The
Benchmark Oil Futures Contract may not correlate with the spot price of
WTI
light, sweet, crude oil and this could cause the price of units to substantially
vary from the spot price of WTI light, sweet crude oil. If this were to
occur,
then investors may not be able to effectively use USOF as a way to hedge
against
oil-related losses or as a way to indirectly invest in
oil.
When
using the Benchmark Oil Futures Contract as a strategy to track the spot
price
of WTI light, sweet crude oil, at best the correlation between changes
in prices
of such oil interests and the spot price can be only approximate. The degree
of
imperfection of correlation depends upon circumstances such as variations
in the
speculative oil market, supply of and demand for such oil interests and
technical influences in oil futures trading. If there is a weak correlation
between the oil interests and the spot price of WTI light, sweet, crude
oil,
then the price of units may not accurately track the spot price of WTI
light,
sweet crude oil and investors may not be able to effectively use USOF as
a way
to hedge the risk of losses in their oil-related transactions or as a way
to
indirectly invest in oil.
USOF
may experience a loss if it is required to sell Treasuries at a price lower
than
the price at which they were acquired.
The
value
of Treasuries generally moves inversely with movements in interest rates.
If
USOF is required to sell Treasuries at a price lower than the price at
which
they were acquired, USOF will experience a loss. This loss may adversely
impact
the price of the units and may decrease the correlation between the price
of the
units, the price of USOF’s Oil Futures Contracts and Other Oil Interests, and
the spot price of WTI light, sweet crude oil.
Certain
of USOF’s investments could be illiquid which could cause large losses to
investors at any time or from time to time.
USOF
may
not always be able to liquidate its positions in its investments at the
desired
price. It is difficult to execute a trade at a specific price when there
is a
relatively small volume of buy and sell orders in a market. A market disruption,
such as a foreign government taking political actions that disrupt the
market in
its currency, its oil production or exports, or in another major export,
can
also make it difficult to liquidate a position. Alternatively, limits imposed
by
futures exchanges or other regulatory organizations, such as accountability
levels, position limits and daily price fluctuation limits, may contribute
to a
lack of liquidity with respect to some commodity interests.
Unexpected
market illiquidity may cause major losses to investors at any time or from
time
to time. In addition, USOF has not and does not intend to establish a credit
facility, which would provide an additional source of liquidity and instead
will
rely only on the Treasuries, cash and cash equivalents that it holds. The
anticipated large value of the positions in certain investments, e.g.,
Oil
Futures Contracts, or in negotiated over-the-counter contracts that the
General
Partner acquires or enters into for USOF, increases the risk of illiquidity.
Such positions may be more difficult to liquidate at favorable prices and
there
is an additional risk that losses may be incurred during the period in
which
positions are being liquidated. The Other Oil Interests that USOF invests
in may
have a greater likelihood
of being
illiquid since they are contracts between two parties that take into account
not
only market risk, but also the relative credit, tax, and settlement risks
under
such contracts. In addition, such contracts have limited transferability
that
results from such risks and the contract’s express limitations. USOF from time
to time also invests in Other Oil Interests as a result of the speculative
position limits on the New York Mercantile Exchange or other
exchanges.
If
the nature of hedgors and speculators in futures markets has shifted such
that
oil purchasers are the predominant hedgors in the market, USOF might have
to
reinvest at higher futures prices or choose Other Oil
Interests.
The
changing nature of the hedgors and speculators in the oil market influences
whether futures prices are above or below the expected future spot price.
In
order to induce speculators to take the corresponding long side of the
same
futures contract, oil producers must generally be willing to sell futures
contracts at prices that are below expected future spot prices. Conversely,
if
the predominant hedgors in the futures market are the purchasers of the
oil who
purchase futures contracts to hedge against a rise in prices, then speculators
will only take the short side of the futures contract if the futures price
is
greater than the expected future spot price of oil. This can have significant
implications for USOF when it is time to reinvest the proceeds from a maturing
futures contract into a new futures contract.
While
USOF does not intend to take physical delivery of oil under Oil Futures
Contracts, physical delivery under such contracts impacts the value of
the
contracts.
While
USOF has not and does not intend to take physical delivery of oil under
its Oil
Futures Contracts, futures contracts are not required to be cash-settled,
and it
is possible to take delivery under these contracts. Storage costs associated
with purchasing oil could result in costs and other liabilities that could
impact the value of Oil Futures Contracts or Other Oil Interests. Storage
costs
include the time value of money invested in oil as a physical commodity
plus the
actual costs of storing the oil less any benefits from ownership of oil
that are
not obtained by the holder of a futures contract. In general, Oil Futures
Contracts have a one-month delay for contract delivery and the back month
(the
back month is any future delivery month other than the spot month) includes
storage costs. To the extent that these storage costs change for oil while
USOF
holds Oil Futures Contracts or Other Oil Interests, the value of the Oil
Futures
Contracts or Other Oil Interests, and therefore USOF’s NAV, may change as
well.
The
price relationship between the near month contract and the next to near
month
contract that compose the Benchmark Oil Futures Contract will vary and
may
impact both the total return over time of USOF’s NAV, as well as the degree to
which its total return tracks other natural gas price indices’ total
returns.
The
design of USOF's Benchmark Oil Futures Contract is such that every month
it begins by using the near month contract to expire until the near month
contract is within two weeks of expiration, when it will use the next month
contract to expire as its benchmark contract and keeps that contract as
its benchmark until it becomes the near month contract and close to
expiration. In the event of an oil futures market where near month contracts
trade at a higher price than next to near month contracts, a situation
described
as “backwardation” in the futures market occurs. Absent the impact of the
overall movement in oil prices the value of the benchmark contract would
tend to
rise as it approaches expiration. As a result the total return of the Benchmark
Oil Futures Contract would tend to track higher. Conversely, in the event
of an
oil futures market where near month contracts trade at a lower price than
next
to near month contracts, a situation described as “contango” in the futures
market occurs. Absent the impact of the overall movement in oil prices
the value
of the benchmark contract would tend to decline as it approaches expiration.
