UNITED STATES 12 MONTH OIL FUND, LP
10-Ks and 10-Qs
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
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x
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Quarterly
report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended June 30,
2010.
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OR
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¨
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Transition
report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the transition period from
to
.
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Commission
File Number: 001-33859
United
States 12 Month Oil Fund, LP
(Exact
name of registrant as specified in its charter)
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Delaware
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20-0431897
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(State
or other jurisdiction of
incorporation
or organization)
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(I.R.S.
Employer
Identification
No.)
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1320
Harbor Bay Parkway, Suite 145
Alameda,
California 94502
(Address
of principal executive offices) (Zip code)
(510)
522-9600
(Registrant’s
telephone number, including area code)
N/A
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
x
Yes
¨
No
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
¨
Yes
¨
No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
|
Large
accelerated filer
¨
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Accelerated
filer
x
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Non-accelerated
filer
¨
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Smaller
reporting company
¨
|
|
(Do
not check if a smaller reporting company)
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
¨
Yes
x
No
UNITED
STATES 12 MONTH OIL FUND, LP
Table
of Contents
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Page
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Part I. FINANCIAL
INFORMATION
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Item 1. Condensed
Financial Statements
.
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1
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Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of
Operations
.
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16
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Item 3. Quantitative and
Qualitative Disclosures About Market Risk
.
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34
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Item 4. Controls and
Procedures
.
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35
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Part II. OTHER
INFORMATION
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||
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Item
1. Legal Proceedings.
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36
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Item
1A. Risk Factors.
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36
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Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
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36
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Item
3. Defaults Upon Senior Securities.
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36
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Item
4. Reserved.
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36
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Item 5. Other
Information
.
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36
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Item 6. Exhibits.
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36
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Index
to Condensed Financial Statements
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Documents
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Page
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Condensed
Statements of Financial Condition at June 30, 2010 (Unaudited) and
December 31, 2009
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2
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Condensed
Schedule of Investments (Unaudited) at June 30, 2010
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3
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Condensed
Statements of Operations (Unaudited) for the three and six months ended
June 30, 2010 and 2009
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4
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Condensed
Statement of Changes in Partners’ Capital (Unaudited) for the six months
ended June 30, 2010
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5
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Condensed
Statements of Cash Flows (Unaudited) for the six months ended June 30,
2010 and 2009
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6
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Notes
to Condensed Financial Statements for the period ended June 30, 2010
(Unaudited)
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7
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1
United
States 12 Month Oil Fund, LP
At
June 30, 2010 (Unaudited) and December 31, 2009
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June 30,
2010 |
December 31,
2009 |
|||||||
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Assets
|
||||||||
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Cash
and cash equivalents (Note 5)
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$ | 137,463,257 | $ | 141,666,539 | ||||
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Equity
in UBS Securities LLC trading accounts:
|
||||||||
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Cash
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23,933,792 | 3,408,951 | ||||||
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Unrealized
gain (loss) on open commodity futures contracts
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(6,474,060 | ) | 20,802,090 | |||||
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Dividend
receivable
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6,053 | 6,219 | ||||||
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Other
assets
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145,001 | 145,723 | ||||||
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Total
assets
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$ | 155,074,043 | $ | 166,029,522 | ||||
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Liabilities
and Partners' Capital
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||||||||
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Professional
fees payable
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$ | 432,521 | $ | 405,399 | ||||
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General
Partner management fees payable (Note 3)
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76,573 | 78,963 | ||||||
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Brokerage
commission fees payable
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6,282 | 10,532 | ||||||
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Other
liabilities
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12,140 | 11,319 | ||||||
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Total
liabilities
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527,516 | 506,213 | ||||||
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Commitments and Contingencies
(Notes 3, 4 and 5)
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||||||||
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Partners'
Capital
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||||||||
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General
Partner
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- | - | ||||||
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Limited
Partners
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154,546,527 | 165,523,309 | ||||||
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Total
Partners' Capital
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154,546,527 | 165,523,309 | ||||||
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Total
liabilities and partners' capital
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$ | 155,074,043 | $ | 166,029,522 | ||||
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Limited
Partners' units outstanding
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4,200,000 | 4,100,000 | ||||||
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Net
asset value per unit
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$ | 36.80 | $ | 40.37 | ||||
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Market
value per unit
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$ | 36.60 | $ | 40.46 | ||||
See
accompanying notes to condensed financial statements.
