusted)
in active markets for
identical
assets or liabilities that the reporting entity has the ability to access at the measurement
date.
Level II – Inputs other than quoted
prices included within Level I that are observable for the asset or liability, either directly or indirectly. Level II assets include
the following: quoted prices for
similar
assets or liabilities in active markets, quoted prices for identical or similar
assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability,
and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated
inputs).
Level III – Unobservable pricing
input at the measurement date for the asset or liability. Unobservable inputs shall be used to measure fair value to the extent
that observable inputs are not available.
In some instances, the inputs used to measure
fair value might fall within different levels of the fair value hierarchy. The level in the fair value hierarchy within which the
fair value measurement in its entirety falls shall be determined based on the lowest input level that is significant to the fair
value measurement in its entirety.
The following table summarizes the valuation
of USSO’s securities at March 31, 2013 using the fair value hierarchy:
At March 31, 2013
|
|
Total
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
Short-Term Investments
|
|
$
|
4,214,428
|
|
|
$
|
4,214,428
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Exchange-Traded Futures Contracts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States Contracts
|
|
|
(838,750)
|
|
|
|
(838,750)
|
|
|
|
—
|
|
|
|
—
|
|
During the three months ended March 31,
2013, there were no transfers between Level I and Level II.
The following table summarizes the valuation
of USSO’s securities at December 31, 2012 using the fair value hierarchy:
At December 31, 2012
|
|
Total
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
Short-Term Investments
|
|
$
|
4,009,494
|
|
|
$
|
4,009,494
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Exchange-Traded Futures Contracts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United States Contracts
|
|
|
(735,330
|
)
|
|
|
(735,330
|
)
|
|
|
—
|
|
|
|
—
|
|
During the year ended December 31, 2012,
there were no transfers between Level I and Level II.
Effective January 1, 2009, USSO adopted
the provisions of Accounting Standards Codification 815 – Derivatives and Hedging, which require presentation of qualitative
disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts and gains
and losses on derivatives.
Fair Value of Derivative Instruments
Derivatives not
|
|
|
|
|
|
|
|
|
Accounted for as
|
|
Condensed
|
|
|
|
|
|
|
Hedging
|
|
Statements of Financial
|
|
Fair Value
|
|
|
Fair Value
|
|
Instruments
|
|
Condition Location
|
|
At March 31, 2013
|
|
|
At December 31, 2012
|
|
Futures –
Commodity
Contracts
|
|
Assets
|
|
$
|
(838,750)
|
|
|
$
|
(735,330)
|
|
The Effect of Derivative Instruments on the Condensed Statements
of Operations
|
|
|
|
For the three months ended
|
|
|
For the three months ended
|
|
|
|
|
|
March 31, 2013
|
|
|
March 31, 2012
|
|
|
|
|
|
Realized
|
|
|
Change in
|
|
|
Realized
|
|
|
Change in
|
|
|
|
Location of
|
|
Gain or
|
|
|
Unrealized
|
|
|
Gain or
|
|
|
Unrealized
|
|
Derivatives not
|
|
Gain or (Loss)
|
|
(Loss)
|
|
|
Gain or (Loss)
|
|
|
(Loss)
|
|
|
Gain or (Loss)
|
|
Accounted for as
|
|
on Derivatives
|
|
on Derivatives
|
|
|
on Derivatives
|
|
|
on Derivatives
|
|
|
on Derivatives
|
|
Hedging
|
|
Recognized in
|
|
Recognized in
|
|
|
Recognized in
|
|
|
Recognized
|
|
|
Recognized in
|
|
Instruments
|
|
Income
|
|
Income
|
|
|
Income
|
|
|
in Income
|
|
|
Income
|
|
Futures -
Commodity Contracts
|
|
Realized loss on closed positions
|
|
$
|
(530,080
|
)
|
|
|
|
|
|
$
|
(802,020
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in unrealized gain (loss) on open positions
|
|
|
|
|
|
$
|
(103,420
|
)
|
|
|
|
|
|
$
|
610,740
|
|
NOTE 8 – OFFSETTING ASSETS AND
LIABILITIES
USSO is required to disclose offsetting
assets and liabilities represented in the Condensed Statements of Financial Condition to disclose information to enable users of
these financial statements to evaluate the effect or potential effect of netting arrangements on its financial position for recognized
assets and liabilities. These recognized assets and liabilities as defined in the Financial Accounting Standards Board (“FASB”)
issued Accounting Standards Update (“ASU”) No. 2011-11 “Balance Sheet (Topic 210): Disclosures about Offsetting
Assets and Liabilities” and subsequently clarified in FASB ASU 2013-01 “Balance Sheet (Topic 210): Clarifying the Scope
of Disclosures about Offsetting Assets and Liabilities.” The derivative instruments include all futures contracts including
exchange-traded futures contracts.
Offsetting
of Financial Liabilities and Derivative Liabilities as of March 31, 2013 and December 31, 2012
Liabilities
|
|
Gross
Amounts of
Recognized
Liabilities
|
|
|
Gross
Amounts
Offset in the
Statements of
Financial
Condition
|
|
|
Net Amounts of
Liabilities
Presented in the
Statements of
Financial
Condition
|
|
|
|
|
|
|
|
|
|
|
|
At March 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
Futures contracts
|
|
$
|
838,750
|
|
|
$
|
—
|
|
|
$
|
838,750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
Futures contracts
|
|
$
|
735,330
|
|
|
$
|
—
|
|
|
$
|
735,330
|
|
Financial
Liabilities, Derivative Liabilities, and Collateral Pledged by Counterparty as of March 31, 2013 and December 31, 2012
|
|
|
|
|
Gross Amounts Not Offset in the
Statements of Financial Condition
|
|
|
|
|
|
|
Net Amounts of
Liabilities
Presented in the
Statements of
Financial
Condition (A)
|
|
|
Financial
Instruments
Collateral
Pledged (B)
|
|
|
Cash Collateral
Pledged (C)
|
|
|
Net Amount
(D)=(A)-(B)-(C)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At March 31, 2013:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UBS Securities
|
|
$
|
838,750
|
|
|
$
|
368,851
|
|
|
$
|
469,899
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2012:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UBS Securities
|
|
$
|
735,330
|
|
|
$
|
251,531
|
|
|
$
|
483,799
|
|
|
$
|
—
|
|
NOTE 9 — SUBSEQUENT EVENTS
USSO has performed an evaluation of
subsequent events through the date the condensed financial statements were issued. This evaluation did not result in any
subsequent events that necessitated disclosures and/or adjustments.
Item 2. Management’s Discussion and Analysis
of Financial Condition and Results of Operations.
The following discussion should be read
in conjunction with the condensed financial statements and the notes thereto of the United States Short Oil Fund, LP (“USSO”)
included elsewhere in this quarterly report on Form 10-Q.
Forward-Looking Information
This quarterly report on Form 10-Q, including
this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking
statements regarding the plans and objectives of management for future operations. This information may involve known and unknown
risks, uncertainties and other factors that may cause USSO’s actual results, performance or achievements to be materially
different from future results, performance or achievements expressed or implied by any forward-looking statements. Forward-looking
statements, which involve assumptions and describe USSO’s future plans, strategies and expectations, are generally identifiable
by use of the words “may,” “will,” “should,” “expect,” “anticipate,”
“estimate,” “believe,” “intend” or “project,” the negative of these words,
other variations on these words or comparable terminology. These forward-looking statements are based on assumptions that may be
incorrect, and USSO cannot assure investors that the projections included in these forward-looking statements will come to pass.
USSO’s actual results could differ materially from those expressed or implied by the forward-looking statements as a result
of various factors.
USSO has based the forward-looking statements
included in this quarterly report on Form 10-Q on information available to it on the date of this quarterly report on Form 10-Q,
and USSO assumes no obligation to update any such forward-looking statements. Although USSO undertakes no obligation to revise
or update any forward-looking statements, whether as a result of new information, future events or otherwise, investors are advised
to consult any additional disclosures that USSO may make directly to them or through reports that USSO in the future files
with the U.S. Securities and Exchange Commission (the “SEC”), including annual reports on Form 10-K, quarterly reports
on Form 10-Q and current reports on Form 8-K.
Introduction
USSO, a Delaware limited partnership, is
a commodity pool that issues units that may be purchased and sold on the NYSE Arca, Inc. (the “NYSE Arca”). The
investment objective of USSO is for the daily changes in percentage terms of its units’ per unit net asset value (“NAV”)
to inversely reflect the daily changes in percentage terms of the spot price of West Texas Intermediate (“WTI”) light,
sweet crude oil delivered to Cushing, Oklahoma, as measured by the daily changes in the price of the futures contract for WTI light,
sweet crude oil traded on the New York Mercantile Exchange (the “NYMEX”) that is the near month contract to expire,
except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contract
that is the next month contract to expire (the “Benchmark Futures Contract”), less USSO’s expenses. “Near
month contract” means the next contract traded on the NYMEX due to expire. “Next month contract” means the first
contract traded on the NYMEX due to expire after the near month contract. It is not the intent of USSO to be operated in a fashion
such that the per unit NAV will equal, in dollar terms, the inverse of the spot price of WTI light, sweet crude oil or any particular
futures contract based on WTI light, sweet crude oil. It is not the intent of USSO to be operated in a fashion such that its per
unit NAV will reflect the inverse of the percentage change of the price of any particular futures contract as measured over a time
period greater than one day. The general partner of USSO, United States Commodity Funds LLC (“USCF”), believes that
it is not practical to manage the portfolio to achieve such an investment goal when investing in short positions in Futures Contracts
(as defined below) and Other Crude Oil-Related Investments (as defined below).