As
a result the total return of the Benchmark Oil Futures Contract would tend
to
track lower. When compared to total return of other price indices, such
as the
spot price of oil, the impact of backwardation and contango may lead the
total
return of USOF’s NAV to vary significantly. In the event of a prolonged period
of contango, and absent the impact of rising or falling oil prices, this
could
have a significant negative impact on USOF’s NAV and total return.
Regulation
of the commodity interests and energy markets is extensive and constantly
changing; future regulatory developments are impossible to predict but
may
significantly and adversely affect USOF.
The
regulation of commodity interest transactions in the United States is a
rapidly
changing area of law and is subject to ongoing modification by government
and
judicial action. In addition, various national governments have expressed
concern regarding the disruptive effects of speculative trading in the
energy
markets and the need to regulate the derivatives markets in general. The
effect
of any future regulatory change on USOF is impossible to predict, but could
be
substantial and adverse.
While
USOF is not currently engaging in hedging strategies, participants in the
oil or
in other industries may use USOF as a vehicle to hedge the risk of losses
in
their oil-related transactions. There are several risks in connection with
using
USOF as a hedging device. While hedging can provide protection against
an
adverse movement in market prices, it can also preclude a hedgor’s opportunity
to benefit from a favorable market movement. In a hedging transaction,
the
hedgor may be concerned that the hedged item will increase in price, but
must
recognize the risk that the price may instead decline and if this happens
he
will have lost his opportunity to profit from the change in price because
the
hedging transaction will result in a loss rather than a gain. Thus, the
hedgor
foregoes the opportunity to profit from favorable price movements.
In
addition, if the hedge is not a perfect one, the hedgor can lose on the
hedging
transaction and not realize an offsetting gain in the value of the underlying
item being hedged.
When
using futures contracts as a hedging technique, at best, the correlation
between
changes in prices of futures contracts and of the items being hedged can
be only
approximate. The degree of imperfection of correlation depends upon
circumstances such as: variations in speculative markets, demand for futures
and
for oil products, technical influences in futures trading, and differences
between anticipated energy costs being hedged and the instruments underlying
the
standard futures contracts available for trading. Even a well-conceived
hedge
may be unsuccessful to some degree because of unexpected market behavior
as well
as the expenses associated with creating the hedge.
In
addition, using an investment in USOF as a hedge for changes in energy
costs
(e.g.
,
investing in oil, gasoline, or other fuels, or electricity) may not correlate
because changes in the spot price of oil may vary from changes in energy
costs
because the spot price of oil does not reflect the refining, transportation,
and
other costs that may impact the hedgor’s energy costs.
An
investment in USOF may provide little or no diversification benefits. Thus,
in a
declining market, USOF may have no gains to offset losses from other
investments, and an investor may suffer losses on an investment in USOF
while
incurring losses with respect to other asset classes.
Historically,
Oil Futures Contracts and Other Oil Interests have generally been non-correlated
to the performance of other asset classes such as stocks and bonds.
Non-correlation means that there is a low statistically valid relationship
between the performance of futures and other commodity interest transactions,
on
the one hand, and stocks or bonds, on the other hand. However, there can
be no
assurance that such non-correlation will continue during future periods.
If,
contrary to historic patterns, USOF’s performance were to move in the same
general direction as the financial markets, investors will obtain little
or no
diversification benefits from an investment in the units. In such a case,
USOF
may have no gains to offset losses from other investments, and investors
may suffer losses on their investment in USOF at the same time they incur
losses
with respect to other investments.
Variables
such as drought, floods, weather, embargoes, tariffs and other political
events
may have a larger impact on oil prices and oil-linked instruments, including
Oil
Futures Contracts and Other Oil Interests, than on traditional securities.
These
additional variables may create additional investment risks that subject
USOF’s
investments to greater volatility than investments in traditional
securities.
Non-correlation
should not be confused with negative correlation, where the performance
of two
asset classes would be opposite of each other. There is no historic evidence
that the spot price of oil and prices of other financial assets, such as
stocks
and bonds, are negatively correlated. In the absence of negative correlation,
USOF cannot be expected to be automatically profitable during unfavorable
periods for the stock market, or vice versa.
USOF’s
Operating Risks
USOF
is not a registered investment company so unitholders do not have the
protections of the Investment Company Act of 1940.
USOF
has a limited operating history so there is no extensive performance history
to
serve as a basis to evaluate an investment in USOF.
USOF
is
new and has a limited operating history. Therefore, it does not have extensive
past performance that could otherwise be used as a basis to evaluate an
investment in USOF. Mr. Nicholas Gerber (discussed below) is the only
principal that has any experience operating a commodity pool. Mr. Gerber
ran the Marc Stevens Futures Index Fund (further discussed below) over
10 years
ago. This fund combined investments in commodity futures and equity stock
index
futures and had under $1 million of assets. Mr. Gerber sold the fund to
Newport Commodities. No other principals of the General Partner have operated
a
public or private commodity pool.
The
General Partner is leanly staffed and relies heavily on key personnel to
manage
trading activities.
