USO roll shift may ease oil spread volatility

NEW YORK Thu Mar 5, 2009 2:08pm EST

NEW YORK (Reuters) - The move by United States Oil Fund (USO.P) to extend the monthly period when it shifts its crude futures position to four days from one could reduce price volatility associated with the transition.

The giant exchange traded fund currently holds over 18 percent of the front-month crude contract on the New York Mercantile Exchange.

The position has grown so large that in February when USO sold its front-month contracts on a scheduled day to buy the second month contract, traders said it increased the spread between the two months by depressing the near month prices and strengthening the later month prices.

USO, which is being investigated by U.S. regulators for the February trades, has since extended this "roll" period to four days rather than just one, a move analysts say may lesson the volatility associated with shifting its position.

"I think it will be less intrusive now that they have expanded (the roll) out," said Phil Flynn of Alaron Trading in Chicago. "Obviously they are going to have to have less orders hit in the market at one time."

(To view a graph of the first to second month spread, click: www.tinyurl.com/cht2x6 )

The ETF is a passive investment vehicle traded on stock exchanges that allows non-oil trade participants exposure to oil futures movements, earning profits when it sells more expensive front month contracts for cheaper second months.

Front month NYMEX crude has been trading at a discount to second month crude this year -- a market structure called a contango -- as weak demand due to the economic crisis continues to pressure prices.

Last week, the U.S. Commodity Futures Trading Commission said it was investigating the February 6 roll by USO, when the ETF sold over 85,000 March futures contracts -- over 20 percent of NYMEX open interest then -- and bought 78,000 April futures.

This month, USO will initiate the new four day roll period starting on March 6. Analysts said that while the volatility may be less, the first to second month spread may still widen.

"The real issue I think is ultimately not the timing of the roll it's the size of the position being rolled," said Tim Evans, energy analyst for Citi Futures Perspective.

"Spreading it out over several days will allow them to diversify over time."

As of March 4, USO held about 50,000 April TI contracts on the NYMEX, out of total open interest of nearly 270,000.

The discount of front to second month NYMEX futures has narrowed to below $2 at Wednesday's close, after widening out to over $8 in early February, as OPEC production cuts and rising U.S. gasoline demand lift near month prices.

Analysts said that in addition to USO, the monthly shifts by other similar passive investment instruments with large interest, such as the S&P GSCI index, also influence spreads.

"Both the ETF and GSCI rolls start tomorrow and therefore the front-month spreads are likely to deteriorate, but not to a number like negative $9, more like negative $5," said Nauman Barakat, senior vice president at Macquarie Futures USA.

Investors have piled into USO in recent months to gain exposure to oil prices, which rocketed up seven fold in a six-year rally to peak over $147 a barrel in July.

Oil has since tumbled to around $43 a barrel in March, and experts say investors may be shifting into the passive investment in a bet longer term prices will move up again.

In the short-term, however, analysts said the contango structure was eroding profits.

"They've got to be looking at their monthly statements and even in a flat market notice that they're losing money," said Jim Ritterbusch, president of Ritterbusch & Associates in Galena, Illinois.

"If these people want to throw good money into a bad idea, that's their business."

(Additional reporting by Robert Gibbons and Richard Valdmanis; Editing by John Picinich)

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