USSO invests in short positions in futures
contracts for crude oil, diesel-heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the NYMEX,
ICE Futures Exchange (“ICE Futures”) or other U.S. and foreign exchanges (collectively, “Futures Contracts”).
USSO may take short positions in other crude oil-related investments such as cash-settled options on Futures Contracts, forward
contracts for crude oil, cleared swap contracts and over-the-counter transactions that are based on the price of crude oil and
other petroleum-based fuels, Futures Contracts and indices based on the foregoing (collectively, “Other Crude Oil-Related
Investments”). For convenience and unless otherwise specified, Futures Contracts and Other Crude Oil-Related Investments
collectively are referred to as “Crude Oil Interests” in this quarterly report on Form 10-Q.
USSO seeks to achieve its investment objective
by investing in short positions in a combination of Futures Contracts and Other Crude Oil-Related Investments such that daily changes
in its per unit NAV, measured in percentage terms, will closely track the inverse of the daily changes in the price of the
Benchmark Futures Contract, also measured in percentage terms. USCF believes the daily changes in the price of the Benchmark Futures
Contract have historically exhibited a close correlation with the daily changes in the spot price of WTI light, sweet crude oil.
It is not the intent of USSO to be operated in a fashion such that the per unit NAV will equal, in dollar terms, the inverse of
the spot price of WTI light, sweet crude oil or any particular futures contract based on WTI light, sweet crude oil. It is not
the intent of USSO to be operated in a fashion such that its per unit NAV will reflect the inverse of the percentage change of
the price of any particular futures contract as measured over a time period greater than one day. USCF believes that it is not
practical to manage the portfolio to achieve such an investment goal when investing in Futures Contracts and Other Crude Oil-Related
Investments.
To achieve its investment objective, USSO
anticipates that it will need to maintain “short” positions in the Futures Contracts and Other Crude-Oil Related Investments
in which it invests. A short position is one in which USSO will have sold the Futures Contract or Other Crude-Oil Related Investment
and must buy it back or otherwise close out the position in the future. As a result, a drop in the market value of the Crude Oil
Interest would lead to a potential gain for USSO, while an increase in the market value of the Crude Oil Interest would lead to
a potential loss for USSO. Typically, a short position will produce a result that is the inverse of buying the Futures Contract
or Other Crude-Oil Related Investment (an approach referred to as being “long” the investment). USCF expects the daily
performance of USSO to generally be inverse to the daily performance of the United States Oil Fund, LP (“USOF”), another
commodity pool managed by USCF, which seeks to have the daily changes in percentage terms of its units’ per unit NAV track
the daily changes in percentage terms of the spot price of light, sweet crude oil as traded in the United States.
Regulatory Disclosure
Impact of Accountability Levels, Position
Limits and Price Fluctuation Limits
. Futures contracts include typical and significant characteristics. Most significantly,
the Commodity Futures Trading Commission (the “CFTC”) and the futures exchanges have established accountability levels
and position limits on the maximum net long or net short futures contracts in commodity interests that any person or group of persons
under common trading control (other than as a hedge, which an investment by USSO is not) may hold, own or control. The net
position is the difference between an individual’s or firm’s open long contracts and open short contracts in any one
commodity. In addition, most U.S.-based futures exchanges, such as the NYMEX, limit the daily price fluctuation for futures
contracts. Currently, the ICE Futures imposes position and accountability limits that are similar to those imposed by U.S.-based
futures exchanges but does not limit the maximum daily price fluctuation, while some other non-U.S. futures exchanges have not
adopted such limits.
The accountability levels for the Benchmark
Futures Contract and other Futures Contracts traded on the NYMEX are not a fixed ceiling, but rather a threshold above which
the NYMEX may exercise greater scrutiny and control over an investor’s positions. The current accountability level for
any one-month in the Benchmark Futures Contract is 10,000 net contracts. In addition, the NYMEX imposes an accountability
level for all months of 20,000 net futures contracts for investments in futures contracts for light, sweet crude oil. In addition,
the ICE Futures maintains the same accountability levels, position limits and monitoring authority for its light, sweet crude oil
contract as the NYMEX. If USSO and the Related Public Funds (as defined below) exceed these accountability levels for investments
in the futures contract for light, sweet crude oil, the NYMEX and ICE Futures will monitor USSO’s and the Related Public
Funds’ exposure and may ask for further information on their activities, including the total size of all positions, investment
and trading strategy, and the extent of liquidity resources of USSO and the Related Public Funds. If deemed necessary by the
NYMEX and/or ICE Futures, USSO and the Related Public Funds could be ordered to reduce their aggregate net position back to the
accountability level. As of March 31, 2013, USSO held short positions in 167 WTI Crude Oil Futures CL Contracts traded on
the NYMEX. USSO did not hold short positions on the ICE Futures as of March 31, 2013. For the three months ended March 31, 2013,
USSO did not exceed accountability levels on the NYMEX or ICE Futures.
Position limits differ from accountability
levels in that they represent fixed limits on the maximum number of futures contracts that any person may hold and cannot allow
such limits to be exceeded without express CFTC authority to do so. In addition to accountability levels and position limits that
may apply at any time, the NYMEX and the ICE Futures impose position limits on contracts held in the last few days of trading in
the near month contract to expire. It is unlikely that USSO will run up against such position limits because USSO’s investment
strategy is to close out its positions and “roll” from the near month contract to expire to the next month contract
beginning two weeks from expiration of the contract. For the three months ended March 31, 2013, USSO did not exceed any position
limits imposed by the NYMEX and ICE Futures.
The regulation of commodity interest trading
in the United States and other countries is an evolving area of the law, as exemplified by the various discussions of the Dodd-Frank
Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). 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 National Futures Association
(the “NFA”), the futures exchanges, clearing organizations and other regulatory bodies. Pending final resolution of
all applicable regulatory requirements, some specific examples of how the new Dodd-Frank Act provisions and rules adopted thereunder
could impact USSO are discussed below.
Futures Contracts and Position Limits
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 on non-U.S. exchanges to be offered
and sold in the United States.
In October 2011, the CFTC adopted rules
that impose new position limits on Referenced Contracts (as defined below) involving 28 energy, metals and agricultural commodities
(the “Position Limit Rules”). The Position Limit Rules were scheduled to become effective on October 12, 2012. However,
on September 28, 2012, the United States District Court for the District of Columbia vacated these regulations on the basis of
ambiguities in the provisions of the Commodity Exchange Act (“CEA”) (as modified by the Dodd-Frank Act) upon which
the regulations were based. In its September 28, 2012 decision, the court remanded the Position Limit Rules to the CFTC with instructions
to use its expertise and experience to resolve the ambiguities in the statute. On November 15, 2012, the CFTC indicated that it
will move forward with an appeal of the District Court’s decision to vacate the Position Limit Rules. At this time, it is
not possible to predict how the CFTC’s appeal could affect USSO, but it may be substantial and adverse. Furthermore, until
such time as the appeal is resolved or, if applicable revisions to the Position Limit Rules are proposed and adopted, the regulatory
architecture in effect prior to the enactment of the Position Limit Rules will govern transactions in commodities and related derivatives
(collectively, “Referenced Contracts”). Under that system, the CFTC enforces federal limits on speculation in agricultural
products (e.g., corn, wheat and soy), while futures exchanges enforce position limits and accountability levels for agricultural
and certain energy products (e.g., oil and natural gas). As a result, USSO may be limited with respect to the size of its investments
in any commodities subject to these limits. Finally, subject to certain narrow exceptions, the vacated Position Limit Rules would
have required the aggregation, for purposes of the position limits, of all positions in the 28 Referenced Contracts held by a single
entity and its affiliates, regardless of whether such position existed on U.S. futures exchanges, non-U.S. futures exchanges, in
cleared swaps or in over-the-counter swaps. The CFTC is presently considering new aggregation rules, under a rulemaking proposal
that is distinct from the Position Limit Rules. At this time, it is unclear how any modified aggregation rules may affect USSO,
but it may be substantial and adverse. By way of example, the aggregation rules in combination with any potential revised Position
Limit Rules may negatively impact the ability of USSO to meet its investment objectives through limits that may inhibit USCF’s
ability to sell additional Creation Baskets of USSO.
Based on its current understanding of the
final position limit regulations, USCF does not anticipate significant negative impact on the ability of USSO to achieve its investment
objective.
“Swap” Transactions
The Dodd-Frank Act imposes new regulatory
requirements on certain “swap” transactions that USSO is authorized to engage in that may ultimately impact the ability
of USSO to meet its investment objective. On August 13, 2012, the CFTC and the SEC published joint final rules defining the
terms “swap” and “security-based swap.” The term “swap” is broadly defined to include various
types of over-the-counter derivatives, including swaps and options. The effective date of these final rules was October 12,
2012.