In
managing and directing the day-to-day activities and affairs of USOF, the
General Partner relies heavily on Mr. Nicholas Gerber, Mr. John Love
and Mr. John Hyland (all discussed in greater detail below). If
Mr. Gerber, Mr. Love or Mr. Hyland were to leave or be unable to
carry out their present responsibilities, it may have an adverse effect
on the
management of USOF. Furthermore, Mr. Gerber, Mr. Love and
Mr. Hyland are involved in the management of USNG. USNG is expected to
be a public commodity pool designed to track the price movements of natural
gas.
Mr. Gerber and Mr. Love are also employed by Ameristock Corporation, a
registered investment adviser that manages a public mutual fund. USOF estimates
that Mr. Gerber will spend approximately 50% of his time on USOF and USNG
matters, Mr. Love will spend approximately 70% of his time on USOF and USNG
matters and Mr. Hyland will spend approximately 50% of his time on USOF and
USNG matters.
Accountability
levels, position limits, and daily price fluctuation limits set by the
exchanges
have the potential to cause a tracking error, which could cause the price
of
units to substantially vary from the price of the Benchmark Oil Futures
Contract
and prevent investors from being able to effectively use USOF as a way
to hedge
against oil-related losses or as a way to indirectly invest in
oil.
U.S.
designated contract markets such as the New York Mercantile Exchange have
established accountability levels and position limits on the maximum net
long or
net short futures contracts in commodity interests that any person or
group of persons under common trading control (other as a hedge, which
an
investment in USOF is not) may hold, own or control. For example, the current
accountability level for investments at any one time in Oil Futures Contracts
(including investments in the Benchmark Oil Futures Contract) is 20,000.
While
this is not a fixed ceiling, it is a threshold above which the New York
Mercantile Exchange may exercise greater scrutiny and control over an investor,
including limiting an investor to holding no more than 20,000 Oil Futures
Contracts. With regard to position limits, the New York Mercantile Exchange
limits an investor from holding more than 2,000 net futures in the last
3 days
of trading in the near month contract to expire.
In
addition to accountability levels and position limits, the New York Mercantile
Exchange also sets daily price fluctuation limits on the Benchmark Oil
Futures
Contract. The daily price fluctuation limit establishes the maximum amount
that
the price of futures contracts may vary either up or down from the previous
day’s settlement price. Once the daily price fluctuation limit has been reached
in a particular Oil Futures Contract, no trades may be made at a price
beyond
that limit.
In
addition to accountability levels and position limits, the New York Mercantile
Exchange also limits the amount of price fluctuation for Oil Futures Contracts.
For example, the New York Mercantile Exchange imposes a $10.00 per barrel
($10,000 per contract) price fluctuation limit for Oil Futures Contracts.
This
limit is initially based off of the previous trading day’s settlement price. If
any Oil Futures Contract is traded, bid, or offered at the limit for five
minutes, trading is halted for five minutes. When trading resumes it begins
at
the point where the limit was imposed and the limit is reset to be $10.00
per
barrel in either direction of that point. If another halt were triggered,
the
market would continue to be expanded by $10.00 per barrel in either direction
after each successive five-minute trading halt. There is no maximum price
fluctuation limits during any one trading session.
All
of
these limits may potentially cause a tracking error between the price of
the
units and the price of the Benchmark Oil Futures Contract.This may in turn
prevent investors from being able to effectively use USOF as a way to hedge
against oil-related losses or as a way to indirectly invest in oil.
USOF
has
not limited the size of its offering and is committed to utilizing substantially
all of its proceeds to purchase Oil Futures Contracts and Other Oil Interests.
If USOF encounters accountability levels, position limits, or price fluctuation
limits for oil contracts on the New York Mercantile Exchange, it has and
will
continue to, if permitted under applicable regulatory requirements, purchase
futures contracts on the ICE Futures (formerly, the International Petroleum
Exchange) or other exchanges that trade listed oil futures. The futures
contracts available on the ICE Futures are generally comparable to the
contracts
on the New York Mercantile Exchange, but they may have different underlying
commodities, sizes, deliveries, and prices.
There
are technical and fundamental risks inherent in the trading system the
General
Partner intends to employ.
The
General Partner’s trading system is quantitative in nature and it is possible
that the General Partner might make a mathematical error. In addition,
it is
also possible that a computer or software program may malfunction and cause
an
error in computation.
USOF
and the General Partner may have conflicts of interest, which may permit
them to
favor their own interests to the detriment of
unitholders.
USOF
and
the General Partner may have inherent conflicts to the extent the General
Partner attempts to maintain USOF’s asset size in order to preserve its fee
income and this may not always be consistent with USOF’s objective of tracking
changes in the spot price of WTI light, sweet crude oil. The General Partner’s
officers, directors and employees do not devote their time exclusively
to USOF.
These persons are directors, officers or employees of other entities that
may
compete with USOF for their services. They could have a conflict between
their
responsibilities to USOF and to those other entities.
In
addition, the General Partner’s principals, officers, directors or employees may
trade futures and related contracts for their own account. A conflict of
interest may exist if their trades are in the same markets and at the same
time
as USOF trades using the clearing broker to be used by USOF. A potential
conflict also may occur if the General Partner’s principals, officers, directors
or employees trade their accounts more aggressively or take positions in
their
accounts which are opposite, or ahead of, the positions taken by
USOF.
The
General Partner has sole current authority to manage the investments and
operations of USOF, and this may allow it to act in a way that furthers
its own
interests which may create a conflict with the best interests of investors.
Limited partners have limited voting control, which will limit the ability
to
influence matters such as amendment of the LP Agreement, change in USOF’s basic
investment policy, dissolution of this fund, or the sale or distribution
of
USOF’s assets.