2
United
States 12 Month Oil Fund, LP
Condensed
Schedule of Investments (Unaudited)
At
June 30, 2010
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Gain (Loss) on
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||||||||||||
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Number of
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Open
Commodity
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% of
Partners'
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||||||||||
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Contracts
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Contracts
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Capital
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||||||||||
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Open
Futures Contracts - Long
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||||||||||||
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United
States Contracts
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||||||||||||
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NYMEX
Crude Oil Futures CL contracts, expire August 2010
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165 | $ | 562,290 | 0.36 | ||||||||
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NYMEX
Crude Oil Futures CL contracts, expire September 2010
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165 | (627,500 | ) | (0.41 | ) | |||||||
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NYMEX
Crude Oil Futures CL contracts, expire October 2010
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165 | 37,750 | 0.02 | |||||||||
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NYMEX
Crude Oil Futures CL contracts, expire November 2010
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166 | 133,310 | 0.09 | |||||||||
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NYMEX
Crude Oil Futures CL contracts, expire December 2010
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165 | (809,990 | ) | (0.52 | ) | |||||||
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NYMEX
Crude Oil Futures CL contracts, expire January 2011
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166 | (916,120 | ) | (0.59 | ) | |||||||
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NYMEX
Crude Oil Futures CL contracts, expire February 2011
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165 | (1,538,540 | ) | (0.99 | ) | |||||||
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NYMEX
Crude Oil Futures CL contracts, expire March 2011
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166 | 216,940 | 0.14 | |||||||||
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NYMEX
Crude Oil Futures CL contracts, expire April 2011
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165 | (1,020,040 | ) | (0.66 | ) | |||||||
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NYMEX
Crude Oil Futures CL contracts, expire May 2011
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166 | (1,572,630 | ) | (1.02 | ) | |||||||
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NYMEX
Crude Oil Futures CL contracts, expire June 2011
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165 | (959,640 | ) | (0.62 | ) | |||||||
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NYMEX
Crude Oil Futures CL contracts, expire July 2011
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166 | 20,110 | 0.01 | |||||||||
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Total
Open Futures Contracts
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1,985 | $ | (6,474,060 | ) | (4.19 | ) | ||||||
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Principal
Amount
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Market Value
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|||||||||||
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Cash
Equivalents
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||||||||||||
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United
States - Money Market Funds
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||||||||||||
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Fidelity
Institutional Government Portfolio - Class I
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$ | 75,122,564 | $ | 75,122,564 | 48.61 | |||||||
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Goldman
Sachs Financial Square Funds - Government Fund - Class SL
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42,433,591 | 42,433,591 | 27.46 | |||||||||
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Morgan
Stanley Institutional Liquidity Fund - Government
Portfolio
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10,000,000 | 10,000,000 | 6.47 | |||||||||
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Total
Cash Equivalents
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$ | 127,556,155 | 82.54 | |||||||||
See
accompanying notes to condensed financial statements.
3
United
States 12 Month Oil Fund, LP
For
the three and six months ended June 30, 2010 and 2009
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Three months
ended
June 30, 2010
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Three months
ended
June 30, 2009
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Six months
ended
June 30, 2010
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Six months
ended
June 30, 2009
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|||||||||||||
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Income
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||||||||||||||||
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Gain
(loss) on trading of commodity futures contracts:
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||||||||||||||||
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Realized
gain on closed positions
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$ | 3,647,430 | $ | 16,210,370 | $ | 14,543,180 | $ | 13,225,860 | ||||||||
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Change
in unrealized gain (loss) on open positions
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(19,570,260 | ) | 25,597,990 | (27,276,150 | ) | 45,577,990 | ||||||||||
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Dividend
income
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15,373 | 72,049 | 23,476 | 112,280 | ||||||||||||
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Interest
income
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1,147 | 6,919 | 2,817 | 11,309 | ||||||||||||
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Other
income
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2,000 | 8,000 | 3,000 | 23,000 | ||||||||||||
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Total
income (loss)
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(15,904,310 | ) | 41,895,328 | (12,703,677 | ) | 58,950,439 | ||||||||||
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Expenses
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||||||||||||||||
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General
Partner management fees (Note 3)
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232,031 | 266,480 | 469,598 | 363,743 | ||||||||||||
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Professional
fees
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78,418 | 77,947 | 243,915 | 102,697 | ||||||||||||
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Brokerage
commission fees
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(1,051 | ) | 10,242 | 4,089 | 39,009 | |||||||||||
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Other
expenses
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34,042 | 61,124 | 51,295 | 87,710 | ||||||||||||
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Total
expenses
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343,440 | 415,793 | 768,897 | 593,159 | ||||||||||||
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Expense
waiver
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- | - | - | (11,227 | ) | |||||||||||
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Net
expenses
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343,440 | 415,793 | 768,897 | 581,932 | ||||||||||||
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Net
income (loss)
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$ | (16,247,750 | ) | $ | 41,479,535 | $ | (13,472,574 | ) | $ | 58,368,507 | ||||||
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Net
income (loss) per limited partnership unit
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$ | (4.31 | ) | $ | 7.43 | $ | (3.57 | ) | $ | 6.51 | ||||||
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Net
income (loss) per weighted average limited partnership
unit
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$ | (4.14 | ) | $ | 7.92 | $ | (3.37 | ) | $ | 15.46 | ||||||
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Weighted
average limited partnership units outstanding
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3,921,978 | 5,238,462 | 3,998,895 | 3,774,586 | ||||||||||||
See
accompanying notes to condensed financial statements.