The Dodd-Frank Act requires that certain
transactions ultimately falling within the definition of “swap” be executed on organized exchanges or “swap execution
facilities” and cleared through regulated clearing organizations (which are referred to in the Dodd-Frank Act as “derivative
clearing organizations” (“DCOs”)), if the CFTC mandates the central clearing of a particular contract. On November
28, 2012, the CFTC issued its final clearing determination requiring that certain credit default swaps and interest rate swaps
be cleared by registered DCOs. This is the CFTC’s first clearing determination under the Dodd-Frank Act and became effective
on February 11, 2013. Beginning on March 11, 2013, “swap dealers,” “major swap participants” and certain
active funds were required to clear certain credit default swaps and interest rate swaps. Determination on other types of swaps
are expected in the future, and, when finalized, could require USSO to centrally clear certain over-the-counter instruments presently
entered into and settled on a bi-lateral basis. If a swap is required to be cleared, the initial margin will be set by the clearing
organization, subject to certain regulatory requirements and guidelines. Initial and variation margin requirements for swap dealers
and major swap participants who enter into uncleared swaps and capital requirements for swap dealers and major swap participants
who enter into both cleared and uncleared trades will be set by the CFTC, the SEC or the applicable “Prudential Regulator.”
On November 14, 2012, the CFTC proposed
new regulations that would require enhanced customer protections, risk management programs, internal monitoring and controls, capital
and liquidity standards, customer disclosures and auditing and examination programs for FCMs. The proposed rules are intended to
afford greater assurances to market participants that customer segregated funds and secured amounts are protected, customers are
provided with appropriate notice of the risks of futures trading and of the FCMs with which they may choose to do business, FCMs
are monitoring and managing risks in a robust manner, the capital and liquidity of FCMs are strengthened to safeguard their continued
operations and the auditing and examination programs of the CFTC and the self-regulatory organizations are monitoring the activities
of FCMs in a thorough manner. The final regulations have not yet been adopted.
Additionally, the CFTC published rules
on February 17, 2012 and April 3, 2012 that require “swap dealers” and “major swap participants”
to: 1) adhere to business conduct standards, 2) implement policies and procedures to ensure compliance with the CEA and 3) maintain
records of such compliance. These new requirements may impact the documentation requirements for both cleared and non-cleared swaps
and cause swap dealers and major swap participants to face increased compliance costs that, in turn, may be passed along to counterparties
(such as USSO) in the form of higher fees and expenses that related to trading swaps.
On December 21, 2012, the CFTC’s
Division of Market Oversight issued two letters providing certain swap dealers with time-limited no-action relief from some swap
data reporting obligations. One letter provides relief from reporting requirements for branches of swap dealers located in emerging
markets who encounter technical difficulties in complying with the reporting rules. The letter also provides that swap dealers
may delay reporting compliance for certain complex and exotic swaps until April 30, 2013.
Under a second letter, all swap dealers
have until April 30, 2013 to report certain information about their counterparties, including: status as a major swap participant,
a financial entity, a U.S. person or a commercial end-user.
On December 18, 2012, the CFTC deferred
the compliance date for many of the Dodd-Frank Act’s external business conduct standards from December 31, 2012 to May 1,
2013, and for some requirements to July 1, 2013, providing swap dealers an additional four to six months from the original compliance
date.
On April 5, 2013, the CFTC’s Division
of Clearing and Risk issued a letter granting no-action relief from certain swap data reporting requirements for swaps entered
into between affiliated counterparties. In general, the letter grants relief from, among others: real-time, historical and regular
swap reporting (under Part 43, Part 45 and Part 46 of the CFTC’s regulations, respectively).
On April 9, 2013, the CFTC’s Division
of Market Oversight issued a letter granting time-limited no-action relief to non-swap dealer, non-major swap participant counterparties
from the real-time, regular and historical swap reporting requirements (under Part 43, Part 45 and Part 46 of the CFTC’s
regulations, respectively). The regular reporting requirements (Part 45 of the CFTC regulations) for interest rate and credit swaps
of a financial entity (including a commodity pool such as USSO) began on April 10, 2013. The letter delays implementation of the
reporting requirements based upon the asset class underlying the swap and the classification of the reporting counterparty. For
a financial entity (including a commodity pool such as USSO), regular reporting requirements for equity, foreign exchange and other
commodity swaps (including swaps on oil) begin on May 29, 2013 and reporting of all historical swaps for all asset classes begins
on September 30, 2013.
The effect of the future regulatory change
on USSO is impossible to predict, but it could be substantial and adverse.
USCF, which is registered as a commodity
pool operator (“CPO”) and a swaps firm (pending) with the CFTC, is authorized by the Second Amended and Restated Agreement
of Limited Partnership of USSO (the “LP Agreement”) to manage USSO. USCF is authorized by USSO in its sole judgment
to employ and establish the terms of employment for, and termination of, commodity trading advisors or FCMs.
Price Movements
WTI light, sweet crude oil futures prices
were volatile during the three months ended March 31, 2013, finishing the period with a downward trend. The price of the Benchmark
Futures Contract started the period at $91.82 per barrel. It hit a peak on February 12, 2013 at $98.07 per barrel. The
low of the period was on March 4, 2013 when the price dropped to $90.12 per barrel. The period ended with the Benchmark Futures
Contract at $97.23 per barrel, up approximately 5.89% over the period. USSO’s per unit NAV began the period at $37.89 and
ended the period at $36.08 on March 31, 2013, a decrease of approximately 4.78% over the period. USSO’s per unit NAV
reached its high for the period on March 4, 2013 at $38.81 and reached its low for the period on January 30, 2013 at $35.63. Since
USSO’s investment objective is to track the inverse of the daily changes in the price of the Benchmark Futures Contract,
the increase in USSO’s per unit NAV reflects the inverse of the decrease in the price of the Benchmark Futures Contract.
The Benchmark Futures Contract prices listed above began with the February 2013 contract and ended with the May 2013 contract. The
increase of approximately 5.89% on the Benchmark Futures Contract listed above is a hypothetical return only and could not actually
be achieved by an investor holding Futures Contracts. An investment in Futures Contracts would need to be rolled forward during
the time period described in order to simulate such a result. Furthermore, the change in the nominal price of these differing
Futures Contracts, measured from the start of the period to the end of the period, does not represent the actual benchmark results
that USSO seeks to track, which are more fully described below in the section titled “
Tracking USSO’s Benchmark
.”
During the three months ended March 31,
2013, the level of contango remained mild, meaning that the price of the near month crude Oil Futures Contract was less than the
price of the next month crude Oil Futures Contract, or contracts further away from expiration. Crude oil inventories, which reached
historic levels in January 2009 and February 2009 and which appeared to be the primary cause of the steep level of contango, began
to drop in March 2009 and continued to drop for the remainder of 2009 and the beginning of 2010. During the year ended December 31,
2011, crude oil inventories began to climb higher, which contributed to the crude oil futures market remaining in contango through
the end of December 2011. During the three months ended March 31, 2012, crude oil inventories maintained present levels, which
contributed to the crude oil futures market remaining in contango through the end of March 2013. For a discussion of the impact
of backwardation and contango on total returns, see
“Term Structure of Crude Oil Prices and the Impact on Total Returns”
below.
Valuation of Futures Contracts and the
Computation of the Per Unit NAV
The per unit NAV of USSO’s units
is calculated once each NYSE Arca trading day. The per unit NAV for a particular trading day is released after 4:00 p.m. New
York time. Trading during the core trading session on the NYSE Arca typically closes at 4:00 p.m. New York time. USSO’s
administrator uses the NYMEX closing price (determined at the earlier of the close of the NYMEX or 2:30 p.m. New York time)
for the contracts held on the NYMEX, but calculates or determines the value of all other USSO investments, including ICE Futures
contracts or other futures contracts, as of the earlier of the close of the NYSE Arca or 4:00 p.m. New York time.
Results of Operations and the Crude
Oil Market
Results of Operations.
On September 24,
2009, USSO listed its units on the NYSE Arca under the ticker symbol “DNO.” On that day, USSO established its
initial offering price at $50.00 per unit and issued 200,000 units to the initial authorized purchaser in exchange for $10,000,000
in cash.
Since its initial offering of 25,000,000
units, USSO has not registered any subsequent offerings of its units. As of March 31, 2013, USSO had issued 2,000,000 units, 450,000
of which were outstanding. As of March 31, 2013, there were 23,000,000 units registered but not yet issued.
More units may have been issued by USSO
than are outstanding due to the redemption of units. Unlike funds that are registered under the Investment Company Act of
1940, as amended, units that have been redeemed by USSO cannot be resold by USSO. As a result, USSO contemplates that additional
offerings of its units will be registered with the SEC in the future in anticipation of additional issuances and redemptions.
As of March 31, 2013, USSO had the following
authorized purchasers:
Citadel Securities LLC, Citigroup Global Markets Inc., Credit Suisse Securities
USA LLC, Deutsche Bank Securities Inc., JP Morgan Securities Inc., Merrill Lynch Professional Clearing Corporation, Morgan Stanley
& Company Inc., NewEdge USA LLC, Nomura Securities International Inc., RBC Capital Markets Corporation, SG Americas Securities
LLC, Virtu Financial Capital Markets and Virtu Financial BD LLC.