The
General Partner serves
as the general partner to both USOF and USNG. The General Partner may have
a
conflict to the extent that its trading decisions may be influenced by
the
effect they would have on USNG. These trading decisions may be influenced
since the General Partner also serves as the general partner for USNG and
is required to meet USNG’s investment objective as well as USOF’s. If the
General Partner believes that a trading decision it made on behalf of USOF
might
(i) impede USNG from reaching its investment objective, or (ii) improve
the
likelihood of meeting USNG’s objective, then the General Partner may choose to
change its trading decision for USOF, which could either impede or improve
the
opportunity for USOF from meeting its investment objective. In addition,
the
General Partner is required to indemnify the officers and directors of
USNG, if
the need for indemnification arises. This potential indemnification will
cause
the General Partner’s assets to decrease. If the General Partner’s other sources
of income are not sufficient to compensate for the indemnification, then
the
General Partner may terminate and investors could lose their
investment.
Unitholders
may only vote on the removal of the General Partner and limited partners
have
only limited voting rights. Unitholders and limited partners will not
participate in the management of USOF and do not control the General Partner
so
they will not have influence over basic matters that affect
USOF.
Unitholders
that have not applied to become limited partners have no voting rights,
other
than to remove the General Partner. Limited partners will have limited
voting
rights with respect to USOF’s affairs. Unitholders may remove the General
Partner only if 66 2/3% of the unitholders elect to do so. Unitholders
and
limited partners will not be permitted to participate in the management
or
control of USOF or the conduct of its business. Unitholders and limited
partners
must therefore rely upon the duties and judgment of the General Partner
to
manage USOF’s affairs.
The
General Partner may manage a large amount of assets and this could affect
USOF’s
ability to trade profitably.
Increases
in assets under management may affect trading decisions. In general, the
General
Partner does not intend to limit the amount of assets of USOF that it may
manage. The more assets the General Partner manages, the more difficult
it may
be for it to trade profitably because of the difficulty of trading larger
positions without adversely affecting prices and performance and of managing
risk associated with larger positions.
USOF
could terminate at any time and cause the liquidation and potential loss
of an
investor's investment and could upset the overall maturity and timing of
an
investor's investment portfolio.
USOF
may
terminate at any time, regardless of whether USOF has incurred losses,
subject
to the terms of the LP Agreement. In particular, unforeseen circumstances,
including the death, adjudication of incompetence, bankruptcy, dissolution,
or
removal of the General Partner could cause USOF to terminate unless a majority
interest of the limited partners within 90 days of the event elects to
continue
the partnership and appoints a successor general partner, or the affirmative
vote of a majority interest of the limited partners subject to certain
conditions. However, no level of losses will require the General Partner
to
terminate USOF. USOF’s termination would cause the liquidation and potential
loss of an investor's investment. Termination could also negatively affect
the
overall maturity and timing of an investor's investment
portfolio.
Limited
partners may not have limited liability in certain circumstances, including
potentially having liability for the return of wrongful
distributions.
Under
Delaware law, a limited partner might be held liable for our obligation
as if it
were a General Partner if the limited partner participates in the control
of the
partnership’s business and the persons who transact business with the
partnership think the limited partner is the General Partner.
A
limited
partner will not be liable for assessments in addition to its initial capital
investment in any of our capital securities representing limited partnership
interests. However, a limited partner may be required to repay to us any
amounts
wrongfully returned or distributed to it under some circumstances. Under
Delaware law, we may not make a distribution to limited partners if the
distribution causes our liabilities (other than liabilities to partners
on
account of their partnership interests and nonrecourse liabilities) to
exceed
the fair value of our assets. Delaware law provides that a limited partner
who
receives such a distribution and knew at the time of the distribution that
the
distribution violated the law will be liable to the limited partnership
for the
amount of the distribution for three years from the date of the
distribution.
With
adequate notice, a limited partner may be required to withdraw from the
partnership for any reason.
If
the
General Partner gives at least fifteen (15) days’ written notice to a limited
partner, then the General Partner may for any reason, in its sole discretion,
require any such limited partner to withdraw entirely from the partnership
or to
withdraw a portion of his partner capital account. The General Partner
may
require withdrawal even in situations where the limited partner has complied
completely with the provisions of the LP Agreement.
USOF’s
existing units are, and any units USOF issues in the future will be, subject
to
restrictions on transfer. Failure to satisfy these requirements will preclude
a
transferee from being able to have all the rights of a limited
partner.
No
transfer of any unit or interest therein may be made if such transfer would
(a)
violate the then applicable federal or state securities laws or rules and
regulations of the SEC, any state securities commission, the CFTC or any
other
governmental authority with jurisdiction over such transfer, or (b) cause
USOF
to be taxable as a corporation or affect USOF’s existence or qualification as a
limited partnership. In addition, investors may only become limited partners
if
they transfer their units to purchasers that meet certain conditions outlined
in
the LP Agreement, which provides that each record holder or limited partner
or
unitholder applying to become a limited partner (each a record holder)
may be
required by the General Partner to furnish certain information, including
that
holder’s nationality, citizenship or other related status. A transferee who is
not a U.S. resident may not be eligible to become a record holder or a
limited
partner if its ownership would subject USOF to the risk of cancellation
or
forfeiture of any of its assets under any federal, state or local law or
regulation. All purchasers of USOF’s units, who wish to become limited partners
or record holders, and receive cash distributions, if any, or have certain
other
rights, must deliver an executed transfer application in which the purchaser
or
transferee must certify that, among other things, he, she or it agrees
to
be bound by USOF’s LP Agreement and is eligible to purchase USOF’s securities.
