Why Is USO -- the Oil ETF -- Outperforming the Price of Oil?

Tickers in this article: CVX USO

NEW YORK ( TheStreet) -- Things are looking good for United States Oil Fund . The security closed Thursday with a 1.4% gain to $37.83 per share, mainly due to the jump in oil prices to $103.08. Developments in the oil futures markets have also benefited investors in oil ETFs.

But why?

Progress in the price of oil has led to "backwardation" in the futures markets -- a situation in which long-term contracts are priced lower than short-term contracts. This situation has also benefited investors in oil ETFs such as USO, because when the ETF rolls its positions in near-term contracts, it purchases next-month futures contract at a lower price than the near-term contract.

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This scenario leads to a gap between the price of West Texas Intermediate crude oil and the price of the USO ETF, as indicated in the chart below.


Source of data: Google finance and U.S. Energy Information Administration


The chart shows the normalized prices of oil and the USO ETF to the end of March. As the chart shows, the gap between USO and the price of oil remained wide.

This means that investors in USO during this time frame recorded a 4% gain, while investors in WTI oil lost nearly 1.5% of their investment.

Today's gains in the oil market are likely to be a short-term gain, partly due to the tensions in the Middle East. The gains don't have much to do with a fundamental change in market outlook. These short-term gains could only widen the backwardation, and investors in USO may benefit from this turn of events.

Conversely, if the price of oil resumes its downward trend, this could close the gap between the short-term futures contracts and long-term contracts. In such a case, USO will continue to come down and close the gap with oil prices.

Despite the recent recovery in the price of oil, it wasn't enough to pull up shares of leading oil producers such as Chevron , which slightly declined today by 0.62% to $130.08 per share at the close.

Today's plunge in natural gas prices by over 4% may have crowded out the positive effect oil prices have on oil companies' stocks.

For more from Lior Cohen, see "How Will the Brent-WTI Spread Impact Oil Refiners?"

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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