For the Three Months Ended March 31,
2013 Compared to the Three Months Ended March 31, 2012
As of March 31, 2013, the total unrealized
loss on short positions in Futures Contracts owned or held on that day was $838,750, and USSO established cash deposits and investments
in short-term obligations of the United States of two years or less (“Treasuries”) and money market funds that were
equal to $17,087,593. USSO held 90.62% of its cash assets in overnight deposits and investments in money market funds at its custodian
bank, while 9.38% of the cash balance was held as investments in Treasuries and as margin deposits for USSO’s short positions
in the Futures Contracts purchased at the FCM. The ending per unit NAV on March 31, 2013 was $36.08.
By comparison, as of March 31, 2012,
the total unrealized gain on short positions in Futures Contracts owned or held on that day was $614,900, and USSO established
cash deposits and investments in Treasuries and money market funds that were equal to $16,668,404. USSO held 91.79% of its cash
assets in overnight deposits and investments in money market funds at its custodian bank, while 8.21% of the cash balance was held
as investments in Treasuries and as margin deposits for USSO’s short positions in the Futures Contracts purchased at the
FCM. The increase in cash assets in overnight deposits, investments in Treasuries and money market funds for March 31, 2013,
as compared to March 31, 2012, was the result of USSO’s total unrealized loss on short positions in Futures Contracts owned
or held as of March 31, 2013 as compared to USSO’s total unrealized gain on short positions in Futures Contracts owned or
held as of March 31, 2012. The ending per unit NAV on March 31, 2012 was $34.56. The increase in the per unit NAV for March
31, 2013, as compared to March 31, 2012, was primarily a result of crude oil futures contracts decreasing in value between the
three months ended March 31, 2012 and the three months ended March 31, 2013.
Portfolio Expenses
. USSO’s
expenses consist of investment management fees, brokerage fees and commissions, certain offering costs, licensing
fees, the fees and expenses of the independent directors of USCF and expenses relating to tax accounting and reporting requirements.
The management fee that USSO pays to USCF is calculated as a percentage of the total net assets of USSO. USSO pays USCF a
management fee of 0.60% of its average daily total net assets. The fee is accrued daily and paid monthly.
During the three months ended March 31,
2013, the average daily total net assets of USSO were $15,411,899. The management fee incurred by USSO during the period amounted
to $22,801. By comparison, during the three months ended March 31, 2012, the average daily total net assets of USSO were $10,032,639. The
management fee paid by USSO during the period amounted to $14,967.
In addition to the management fee, USSO pays
all brokerage fees and other expenses, including tax reporting costs, licensing fees for the use of intellectual property, ongoing
registration or other fees paid to the SEC, the Financial Industry Regulatory Authority (“FINRA”) and any
other regulatory agency in connection with offers and sales of its units subsequent to the initial offering and all legal,
accounting, printing and other expenses associated therewith. The gross total of these fees and expenses for the three months ended
March 31, 2013 was $36,185, as compared to $25,120 for the three months ended March 31, 2012. The increase in gross total
fees and expenses excluding management fees for the three months ended March 31, 2013, as compared to the three months ended March
31, 2012, was primarily a result of USSO’s increased legal, accounting and other expenses during the three months ended March
31, 2013. For the three months ended March 31, 2013 and 2012, USSO did not incur any ongoing registration fees or other expenses
relating to the registration and offering of additional units. During the three months ended March 31, 2013 and 2012, an expense
waiver was in effect which offset certain of the expenses incurred by USSO. The total amount of the expense waiver was $25,557
for the three months ended March 31, 2013 and $17,810 for the three months ended March 31, 2012. For the three months ended
March 31, 2013 and 2012, the expenses of USSO, including management fees, commissions, and all other expenses, before allowance
for the expense waiver, totaled $58,986 and $40,087, respectively, and after allowance for the expense waiver, totaled $33,429
and $22,277, respectively.
USSO is responsible for paying its portion
of the directors’ and officers’ liability insurance of USSO and the United States Oil Fund, LP, the United States Natural
Gas Fund, LP, the United States 12 Month Oil Fund, LP, the United States Gasoline Fund, LP, the United States Diesel-Heating Oil
Fund, LP (formerly, the United States Heating Oil Fund, LP), the United States 12 Month Natural Gas Fund, LP, the United States
Brent Oil Fund, LP, the United States Commodity Index Fund, the United States Copper Index Fund, the United States Agriculture
Index Fund and the United States Metals Index Fund (collectively, the “Related Public Funds”) and the fees and expenses
of the independent directors who also serve as audit committee members of USSO and the Related Public Funds organized as limited
partnerships and, as of July 8, 2011, the Related Public Funds organized as a series of a Delaware statutory trust. USSO shares
the fees and expenses on a pro rata basis with each Related Public Fund, as described above, based on the relative assets of each
fund computed on a daily basis. These fees and expenses for the year ending December 31, 2013 are estimated to be a total
of $560,625 for USSO and the Related Public Funds. By comparison, for the year ended December 31, 2012, these fees and expenses
amounted to a total of $540,586 for USSO and the Related Public Funds. USSO’s portion of such fees and expenses for the year
ended December 31, 2012 was $1,664.
USSO also incurs commissions to brokers
for the purchase and sale of Futures Contracts, Other Crude Oil-Related Investments or Treasuries. During the three months
ended March 31, 2013, total commissions accrued to brokers amounted to $3,777. Of this amount, approximately $2,130 was a
result of rebalancing costs and approximately $1,647 was the result of trades necessitated by creation and redemption activity.
By comparison, during the three months ended March 31, 2012, total commissions accrued to brokers amounted to $2,867. Of this amount,
approximately $1,420 was a result of rebalancing costs and approximately $1,447 was the result of trades necessitated by creation
and redemption activity. The increase in the total commissions accrued to brokers for the three months ended March 31, 2013, as
compared to the three months ended March 31, 2012, was primarily a function of increased brokerage fees due to a higher number
of futures contracts being held and traded as a result of the increase in USSO’s total net assets during the three months
ended March 31, 2013. As an annualized percentage of average daily total net assets, the figure for the three months ended March
31, 2013 represents approximately 0.10% of average daily total net assets. By comparison, the figure for the three months
ended March 31, 2012 represented approximately 0.11% of average daily 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.
The fees and expenses associated with
USSO’s audit expenses and tax accounting and reporting requirements are paid by USSO. These costs are estimated to be $85,000
for the year ending December 31, 2013. USCF has voluntarily agreed to pay certain expenses normally borne by USSO to
the extent that such expenses exceed 0.15% (15 basis points) of USSO’s NAV, on an annualized basis, through at least June
30, 2013. USCF has no obligation to continue such payments into subsequent periods. For the three months ended March 31, 2013,
USCF waived $25,557 of USSO’s expenses. This voluntary expense waiver is in addition to those amounts USCF is contractually
obligated to pay as described in
Note 4
in
Item 1
of this quarterly report on Form 10-Q.
Dividend and Interest Income
. USSO
seeks to invest its assets such that it holds short positions in Futures Contracts and invests in Other Crude Oil-Related
Investments in an amount equal to the total net assets of its portfolio. Typically, such investments do not require USSO to pay
the full amount of the contract value at the time of purchase, but rather require USSO to post an amount as a margin deposit against
the eventual settlement of the short position. As a result, USSO retains an amount that is approximately equal to its total
net assets, which USSO invests in Treasuries, cash and/or cash equivalents. This includes both the amount on deposit
with the FCM as margin, as well as unrestricted cash and cash equivalents held with USSO’s custodian bank. The Treasuries,
cash and/or cash equivalents earn income that accrues on a daily basis. For the three months ended March 31, 2013, USSO earned
$1,142 in dividend and interest income on such Treasuries, cash and/or cash equivalents. Based on USSO’s average daily
total net assets, this was equivalent to an annualized yield of approximately 0.03%. USSO purchased Treasuries during the three
months ended March 31, 2013 and also held cash and/or cash equivalents during this time period. By comparison, for the three months
ended March 31, 2012, USSO earned $642 in dividend and interest income on such Treasuries, cash and/or cash equivalents. Based
on USSO’s average daily total net assets, this was equivalent to an annualized yield of approximately 0.02%. USSO purchased
Treasuries during the three months ended March 31, 2012 and also held cash and/or cash equivalents during this time period. Interest
rates on short-term investments held by USSO, including cash, cash equivalents and Treasuries, were higher during the three months
ended March 31, 2013, as compared to the three months ended March 31, 2012. As a result, the amount of income earned by USSO
as a percentage of average daily total net assets was higher during the three months ended March 31, 2013, as compared to the three
months ended March 31, 2012.
Tracking USSO’s Benchmark
USCF seeks to manage USSO’s portfolio
such that changes in its average daily per unit NAV, on a percentage basis, closely inversely track the daily changes in the average
price of the Benchmark Futures Contract. Specifically, USCF seeks to manage the portfolio such that over any rolling period of
30-valuation days, the average daily change in USSO’s per unit NAV is within a range of (90)% to (110)% ((0.9) to (1.1)) of
the average daily change in the price of the Benchmark Futures Contract. As an example, if the average daily movement of the price
of the Benchmark Futures Contract for a particular 30-valuation day time period was 0.5% per day, USCF would attempt to manage
the portfolio such that the average daily movement of the per unit 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). USSO’s portfolio management goals do not include
trying to make the nominal price of USSO’s per unit NAV equal to the inverse of the nominal price of the current Benchmark
Futures Contract or the inverse of the spot price for WTI light, sweet crude oil. USCF believes that it is not practical to manage
the portfolio to achieve such an investment goal when investing in short positions in listed Futures Contracts.