Any transfer of units will not be recorded by the transfer agent or recognized
by us unless a completed transfer application is delivered to the General
Partner or the Administrator. A person purchasing USOF’s existing units, who
does not execute a transfer application and certify that the purchaser
is
eligible to purchase those securities acquires no rights in those securities
other than the right to resell those securities. Whether or not a transfer
application is received or the consent of the General Partner obtained,
our
units will be securities and will be transferable according to the laws
governing transfers of securities. See “Transfer of Units.”
USOF
does not expect to make cash distributions.
The
General Partner intends to re-invest any realized gains in additional oil
interests rather than distributing cash to limited partners. Therefore,
unlike
mutual funds, commodity pools or other investment pools that actively manage
their investments in an attempt to realize income and gains from their
investing
activities and distribute such income and gains to their investors, USOF
generally does not expect to distribute cash to limited partners. An investor
should not invest in USOF if it will need cash distributions from USOF
to pay
taxes on its share of income and gains of USOF, if any, or for any other
reason.
Although USOF does not intend to make cash distributions, the income earned
from
its investments held directly or posted as margin may reach levels that
merit
distribution, e.g., at levels where such income is not necessary to support
its
underlying investments in Oil Interests and investors adversely react to
being
taxed on such income without receiving distributions that could be used
to pay
such tax. If this income becomes significant then cash distributions may
be
made.
There
is a risk that USOF will not earn trading gains sufficient to compensate
for the
fees and expenses that it must pay and as such USOF may not earn any
profit.
USOF
pays
brokerage charges of approximately 0.15%, futures commission merchant fees
of
$3.50 per buy or sell, management fees of 0.50% of NAV on the first
$1,000,000,000 of assets and 0.20% of NAV after the first $1,000,000,000
of
assets, and over-the-counter spreads and extraordinary expenses ( i.e.
expenses
not in the ordinary course of business, including the indemnification of
any
person against liabilities and obligations to the extent permitted by law
and
required under the LP Agreement and under agreements entered into by the
General
Partner on USOF’s behalf and the bringing and defending of actions at law or in
equity and otherwise engaging in the conduct of litigation and the incurring
of
legal expenses and the settlement of claims and litigation) that can not
be
quantified. These fees and expenses must be paid in all cases regardless
of
whether USOF’s activities are profitable. Accordingly, USOF must earn trading
gains sufficient to compensate for these fees and expenses before it can
earn
any profit.
USOF
may incur higher fees and expenses upon renewing existing or entering into
new
contractual relationships.
The
clearing arrangements between the clearing brokers and USOF generally are
terminable by the clearing brokers once the clearing broker has given USOF
notice. Upon termination, the General Partner may be required to renegotiate
or
make other arrangements for obtaining similar services if USOF intends
to
continue trading in Oil Futures Contracts or Other Oil Interest contracts
at its
present level of capacity.
The
services of any clearing broker may not be available, or even if available,
these services may not be available on the terms as favorable as those
of the
expired or terminated clearing arrangements.
USOF
may miss certain trading opportunities because it will not receive the
benefit
of the expertise of trading advisors.
The
General Partner does not employ trading advisors for USOF; however, it
reserves
the right to employ them in the future. The only advisor to USOF is the
General
Partner. A lack of trading advisors may be disadvantageous to USOF because
it
will not receive the benefit of a trading advisor’s expertise.
An
unanticipated number of redemption requests during a short period of time
could
have an adverse effect on the NAV of USOF.
If
a
substantial number of requests for redemption of Redemption Baskets are
received
by USOF during a relatively short period of time, USOF may not be able
to
satisfy the requests from USOF’s assets not committed to trading. As a
consequence, it could be necessary to liquidate positions in USOF’s trading
positions before the time that the trading strategies would otherwise dictate
liquidation.
The
failure or bankruptcy of a clearing broker could result in a substantial
loss of
USOF’s assets.
Under
CFTC regulations, a clearing broker maintains customers’ assets in a bulk
segregated account. If a clearing broker fails to do so, or is unable to
satisfy
a substantial deficit in a customer account, its other customers may be
subject
to risk of loss of their funds in the event of that clearing broker’s
bankruptcy. In that event, the clearing broker’s customers, such as USOF, are
entitled to recover, even in respect of property specifically traceable
to them,
only a proportionate share of all property available for distribution to
all of
that clearing broker’s customers. USOF also may be subject to the risk of the
failure of, or delay in performance by, any exchanges and markets and their
clearing organizations, if any, on which commodity interest contracts are
traded.
From
time
to time, the clearing brokers may be subject to legal or regulatory proceedings
in the ordinary course of their business. A clearing broker’s involvement in
costly or time-consuming legal proceedings may divert financial resources
or
personnel away from the clearing broker’s trading operations, which could impair
the clearing broker’s ability to successfully execute and clear USOF’s
trades.
Third
parties may infringe upon or otherwise violate intellectual property
rights or
assert that the General Partner has infringed or otherwise violated their
intellectual property rights, which may result in significant costs and
diverted
attention.
Third
parties may utilize USOF’s intellectual property or technology, including the
use of its business methods, trademarks and trading program software,
without
permission. The General Partner has a patent pending for USOF’s business method
and it is registering its trademarks. USOF does not currently have any
proprietary software. However, if it obtains proprietary software in
the future,
then any unauthorized use of USOF’s proprietary software and other technology
could also adversely affect its competitive advantage. USOF may have
difficulty
monitoring unauthorized uses of its patents, trademarks, proprietary
software
and other technology. Also, third parties may independently develop business
methods, trademarks or proprietary software and other technology similar
to that
of the General Partner or claim that the General Partner has violated
their
intellectual property rights, including their copyrights, trademark rights,
trade names, trade secrets and patent rights. As a result, the General
Partner
may have to litigate in the future to protect its trade secrets, determine
the
validity and scope of other parties’ proprietary rights, defend itself against
claims that it has infringed or otherwise violated other parties’ rights, or
defend itself against claims that its rights are invalid. Any litigation
of this
type, even if the General Partner is successful and regardless of the
merits,
may result in significant costs, divert its resources from USOF, or require
it
to change its proprietary software and other technology or enter into
royalty or
licensing agreements.
The
success of USOF depends on the ability of the General Partner to accurately
implement trading systems, and any failure to do so could subject USOF
to losses
on such transactions.
USOF
may experience substantial losses on transactions if the computer or
communications system fails.
USOF’s
trading activities, including its risk management, depend on the integrity
and
performance of the computer and communications systems supporting them.
Extraordinary transaction volume, hardware or software failure, power
or
telecommunications failure, a natural disaster or other catastrophe could
cause
the computer systems to operate at an unacceptably slow speed or even
fail. Any
significant degradation or failure of the systems that the General Partner
uses
to gather and analyze information, enter orders, process data, monitor
risk
levels and otherwise engage in trading activities may result in substantial
losses on transactions, liability to other parties, lost profit opportunities,
damages to the General Partner’s and USOF’s reputations, increased operational
expenses and diversion of technical resources.
If
the computer and communications systems are not upgraded, as needed,
USOF’s
financial condition could be harmed.
The
development of complex computer and communications systems and new technologies
may render the existing computer and communications systems supporting
USOF’s
trading activities obsolete. In addition, these computer and communications
systems must be compatible with those of third parties, such as the systems
of
exchanges, clearing brokers and the executing brokers. As a result, if
these
third parties upgrade their systems, the General Partner will need to
make
corresponding upgrades to continue effectively its trading activities.
USOF’s
future success will depend on USOF’s ability to respond to changing technologies
on a timely and cost-effective basis.
USOF
depends on the reliable performance of the computer and communications
systems
of third parties, such as brokers and futures exchanges, and may experience
substantial losses on transactions if they fail.
USOF
depends on the proper and timely function of complex computer and communications
systems maintained and operated by the futures exchanges, brokers and
other data
providers that the General Partner uses to conduct trading activities.
Failure
or inadequate performance of any of these systems could adversely affect
the
General Partner’s ability to complete transactions, including its ability to
close out positions, and result in lost profit opportunities and significant
losses on commodity interest transactions. This could have a material
adverse
effect on revenues and materially reduce USOF’s available capital. For example,
unavailability of price quotations from third parties may make it difficult
or
impossible for the General Partner to use its proprietary software that
it
relies upon to conduct its trading activities. Unavailability of records
from
brokerage firms may make it difficult or impossible for the General Partner
to
accurately determine which transactions have been executed or the details,
including price and time, of any transaction executed. This unavailability
of
information also may make it difficult or impossible for the General
Partner to
reconcile its records of transactions with those of another party or
to
accomplish settlement of executed transactions.
The
occurrence of a terrorist attack, or the outbreak, continuation or expansion
of
war or other hostilities could disrupt USOF’s trading activity and materially
affect USOF’s profitability.
The
operations of USOF, the exchanges, brokers and counterparties with which
USOF
does business, and the markets in which USOF does business could be severely
disrupted in the event of a major terrorist attack or the outbreak, continuation
or expansion of war or other hostilities. The terrorist attacks of September
11,
2001 and the war in Iraq, global anti-terrorism initiatives and political
unrest
in the Middle East and Southeast Asia continue to fuel this
concern.
Risk
of Leverage and Volatility
If
the General Partner permits USOF to become leveraged, investors could
lose all
or substantially all of their investment if USOF’s trading positions suddenly
turn unprofitable.
Over-the-Counter
Contract Risk
Over-the-counter
transactions are subject to little, if any,
regulation.
A
portion
of USOF’s assets may be used to trade over-the-counter oil interest contracts,
such as forward contracts or swap or spot contracts. Over-the-counter
contracts
are typically traded on a principal-to-principal basis through dealer
markets
that are dominated by major money center and investment banks and other
institutions and are essentially unregulated by the CFTC. Investors therefore
do
not receive the protection of CFTC regulation or the statutory scheme
of the
Commodity Exchange Act in connection with this trading activity by USOF.
The
markets for over-the-counter contracts rely upon the integrity of market
participants in lieu of the additional regulation imposed by the CFTC
on
participants in the futures markets. The lack of regulation in these
markets
could expose USOF in certain circumstances to significant losses in the
event of
trading abuses or financial failure by participants.
USOF
will be subject to credit risk with respect to counterparties to
over-the-counter contracts entered into by USOF or held by special purpose
or
structured vehicles.
USOF
faces the risk of non-performance by the counterparties to the over-the-counter
contracts. Unlike in futures contracts, the counterparty to these contracts
is
generally a single bank or other financial institution, rather than a
clearing
organization backed by a group of financial institutions. As a result,
there
will be greater counterparty credit risk in these transactions. A counterparty
may not be able to meet its obligations to USOF, in which case USOF could
suffer
significant losses on these contracts.
If
a
counterparty becomes bankrupt or otherwise fails to perform its obligations
due
to financial difficulties, USOF may experience significant delays in
obtaining
any recovery in a bankruptcy or other reorganization proceeding. USOF
may obtain
only limited recovery or may obtain no recovery in such
circumstances.
USOF
may be subject to liquidity risk with respect to its over-the-counter
contracts.
Risk
of Trading in International Markets
Trading
in international markets would expose USOF to credit and regulatory
risk.