For the 30-valuation days ended March 31,
2013, the inverse of the simple average daily change in the Benchmark Futures Contract was (0.024)%, while the simple average daily
change in the per unit NAV of USSO over the same time period was (0.020)%. The average daily difference was (0.004)% (or (0.4)
basis points, where 1 basis point equals 1/100 of 1%). As a percentage of the inverse of the daily movement of the Benchmark Futures
Contract, the average error in daily tracking by the per unit NAV was (1.799)%, meaning that over this time period USSO’s
tracking error was within the plus or minus 10% range established as its benchmark tracking goal. The first chart below shows the
daily movement of USSO’s per unit NAV versus the inverse of the daily movement of the Benchmark Futures Contract for the
30-valuation day period ended March 31, 2013. The second chart below shows the monthly total returns of USSO as compared to the
inverse of the monthly value of the Benchmark Futures Contract since inception.
Since the commencement of the offering
of USSO’s units to the public on September 24, 2009 to March 31, 2013, the inverse of the simple average daily change
in the Benchmark Futures Contract was (0.017)%, while the simple average daily change in the per unit NAV of USSO over the same
time period was (0.021)%. The average daily difference was (0.004)% (or (0.4) basis points, where 1 basis point equals 1/100 of
1%). As a percentage of the inverse of the daily movement of the Benchmark Futures Contract, the average error in daily tracking
by the per unit NAV was (1.256)%, meaning that over this time period USSO’s tracking error was within the plus or minus 10%
range established as its benchmark tracking goal.
*PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
*PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
An alternative tracking measurement of
the return performance of USSO versus the inverse of the return of its Benchmark Futures Contract can be calculated by comparing
the actual return of USSO, measured by changes in its per unit NAV, versus the
expected
changes in its per unit NAV
under the assumption that USSO’s returns had been exactly inverse to the daily changes in its Benchmark Futures Contract.
For the three months ended March 31, 2013,
the actual total return of USSO as measured by changes in its per unit NAV was (4.78)%. This is based on an initial per unit NAV of
$37.89 as of December 31, 2012 and an ending per unit NAV as of March 31, 2013 of $36.08. During this time period, USSO made no
distributions to its unitholders. However, if USSO’s daily changes in its per unit NAV had instead exactly inversely tracked
the changes in the daily total return of the Benchmark Futures Contract, USSO would have had an estimated per unit NAV of $36.15
as of March 31, 2013, for a total return over the relevant time period of (4.59)%. The difference between the actual per unit NAV
total return of USSO of (4.78)% and the expected total return based on the inverse of changes in the daily return of the Benchmark
Futures Contract of (4.59)% was an error over the time period of (0.19)%, which is to say that USSO’s actual total return
underperformed the inverse of the benchmark result by that percentage. USCF believes that a portion of the difference between
the actual total return and the expected benchmark total return can be attributed to the net impact of contango and the expenses
that USSO pays, offset in part by the income that USSO collects on its cash and cash equivalent holdings. During the three months
ended March 31, 2013, USSO earned dividend and interest income of $1,142, which is equivalent to a weighted average income rate
of approximately 0.03% for such period. In addition, during the three months ended March 31, 2013, USSO also collected $700 from
its Authorized Purchasers for creating or redeeming baskets of units. This income also contributed to USSO’s actual total
return. During the three months ended March 31, 2013, USSO incurred net expenses of $33,429. Income from dividends and interest
and Authorized Purchaser collections net of expenses was $(31,587), which is equivalent to an annualized weighted average net income
rate of approximately (0.83)% for the three months ended March 31, 2013.
By comparison, for the three months ended
March 31, 2012, the actual total return of USSO as measured by changes in its per unit NAV was (4.42)%. This was based on
an initial per unit NAV of $36.16 as of December 31, 2011 and an ending per unit NAV as of March 31, 2012 of $34.56.
During this time period, USSO made no distributions to its unitholders. However, if USSO’s daily changes in its per unit
NAV had instead exactly inversely tracked the changes in the daily total return of the Benchmark Futures Contract, USSO would have
had an estimated per unit NAV of $34.66 as of March 31, 2012, for a total return over the relevant time period of (4.15)%.
The difference between the actual per unit NAV total return of USSO of (4.42)% and the expected total return based on the
inverse of changes in the daily return of the Benchmark Futures Contract of (4.15)% was an error over the time period of (0.27)%,
which is to say that USSO’s actual total return underperformed the inverse of the benchmark result by that percentage. USCF
believes that a portion of the difference between the actual total return and the expected benchmark total return can be attributed
to the net impact of contango and the expenses that USSO paid, offset in part by the income that USSO collected on its cash and
cash equivalent holdings. During the three months ended March 31, 2012, USSO earned dividend and interest income of $642,
which was equivalent to a weighted average income rate of approximately 0.02% for such period. In addition, during the three months
ended March 31, 2012, USSO also collected $1,750 from its Authorized Purchasers for creating or redeeming baskets of units.
This income also contributed to USSO’s actual total return. During the three months ended March 31, 2012, USSO incurred
net expenses of $22,277. Income from dividends and interest and Authorized Purchaser collections net of expenses was $(19,885),
which was equivalent to an annualized weighted average net income rate of approximately (0.80)% for the three months ended March 31,
2012.
There are currently three factors that
have impacted or are most likely to impact USSO’s ability to accurately inversely track its Benchmark Futures Contract.
First, USSO may buy or sell its holdings
in the then current Benchmark Futures Contract at a price other than the closing settlement price of that contract on the day during
which USSO executes the trade. In that case, USSO may pay a price that is higher, or lower, than that of the Benchmark Futures
Contract, which could cause the changes in the daily per unit NAV of USSO to either be too high or too low relative to the
inverse of the daily changes in the Benchmark Futures Contract. During the three months ended March 31, 2013, USCF attempted to
minimize the effect of these transactions by seeking to execute its purchase or sale of the Benchmark Futures Contract at, or as
close as possible to, the end of the day settlement price. However, it may not always be possible for USSO 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 USSO’s attempt to inversely track the Benchmark Futures Contract over time.
Second, USSO earns dividend and interest
income on its cash, cash equivalents and Treasuries. USSO is not required to distribute any portion of its income to its unitholders
and did not make any distributions to unitholders during the three months ended March 31, 2013. Interest payments, and any other
income, were retained within the portfolio and added to USSO’s NAV. When this income exceeds the level of USSO’s expenses
for its management fee, brokerage commissions and other expenses (including ongoing registration fees, licensing fees and the fees
and expenses of the independent directors of USCF), USSO will realize a net yield that will tend to cause daily changes in the
per unit NAV of USSO to track slightly higher than the inverse of daily changes in the Benchmark Futures Contract. During the three
months ended March 31, 2013, USSO earned, on an annualized basis, approximately 0.03% on its cash and cash equivalent holdings.
It also incurred cash expenses on an annualized basis of 0.60% for management fees, approximately 0.10% in brokerage commission
costs related to the purchase and sale of futures contracts and approximately 0.18% for other net expenses. The foregoing fees
and expenses resulted in a net yield on an annualized basis of approximately (0.85)% and affected USSO’s ability to track
the inverse of the daily changes in the Benchmark Futures Contract. If short-term interest rates rise above the current levels,
the level of deviation created by the yield would decrease. Conversely, if short-term interest rates were to decline, the amount
of error created by the yield would increase. When short-term yields drop to a level lower than the combined expenses of the management
fee and the brokerage commissions, then the tracking error becomes a negative number and would tend to cause the daily returns
of the per unit NAV to underperform the inverse of the daily returns of the Benchmark Futures Contract. USCF anticipates that interest
rates will continue to remain at historical lows and, therefore, it is anticipated that fees and expenses paid by USSO will continue
to be higher than interest earned by USSO. As such, USCF anticipates that USSO will continue to underperform its benchmark until
such a time when interest earned at least equals or exceeds the fees and expenses paid by USSO.
Third, USSO may hold Other Crude Oil-Related
Investments in its portfolio that may fail to closely track the inverse of the Benchmark Futures Contract’s total return
movements. In that case, the error in tracking the inverse of the Benchmark Futures Contract could result in daily changes in the
per unit NAV of USSO that are either too high, or too low, relative to the inverse of the daily changes in the Benchmark Futures
Contract. During the three months ended March 31, 2013, USSO did not hold any Other Crude Oil-Related Investments. If USSO increases
in size, and due to its obligations to comply with regulatory limits, USSO may invest in Other Crude Oil-Related Investments which
may have the effect of increasing transaction related expenses and may result in increased tracking error.
Term Structure of Crude Oil Futures
Prices and the Impact on Total Returns.
Several factors determine the total return from investing in a futures contract position.
One factor that impacts the total return that will result from investing in near month futures contracts and “rolling”
those contracts forward each month is the price relationship between the current near month contract and the next month contract.
For example, if the price of the near month contract is higher than the next month contract (a situation referred to as “backwardation”
in the futures market), then absent any other change there is a tendency for the price of a next month contract to rise in value
as it becomes the near month contract and approaches expiration. Conversely, if the price of a near month contract is lower than
the next month contract (a situation referred to as “contango” in the futures market), then absent any other change
there is a tendency for the price of a next month contract to decline in value as it becomes the near month contract and approaches
expiration.
As an example, assume that the price of
crude oil for immediate delivery (the “spot” price), was $50 per barrel, and the value of a position in the near month
futures contract was also $50. Over time, the price of the barrel of crude oil will fluctuate based on a number of market
factors, including demand for oil relative to its supply. The value of the near month contract will likewise fluctuate in
reaction to a number of market factors. If investors seek to maintain their position in a near month contract and not take delivery
of the oil, every month they must sell their current near month contract as it approaches expiration and invest in the next month
contract.
If the futures market is in backwardation,
e.g.
, when the expected price of crude oil in the future would be less, the investor would be buying a next month contract
for a lower price than the current near month contract. Using the $50 per barrel price above to represent the front month price,
the price of the next month contract could be $49 per barrel, that is, 2% cheaper than the front 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 income earned on cash and/or cash
equivalents), the value of the $49 next month contract would rise as it approaches expiration and becomes the new near month contract
with a price of $50. In this example, the value of an investment in the second month contract 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 spot price of crude
oil to have risen 10% after some period of time, while the value of the investment in the second month futures contract would have
risen 12%, assuming backwardation is large enough or enough time has elapsed. Similarly, the spot price of crude oil could have
fallen 10% while the value of an investment in the futures contract could have fallen only 8%. Over time, if backwardation remained
constant, the difference would continue to increase.
If the futures market is in contango, the
investor would be buying a next month contract for a higher price than the current near month contract. Using again the $50 per
barrel price above to represent the front month price, the price of the next month contract could be $51 per barrel, that is, 2%
more expensive than the front 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 income earned on cash and/or cash equivalents), the value of the next month contract would fall as
it approaches expiration and becomes the new near month contract with a price of $50. In this example, it would mean that the value
of an investment in the second month would tend to rise slower than the spot price of crude oil, or fall faster. As a result, it
would be possible in this hypothetical example for the spot price of crude oil to have risen 10% after some period of time, while
the value of the investment in the second month futures contract will have risen only 8%, assuming contango is large enough or
enough time has elapsed. Similarly, the spot price of crude oil could have fallen 10% while the value of an investment in the second
month futures contract could have fallen 12%. Over time, if contango remained constant, the difference would continue to increase.
The chart below compares the price of the
near month contract to the average price of the near 12-month contracts over the last 10 years for WTI light, sweet crude oil.
When the price of the near month contract is higher than the average price of the near 12-month contracts, the market would be
described as being in backwardation. When the price of the near month contract is lower than the average price of the near 12-month
contracts, the market would be described as being in contango. Although the prices of the near month contract and the average price
of the near 12-month contracts do tend to move up or down together, it can be seen that at times the near month prices are clearly
higher than the average price of the near 12-month contracts (backwardation), and other times they are below the average price
of the near 12-month contracts (contango).
*PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
An alternative way to view the same data
is to subtract the dollar price of the average dollar price of the near 12-month contracts for WTI light, sweet crude oil from
the dollar price of the near month contract for WTI light, sweet crude oil. If the resulting number is a positive number, then
the near month price is higher than the average price of the near 12 months and the market could be described as being in backwardation.
If the resulting number is a negative number, then the near month price is lower than the average price of the near 12 months and
the market could be described as being in contango. The chart below shows the results from subtracting the average dollar
price of the near 12-month contracts from the near month price for the 10-year period between March 31, 2003 and March 31, 2013.
*PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
An investment in a portfolio that involved
owning only the near month contract would likely produce a different result than an investment in a portfolio that owned an equal
number of each of the near 12 months’ worth of contracts. Generally speaking, when the crude oil futures market is in
backwardation, the near month only portfolio would tend to have a higher total return than the 12-month portfolio. Conversely,
if the crude oil futures market was in contango, the portfolio containing 12 months’ worth of contracts would tend to outperform
the near month only portfolio. The chart below shows the annual results of owning a portfolio consisting of the near month contract
and a portfolio containing the near 12 months’ worth of contracts. In addition, the chart shows the annual change in the
spot price of WTI light, sweet crude oil. In this example, each month, the near month only portfolio would sell the near month
contract at expiration and buy the next month out contract. The portfolio holding an equal number of the near 12 months’
worth of contracts would sell the near month contract at expiration and replace it with the contract that becomes the new twelfth
month contract.
*PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
HYPOTHETICAL PERFORMANCE RESULTS HAVE
MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT USSO WILL OR IS LIKELY TO ACHIEVE
PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE
RESULTS AND THE ACTUAL RESULTS ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.
ONE OF THE LIMITATIONS OF HYPOTHETICAL
PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT
INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING.
FOR EXAMPLE, THE ABILITY TO WITHSTAND
LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT
ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC
TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN
ADVERSELY AFFECT ACTUAL TRADING RESULTS.
As seen in the chart above, there have
been periods of both positive and negative annual total returns for both hypothetical portfolios over the last 10 years. In addition,
there have been periods during which the near month only approach had higher returns, and periods where the 12-month approach had
higher total returns. The above chart does not represent the performance history of USSO or any Related Public Fund.
Historically, the crude oil futures
markets have experienced periods of contango and backwardation, with backwardation being in place more often than contango. During
2006 and the first half of 2007, these markets experienced contango. However, starting early in the third quarter of 2007, the
crude oil futures market moved into backwardation. The crude oil markets remained in backwardation until late in the second quarter
of 2008 when they moved into contango. The crude oil markets remained in contango until late in the third quarter of 2008, when
the markets moved into backwardation. Early in the fourth quarter of 2008, the crude oil market moved back into contango and remained
in contango for the balance of 2008. Throughout 2009, the crude oil market remained in contango. During parts of January and February
2009, the level of contango was unusually steep. Crude oil inventories, which reached historic levels in January and February 2009
and which appeared to be the primary cause of the steep level of contango, began to drop in March 2009 and continued to drop for
the balance of 2009 and the beginning of 2010. The crude oil futures market remained in contango through 2010. In 2011, the crude
oil futures market experienced long periods of mild contango, with the exception of a short period during the first quarter of
2011 where contango steepened by 4%. The crude oil futures market remained in contango through the three months ended March 31,
2013.
Periods of contango or backwardation do
not materially impact USSO’s investment objective of having the daily percentage changes in its per unit NAV inversely track
the daily percentage changes in the price of the Benchmark Futures Contract since the impact of backwardation and contango tend
to equally impact the daily percentage changes in price of both USSO’s units and the Benchmark Futures Contract. It
is impossible to predict with any degree of certainty whether backwardation or contango will occur in the future. It is likely
that both conditions will occur during different periods.
Crude Oil Market
. During the three
months ended March 31, 2013, crude oil prices were impacted by several factors. On the consumption side, demand moderated inside
and outside the United States as global economic growth, including emerging economies such as China and India, showed signs of
slowing economic growth. Europe in particular showed signs of weakness as the ongoing financial and banking crisis raised concerns
during the first quarter of 2013. On the supply side, efforts to reduce production by the Organization of the Petroleum Exporting
Countries (“OPEC”) to more closely match global consumption were partially successful. In the summer of 2011, production
had been disrupted by political unrest in the Middle East, particularly Libya, which reduced global supply by approximately 1.8 million
barrels per day. A partial resolution of the Libyan situation has reduced concerns regarding the global supply of crude oil. However,
continuing concerns about the political standoff with Iran have left the market subject to bouts of heightened volatility as OPEC’s
ability to replace Iranian oil currently subject to embargo is not unlimited. In recent years, oil production in the United States
has increased, particularly in the Midwest. However, limits on oil transportation infrastructure, including pipelines, have made
it more difficult for the increased production to move to the centers of refining, often leading to a build-up in crude oil inventory
in the U.S. Midwest. The result is that crude oil prices in the middle of the United States, where the pricing point of the light,
sweet crude oil contract is located, have tended to trade at a lower price than crude oil in other parts of the United States or
globally. United States crude oil prices finished the first quarter of 2013 approximately 5.89% higher than at the beginning of
the year, as the global economy continues to adjust to periods of slow recovery and economic growth. USCF believes that should
the global economic situation cease to improve, or decline, there is a meaningful possibility that crude oil prices could further
retreat from their current levels, while any military actions involving Iran would likely have the opposite effect.
Crude Oil Price Movements in Comparison
to Other Energy Commodities and Investment Categories.
USCF believes that investors frequently measure the degree to which
prices or total returns of one investment or asset class move up or down in value in concert with another investment or asset class.
Statistically, such a measure is usually done by measuring the correlation of the price movements of the two different investments
or asset classes over some period of time. The correlation is scaled between 1 and -1, where 1 indicates that the two investment
options move up or down in price or value together, known as “positive correlation,” and -1 indicates that they move
in completely opposite directions, known as “negative correlation.” A correlation of 0 would mean that the movements
of the two are neither positively nor negatively correlated, known as “non-correlation.” That is, the investment options
sometimes move up and down together and other times move in opposite directions.