The
General Partner invests primarily in Oil Futures Contracts, a significant
portion of which are traded on United States exchanges including the
New York
Mercantile Exchange. However, a portion of USOF’s trades take place on markets
and exchanges outside the United States. Some non-U.S. markets present
risks
because they are not subject to the same degree of regulation as their
U.S.
counterparts. None of the CFTC, NFA, or any domestic exchange regulates
activities of any foreign boards of trade or exchanges, including the
execution,
delivery and clearing of transactions, nor has the power to compel enforcement
of the rules of a foreign board of trade or exchange or of any applicable
non-U.S. laws. Similarly, the rights of market participants, such as
USOF, in
the event of the insolvency or bankruptcy of a non-U.S. market or broker
are
also likely to be more limited than in the case of U.S. markets or brokers.
As a
result, in these markets, USOF has less legal and regulatory protection
than it
does when it trades domestically.
In
some
of these non-U.S. markets, the performance on a contract is the responsibility
of the counterparty and is not backed by an exchange or clearing corporation
and
therefore exposes USOF to credit risk. Trading in non-U.S. markets also
leaves
USOF susceptible to swings in the value of the local currency against
the U.S.
dollar. Additionally, trading on non-U.S. exchanges is subject to the
risks
presented by exchange controls, expropriation, increased tax burdens
and
exposure to local economic declines and political instability. An adverse
development with respect to any of these variables could reduce the profit
or
increase the loss earned on trades in the affected international
markets.
International
trading activities subject USOF to foreign exchange
risk.
The
price
of any non-U.S. futures, options on futures or other commodity interest contract
and, therefore, the potential profit and loss on such contract, may be
affected
by any variance in the foreign exchange rate between the time the order
is
placed and the time it is liquidated, offset or exercised. As a result,
changes
in the value of the local currency relative to the U.S. dollar may cause
losses
to USOF even if the contract traded is profitable.
USOF’s
international trading would expose it to losses resulting from non-U.S.
exchanges that are less developed or less reliable than United States
exchanges.
Some
non-U.S. exchanges may be in a more developmental stage so that prior
price
histories may not be indicative of current price dynamics. In addition,
USOF may
not have the same access to certain positions on foreign trading exchanges
as do
local traders, and the historical market data on which General Partner
bases its
strategies may not be as reliable or accessible as it is for U.S.
exchanges.
Tax
Risk
An
investor's tax liability may exceed the amount of distributions, if any,
on its
units.
Cash
or
property will be distributed at the sole discretion of the General Partner,
and
the General Partner currently does not intend to make cash or other
distributions with respect to units. Investors will be required to pay
U.S.
federal income tax and, in some cases, state, local, or foreign income
tax, on
their allocable share of USOF’s taxable income, without regard to whether they
receive distributions or the amount of any distributions. Therefore,
the tax
liability of an investor with respect to its units may exceed the amount of
cash or value of property (if any) distributed.
An
investor's allocable share of taxable income or loss may differ from
its
economic income or loss on its units.
Items
of income, gain, deduction, loss and credit with respect to units could
be
reallocated if the IRS does not accept the assumptions and conventions
applied
by USOF in allocating those items, with potential adverse consequences
for an
investor.
The
U.S.
tax rules pertaining to partnerships are complex and their application
to large,
publicly traded partnerships such as USOF is in many respects uncertain.
USOF
applies certain assumptions and conventions in an attempt to comply with
the
intent of the applicable rules and to report taxable income, gains, deductions,
losses and credits in a manner that properly reflects unitholders’ economic
gains and losses. These assumptions and conventions may not fully comply
with
all aspects of the Internal Revenue Code (“Code”) and applicable Treasury
Regulations, however, and it is possible that the U.S. Internal Revenue
Service
will successfully challenge our allocation methods and require us to
reallocate
items of income, gain, deduction, loss or credit in a manner that adversely
affects investors. If this occurs, investors may be required to file
an amended
tax return and to pay additional taxes plus deficiency interest.
We
could be treated as a corporation for federal income tax purposes, which
may
substantially reduce the value of the units.
USOF
has
received an opinion of counsel that, under current U.S. federal income
tax laws,
USOF will be treated as a partnership that is not taxable as a corporation
for
U.S. federal income tax purposes, provided that (i) at least 90 percent
of
USOF’s annual gross income consists of “qualifying income” as defined in the
Code, (ii) USOF is organized and operated in accordance with its governing
agreements and applicable law and (iii) USOF does not elect to be taxed
as a
corporation for federal income tax purposes. Although the General Partner
anticipates that USOF will satisfy the “qualifying income” requirement for all
of its taxable years, that result cannot be assured. USOF has not requested
and
will not request any ruling from the IRS with respect to its classification
as a
partnership not taxable as a corporation for federal income tax purposes.
If the
IRS were to successfully assert that USOF is taxable as a corporation
for
federal income tax purposes in any taxable year, rather than passing
through its
income, gains, losses and deductions proportionately to unitholders,
USOF would
be subject to tax on its net income for the year at corporate tax rates.
In
addition, although the General Partner does not currently intend to make
distributions with respect to units, any distributions would be taxable
to
unitholders as dividend income. Taxation of USOF as a corporation could
materially reduce the after-tax return on an investment in units and
could
substantially reduce the value of the units.
Legal
Risks
Representatives
of the New York Mercantile Exchange have notified USOF of its belief
that USOF
is engaging in unauthorized use of such Exchange’s service marks and settlement
prices.
USOF
invests primarily in Oil Futures Contracts, and particularly in Oil Futures
Contracts traded on the New York Mercantile Exchange. Representatives
of the New
York Mercantile Exchange have at various times asserted varying claims
regarding
USOF’s operations and the Exchange’s service marks and settlement prices of oil
futures contracts traded on the Exchange.