For the ten-year time period between March
31, 2003 and March 31, 2013, the table below compares the monthly movements of crude oil prices versus the monthly movements of
the prices of several other energy commodities, such as natural gas, diesel-heating oil, and unleaded gasoline, as well as several
major non-commodity investment asset classes, such as large cap U.S. equities, or U.S. government bonds and global equities. It
can be seen that over this particular time period, the movement of crude oil on a monthly basis was not strongly correlated, positively
or negatively, with the movements of U.S. government bonds, global equities, large cap U.S. equities and natural gas. However,
movements in crude oil had a positive correlation to movements in diesel-heating oil and unleaded gasoline.
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|
|
|
|
|
|
|
|
|
|
|
Bonds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large
|
|
|
(EFFAS
|
|
|
Global
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cap U.S.
|
|
|
U.S.
|
|
|
Equities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities
|
|
|
Gov’t.
|
|
|
(FTSE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Correlation Matrix
|
|
(S&P
|
|
|
Bond
|
|
|
World
|
|
|
Unleaded
|
|
|
Diesel-Heating
|
|
|
Natural
|
|
|
Crude
|
|
March 31, 2003-2013
|
|
500)
|
|
|
Index)
|
|
|
Index)
|
|
|
Gasoline
|
|
|
Oil
|
|
|
Gas
|
|
|
Oil
|
|
Large
Cap U.S. Equities (S&P 500)
|
|
|
1.000
|
|
|
|
(0.266
|
)
|
|
|
0.965
|
|
|
|
0.260
|
|
|
|
0.373
|
|
|
|
0.111
|
|
|
|
0.393
|
|
U.S. Gov’t.
Bonds (EFFAS U.S. Gov’t. Bond Index)
|
|
|
|
|
|
|
1.000
|
|
|
|
(0.255
|
)
|
|
|
(0.266
|
)
|
|
|
(0.260
|
)
|
|
|
0.011
|
|
|
|
(0.271
|
)
|
Global
Equities (FTSE World Index)
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
|
|
0.305
|
|
|
|
0.443
|
|
|
|
0.152
|
|
|
|
0.462
|
|
Unleaded
Gasoline
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
|
|
0.765
|
|
|
|
0.262
|
|
|
|
0.732
|
|
Diesel-Heating
Oil
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
|
|
0.382
|
|
|
|
0.851
|
|
Natural
Gas
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
|
|
0.324
|
|
Crude Oil
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
Source: Bloomberg, NYMEX
PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
The table below covers a more recent, but
much shorter, range of dates than the above table. Over the one-year period ended March 31, 2013, crude oil had a strong positive
correlation with domestic and global equities. The correlation of crude oil with the movements of diesel-heating oil was stronger
compared to what it had displayed over the ten-year period ended March 31, 2013. Notably, the correlation between crude oil and
large cap U.S. equities, which had been weakly correlated over the ten-year period ended March 31, 2013, displayed results that
indicated that they had a stronger positive correlation over this shorter time period. Unleaded gasoline still had a positive,
yet weaker, correlation during the one-year period as compared to the ten-year period ended March 31, 2013. Crude oil and natural
gas, which had been positively correlated over the ten-year period, were essentially weakly negatively correlated over the shorter
time frame. Finally, the results showed that crude oil and U.S. government bonds, which had essentially been non-correlated for
the ten-year period ended March 31, 2013, were moderately negatively correlated over this more recent time period.
|
|
|
|
|
U.S.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gov’t.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Bonds
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Large
|
|
|
(EFFAS
|
|
|
Global
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cap U.S.
|
|
|
U.S.
|
|
|
Equities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equities
|
|
|
Gov’t.
|
|
|
(FTSE
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Correlation Matrix
|
|
(S&P
|
|
|
Bond
|
|
|
World
|
|
|
Unleaded
|
|
|
Diesel-Heating
|
|
|
Natural
|
|
|
Crude
|
|
12 Months
ended March 31, 2013
|
|
500)
|
|
|
Index)
|
|
|
Index)
|
|
|
Gasoline
|
|
|
Oil
|
|
|
Gas
|
|
|
Oil
|
|
Large
Cap U.S. Equities (S&P 500)
|
|
|
1.000
|
|
|
|
(0.723
|
)
|
|
|
0.919
|
|
|
|
0.741
|
|
|
|
0.635
|
|
|
|
(0.063
|
)
|
|
|
0.674
|
|
U.S. Gov’t.
Bonds (EFFAS U.S. Gov’t. Bond Index)
|
|
|
|
|
|
|
1.000
|
|
|
|
(0.737
|
)
|
|
|
(0.469
|
)
|
|
|
(0.425
|
)
|
|
|
0.314
|
|
|
|
(0.359
|
)
|
Global
Equities (FTSE World Index)
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
|
|
0.575
|
|
|
|
0.725
|
|
|
|
0.011
|
|
|
|
0.727
|
|
Unleaded
Gasoline
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
|
|
0.586
|
|
|
|
(0.320
|
)
|
|
|
0.588
|
|
Diesel-Heating
Oil
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
|
|
(0.255
|
)
|
|
|
0.867
|
|
Natural
Gas
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
|
|
(0.223
|
)
|
Crude
Oil
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000
|
|
Source: Bloomberg, NYMEX
PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
Investors are cautioned that the historical
price relationships between crude oil and various other energy commodities, as well as other investment asset classes, as measured
by correlation may not be reliable predictors of future price movements and correlation results. The results pictured above
would have been different if a different range of dates had been selected. USCF believes that crude oil has historically not
demonstrated a strong correlation with equities or bonds over long periods of time. However, USCF also believes that in the
future it is possible that crude oil could have long-term correlation results that indicate prices of crude oil more closely track
the movements of equities or bonds. In addition, USCF believes that, when measured over time periods shorter than ten years,
there will always be some periods where the correlation of crude oil to equities and bonds will be either more strongly positively
correlated or more strongly negatively correlated than the long-term historical results suggest.
The correlations between crude
oil, natural gas, diesel-heating oil and gasoline are relevant because USCF endeavors to invest USSO’s assets in Futures
Contracts and Other Crude Oil-Related Investments so that daily changes in percentage terms in USSO’s per unit NAV correlate
as closely as possible with the inverse of the daily changes in percentage terms in the price of the Benchmark Futures Contract.
If certain other fuel-based commodity futures contracts do not closely correlate with the Benchmark Futures Contract, then
their use could lead to greater tracking error. As noted above, USCF also believes that the changes in percentage terms in
the price of the Benchmark Futures Contract will closely correlate with changes in percentage terms in the inverse of the spot
price of WTI light, sweet crude oil.
Critical Accounting Policies
Preparation of the condensed financial
statements and related disclosures in compliance with accounting principles generally accepted in the United States of America
requires the application of appropriate accounting rules and guidance, as well as the use of estimates. USSO’s application
of these policies involves judgments and actual results may differ from the estimates used.
USCF has evaluated the nature and types
of estimates that it makes in preparing USSO’s condensed financial statements and related disclosures and has determined
that the valuation of its investments, which are not traded on a United States or internationally recognized futures exchange (such
as forward contracts and over-the-counter contracts) involves a critical accounting policy. The values which are used by USSO
for its Futures Contracts are provided by its commodity broker who uses market prices when available, while over-the-counter contracts
are valued based on the present value of estimated future cash flows that would be received from or paid to a third party
in settlement of these derivative contracts prior to their delivery date and valued on a daily basis. In addition, USSO estimates
interest and dividend income on a daily basis using prevailing rates earned on its cash and cash equivalents. These estimates are
adjusted to the actual amount received on a monthly basis and the difference, if any, is not considered material.
Liquidity and Capital Resources
USSO has not made, and does not anticipate
making, use of borrowings or other lines of credit to meet its obligations. USSO has met, and it is anticipated that USSO will
continue to meet, its liquidity needs in the normal course of business from the proceeds of the sale of its investments, or from
the Treasuries, cash and/or cash equivalents that it intends to hold at all times. USSO’s liquidity needs include: redeeming
units, providing margin deposits for its existing Futures Contracts or the purchase of additional Futures Contracts and posting
collateral for its over-the-counter contracts, if applicable, and, except as noted below, payment of its expenses, summarized below
under “Contractual Obligations.”
USSO currently generates cash primarily
from: (i) the sale of baskets consisting of 50,000 units (“Creation Baskets”) and (ii) income earned on Treasuries,
cash and/or cash equivalents. USSO has allocated substantially all of its net assets to trading in Crude Oil Interests. USSO invests
in Crude 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 Futures Contracts and Other Crude Oil-Related Investments. A significant
portion of USSO’s NAV is held in cash and cash equivalents that are used as margin and as collateral for its trading in Crude
Oil Interests. The balance of the assets is held in USSO’s account at its custodian bank and in investments in Treasuries
at the FCM. Income received from USSO’s investments in money market funds and Treasuries is paid to USSO. During the three
months ended March 31, 2013, USSO’s expenses exceeded the income USSO earned and the cash earned from the sale of Creation
Baskets and the redemption of Redemption Baskets. During the three months ended March 31, 2013, USSO used other assets to pay expenses,
which could cause a drop in USSO’s NAV over time. To the extent expenses exceed income, USSO’s NAV will be negatively
impacted.
USSO’s investments in Crude Oil Interests
may be subject to periods of illiquidity because of market conditions, regulatory considerations and other reasons. For example,
most commodity exchanges limit the fluctuations in futures contracts prices during a single day by regulations referred to as “daily
limits.” During a single day, no trades may be executed at prices beyond the daily limit. Once the price of a futures contract
has increased or decreased by an amount equal to the daily limit, positions in the contracts can neither be taken nor liquidated
unless the traders are willing to effect trades at or within the specified daily limit. Such market conditions could prevent USSO
from promptly liquidating its positions in Futures Contracts. During the three months ended March 31, 2013, USSO was not forced
to purchase or liquidate any of its positions while daily limits were in effect; however, USSO cannot predict whether such an event
may occur in the future.
Since the initial offering of USSO, all
payments with respect to USSO’s expenses were paid by USCF. USSO does not have an obligation or intention to refund such
payments by USCF. USCF is under no obligation to pay USSO’s current or future expenses. Since the initial offering of units,
USSO has been responsible for expenses relating to: (i) management fees, (ii) brokerage fees and commissions, (iii) licensing
fees for the use of intellectual property, (iv) ongoing registration expenses in connection with offers and sales of its units
subsequent to the initial offering, (v) other expenses, including tax reporting costs, (vi) fees and expenses of the
independent directors of USCF and (vii) other extraordinary expenses not in the ordinary course of business, while USCF has
been responsible for expenses relating to the fees of USSO’s Marketing Agent, Administrator and Custodian and registration
expenses relating to the initial offering of units. If USCF and USSO are unsuccessful in raising sufficient funds to cover these
respective expenses or in locating any other source of funding, USSO will terminate and investors may lose all or part of their
investment.
Market Risk
Trading in Futures Contracts and Other
Crude Oil-Related Investments, such as forwards, involves USSO entering into contractual commitments to purchase or sell crude
oil at a specified date in the future. The aggregate market value of the contracts will significantly exceed USSO’s future
cash requirements since USSO intends to close out its open positions prior to settlement. As a result, USSO is generally only subject
to the risk of loss arising from the change in value of the contracts. USSO considers the “fair value” of its derivative
instruments to be the unrealized gain or loss on the contracts. The market risk associated with USSO’s commitments to purchase
oil is limited to the aggregate market value of the contracts held. However, should USSO 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 USSO could be unlimited.
USSO’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 Futures Contracts and Other Crude Oil-Related Investments markets and the relationships among the contracts held by USSO.
Drastic market occurrences could ultimately lead to the loss of all or substantially all of an investor’s capital.
Credit Risk
When USSO enters into Futures Contracts
and Other Crude Oil-Related Investments, it is exposed to the credit risk that the counterparty will not be able to meet its obligations.
The counterparty for the Futures Contracts traded on the NYMEX and on most other futures exchanges is the clearinghouse associated
with the particular exchange. In general, in addition to margin required to be posted by the clearinghouse in connection with cleared
trades, clearinghouses are backed by their members who may be required to share in the financial burden resulting from the nonperformance
of one of their members and, therefore, this additional member support should significantly reduce credit risk. Some foreign exchanges
are not backed by their clearinghouse members but may be backed by a consortium of banks or other financial institutions. There
can be no assurance that any counterparty, clearinghouse, or their members or their financial backers will satisfy their obligations
to USSO in such circumstances.
USCF attempts to manage the credit risk
of USSO by following various trading limitations and policies. In particular, USSO generally posts margin and/or holds liquid assets
that are approximately equal to the market value of its obligations to counterparties under the Futures Contracts and Other Crude
Oil-Related Investments it holds. USCF has implemented procedures that include, but are not limited to, executing and clearing
trades only with creditworthy parties and/or requiring the posting of collateral or margin by such parties for the benefit of USSO
to limit its credit exposure. UBS Securities LLC, USSO’s commodity broker, or any other broker that may be retained by USSO
in the future, when acting as USSO’s FCM in accepting orders to purchase or sell Futures Contracts on United States exchanges,
is required by CFTC regulations to separately account for and segregate as belonging to USSO, all assets of USSO relating to domestic
Futures Contracts trading. These FCMs are not allowed to commingle USSO’s assets with their other assets. In addition, the
CFTC requires commodity brokers to hold in a secure account USSO’s assets related to foreign Futures Contracts trading.
If, in the future, USSO purchases over-the-counter
contracts, see
“Item 3. Quantitative and Qualitative Disclosures About Market Risk”
in this quarterly report
on Form 10-Q for a discussion of over-the-counter contracts.
As of March 31, 2013, USSO held cash deposits
and investments in Treasuries and money market funds in the amount of $17,087,593 with the custodian and FCM. Some or all
of these amounts may be subject to loss should USSO’s custodian and/or FCM cease operations.
Off Balance Sheet Financing
As of March 31, 2013, USSO had no loan
guarantee, credit support or other off-balance sheet arrangements of any kind other than agreements entered into in the normal
course of business, which may include indemnification provisions relating to certain risks that service providers undertake in
performing services which are in the best interests of USSO. While USSO’s exposure under these indemnification provisions
cannot be estimated, they are not expected to have a material impact on USSO’s financial position.
European Sovereign Debt
USSO had no direct exposure to European
sovereign debt as of March 31, 2013 and has no direct exposure to European sovereign debt as of the filing of this quarterly report
on Form 10-Q.
Redemption Basket Obligation
In order to meet its investment objective
and pay its contractual obligations described below, USSO requires liquidity to redeem units, which redemptions must be in blocks
of 50,000 units as of February 29, 2012 called “Redemption Baskets.” (Prior to February 29, 2012, the size
of the Redemption Basket was 100,000 units). USSO has to date satisfied this obligation by paying from the cash or cash equivalents
it holds or through the sale of its Treasuries in an amount proportionate to the number of units being redeemed.
Contractual Obligations
USSO’s primary contractual obligations
are with USCF. In return for its services, USCF is entitled to a management fee calculated daily and paid monthly as a fixed percentage
of USSO’s NAV, currently 0.60% of NAV on its average daily total net assets.
USCF agreed to pay the start-up costs associated
with the formation of USSO, primarily its legal, accounting and other costs in connection with USCF’s registration with the
CFTC as a CPO and the registration and listing of USSO and its units with the SEC, FINRA and NYSE Arca (formerly, AMEX), respectively.
However, since USSO’s initial offering of units, offering costs incurred in connection with registering and listing additional
units of USSO have been directly borne on an ongoing basis by USSO, and not by USCF.
USCF pays the fees of USSO’s marketing
agent, ALPS Distributors, Inc., and the fees of the custodian and transfer agent, Brown Brothers Harriman & Co. (“BBH&Co.”),
as well as BBH&Co.’s fees for performing administrative services, including those in connection with the preparation
of USSO’s condensed financial statements and its SEC, NFA and CFTC reports. USCF and USSO have also entered into a licensing
agreement with the NYMEX pursuant to which USSO and the Related Public Funds, other than USBO, USCI, CPER, USAG and USMI, pay a
licensing fee to the NYMEX. USSO also pays the fees and expenses associated with its tax accounting and reporting requirements.
USCF has voluntarily agreed to pay certain expenses normally borne by USSO to the extent that such expenses exceed 0.15% (15 basis
points) of USSO’s NAV, on an annualized basis, through at least June 30, 2013. USCF has no obligation to continue such payments
into subsequent periods. This voluntary expense waiver is in addition to those amounts USCF is contractually obligated to pay as
described in
Note 4
in
Item 1
of this quarterly report on Form 10-Q.
In addition to USCF’s management
fee, USSO pays its brokerage fees (including fees to a FCM), over-the-counter dealer spreads, any licensing fees for the use of
intellectual property, and, subsequent to the initial offering, registration and other fees paid to the SEC, FINRA, or other regulatory
agencies in connection with the offer and sale of units, as well as legal, printing, accounting and other expenses associated therewith,
and extraordinary expenses. The latter are expenses not incurred in the ordinary course of USSO’s business, including expenses
relating to the indemnification of any person against liabilities and obligations to the extent permitted by law and under the
LP Agreement, the bringing or defending of actions in law or in equity or otherwise conducting litigation and incurring legal expenses
and the settlement of claims and litigation. Commission payments to a FCM are on a contract-by-contract, or round turn, basis.
USSO also pays a portion of the fees and expenses of the independent directors of USCF. See
Note 3
to the
Notes
to Condensed Financial Statements (Unaudited)
in
Item 1
of this quarterly report on Form 10-Q.
The parties cannot anticipate the amount
of payments that will be required under these arrangements for future periods, as USSO’s per unit NAVs and trading levels
to meet its investment objective will not be known until a future date. These agreements are effective for a specific term agreed
upon by the parties with an option to renew, or, in some cases, are in effect for the duration of USSO’s existence. Either
party may terminate these agreements earlier for certain reasons described in the agreements.
As of March 31, 2013, USSO’s portfolio
consisted of 167 short positions in WTI Crude Oil Futures CL Contracts traded on the NYMEX. USSO did not hold short positions on
the ICE Futures as of March 31, 2013. For a list of USSO’s current holdings, please see USSO’s website at www.unitedstatesshortoilfund.com.