The
New
York Mercantile Exchange initially claimed that USOF’s use of the Exchange’s
service marks would cause confusion as to USOF’s source, origin, sponsorship or
approval, and constitute infringement of the Exchange’s trademark rights and
unfair competition and dilution of the Exchange’s marks. In response to these
claims, the General Partner changed USOF’s name. In addition, USOF expressly
disclaims any association with the Exchange or endorsement of USOF by
the
Exchange and acknowledges that “NYMEX” and “New York Mercantile Exchange” are
registered trademarks of such Exchange.
The
General Partner has also engaged in discussions with the New York Mercantile
Exchange regarding a possible license agreement. In this regard, USOF
received a
letter from the Exchange dated March 29, 2006 (“March 29th Letter”). The March
29th Letter was in response to USOF’s request for additional information in
connection with the negotiation of the possible license agreement. In
the March
29th Letter, the Exchange stated that it would cause the cessation of
any market
data vendor’s provision of New York Mercantile Exchange settlement prices to
USOF and/or take other action to prevent USOF from using any New York
Mercantile
Exchange settlement prices unless USOF enters into a license agreement
with the
Exchange, or has indicated in writing that it will cease from using any
Exchange
settlement prices. USOF will continue to seek an amicable resolution
to this
situation. It is evaluating the current draft of the license agreement
in view
of the March 29th letter but is also taking into account a recent New
York
federal district court decision against the NYMEX that found under similar
circumstances that NYMEX’s intellectual property rights, including those related
to its settlement prices, were significantly limited. USOF and the General
Partner have retained separate counsel to represent them in this
matter.
At
this
time, USOF is unable to determine what the outcome from this matter will
be.
There could be a number of consequences. Under the license agreement
currently
being negotiated, USOF would be required to pay a license fee to the
New York
Mercantile Exchange for the use of its settlement prices. Also, if the
resolution or lack of resolution of this matter results in a material
restriction on, or significant additional expense associated with, the
use of
the New York Mercantile Exchange’s oil futures contract settlement prices, USOF
may be required to invest to a greater degree than currently anticipated
in Oil
Futures Contracts traded on commodity exchanges other than the New York
Mercantile Exchange and Other Oil Interests. These or other consequences
may
adversely affect USOF’s ability to achieve its investment
objective.
Others
may also notify USOF of intellectual property rights that could adversely
impact
USOF.
Separately,
Goldman, Sachs & Co. (“Goldman Sachs”) sent USOF a letter on March 17, 2006,
providing USOF notice under 35 U.S.C. Section 154(d) of two pending United
States patent applications, Publication Nos. 2004/0225593A1 and 2006/0036533A1.
Both patent applications are generally directed to a method and system
for
creating and administering a publicly traded interest in a commodity
pool. In
particular, the Abstract of each patent application defines a means for
creating
and administering a publicly traded interest in a commodity pool that
includes
the steps of forming a commodity pool having a first position in a futures
contract and a corresponding second position in a margin investment,
and issuing
equity interest of the commodity pool to third party investors. USOF
Units are
equity interests in a publicly traded commodity pool. In addition, USOF
will
directly invest in futures contracts and hold other investments to be
used as
margin for its future contract positions. If patents were to be
issued
to Goldman Sachs based upon these patent applications as currently drafted,
and
USOF continued to operate as currently contemplated after the patents
were
issued, claims against USOF and the General Partner for infringement
of the
patents may be made by Goldman Sachs. However, as these patent applications
are
pending and have not been substantively examined by the U.S. Patent and
Trademark Office, it is uncertain at this time what subject matter will
be
covered by the claims of any patent issuing on one of these applications,
should
a patent issue at all.
Under
the
provisions of 35 U.S.C. § 154(d), Goldman Sachs may seek damages in the form of
a reasonable royalty from the date the Units are publicly offered for
sale to
the date one of their cited patent applications issues as a U.S. Patent
if, and
only if, the invention as claimed in the issued patent is substantially
identical to the invention as claimed in the published patent application.
To
obtain a reasonable royalty under 35 U.S.C. § 154(d), one of Goldman Sachs’s
patents must issue and then it must be proved that post-issuance acts
or systems
of USOF infringe a valid claim of the issued patent, and that the infringed
claim is substantially identical to one of the claims in the corresponding
published application. If at the time a Goldman Sachs patent issues,
USOF does
not infringe the claims of the issued patent based on its current design
or
through modifications made prior to issuance, or if any infringed issued
claim
is not substantially identical to a published claim, then Goldman Sachs
will not
be able to obtain a reasonable royalty under 35 U.S.C. § 154(d). At this time
neither of Goldman Sachs’s patent applications have been substantively examined
by an examiner at the U.S. Patent and Trademark Office nor are they currently
being considered for examination on an expedited basis under a Petition
to Make
Special, and considering that both have been placed in Class 705 for
examination, which has an average pendency of approximately 44-45 months
to
issuance (or abandonment) and an issuance rate of approximately 11% in
2004, it
is likely that neither application will issue within the next two years.
Nonetheless, USOF currently is reviewing the Goldman Sachs published
patent
applications, and is engaged in discussions with Goldman Sachs regarding
their
pending applications and USOF’s own pending patent application. At this time,
due in part to the requirements of 35 U.S.C. § 154(d) and the fact that the
Goldman Sachs patent applications are pending and have not been issued
as U.S.
Patents, USOF is unable to determine what the outcome from this matter
will be.
See “Operating Risks — Third parties may infringe upon or otherwise violate
intellectual property rights or assert that the General Partner has infringed
or
otherwise violated their intellectual property rights, which may result
in
significant costs and diverted attention.”