4
United
States 12 Month Oil Fund, LP
Condensed
Statement of Changes in Partners’ Capital (Unaudited)
For
the six months ended June 30, 2010
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General
Partner |
Limited
Partners |
Total
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||||||||||
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Balances,
at December 31, 2009
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$ | - | $ | 165,523,309 | $ | 165,523,309 | ||||||
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Addition
of 400,000 partnership units
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- | 14,577,236 | 14,577,236 | |||||||||
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Redemption
of 300,000 partnership units
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- | (12,081,444 | ) | (12,081,444 | ) | |||||||
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Net
loss
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- | (13,472,574 | ) | (13,472,574 | ) | |||||||
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Balances,
at June 30, 2010
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$ | - | $ | 154,546,527 | $ | 154,546,527 | ||||||
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Net
Asset Value Per Unit
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||||||||||||
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At
December 31, 2009
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$ | 40.37 | ||||||||||
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At
June 30, 2010
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$ | 36.80 | ||||||||||
See
accompanying notes to condensed financial statements.
5
United
States 12 Month Oil Fund, LP
For
the six months ended June 30, 2010 and 2009
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Six months ended
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Six months ended
|
|||||||
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June 30, 2010
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June 30, 2009
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|||||||
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Cash
Flows from Operating Activities:
|
||||||||
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Net
income (loss)
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$ | (13,472,574 | ) | $ | 58,368,507 | |||
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Adjustments
to reconcile net income (loss) to net cash provided by (used in) operating
activities:
|
||||||||
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Decrease
(increase) in commodity futures trading account
– cash
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(20,524,841 | ) | 11,548,267 | |||||
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Unrealized
(gain) loss on futures contracts
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27,276,150 | (45,577,990 | ) | |||||
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Decrease
in receivable from General Partner
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- | 97,019 | ||||||
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Decrease
(increase) in dividend receivable and other assets
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888 | (208,648 | ) | |||||
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Increase
(decrease) in General Partner management fees payable
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(2,390 | ) | 94,401 | |||||
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Increase
in professional fees payable
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27,122 | 24,954 | ||||||
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Increase
(decrease) in brokerage commission fees payable
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(4,250 | ) | 14,882 | |||||
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Increase
(decrease) in other liabilities
|
821 | (36,845 | ) | |||||
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Net
cash provided by (used in) operating activities
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(6,699,074 | ) | 24,324,547 | |||||
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Cash
Flows from Financing Activities:
|
||||||||
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Subscription
of partnership units
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14,577,236 | 166,254,945 | ||||||
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Redemption
of partnership units
|
(12,081,444 | ) | (49,655,729 | ) | ||||
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Net
cash provided by financing activities
|
2,495,792 | 116,599,216 | ||||||
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Net
Increase (Decrease) in Cash and Cash Equivalents
|
(4,203,282 | ) | 140,923,763 | |||||
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Cash and Cash
Equivalents
, beginning of period
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141,666,539 | 4,012,323 | ||||||
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Cash and Cash
Equivalents
, end of period
|
$ | 137,46 3,257 | $ | 144,936,086 | ||||
See
accompanying notes to condensed financial statements.
6
United
States 12 Month Oil Fund, LP
Notes
to Condensed Financial Statements
For
the period ended June 30, 2010 (Unaudited)
The
United States 12 Month Oil Fund, LP (“US12OF”) was organized as a limited
partnership under the laws of the state of Delaware on June 27,
2007. US12OF is a commodity pool that issues limited partnership
units (“units”) that may be purchased and sold on the NYSE Arca, Inc. (the “NYSE
Arca”). Prior to November 25, 2008, US12OF’s units traded on the American Stock
Exchange (the “AMEX”). US12OF will continue in perpetuity, unless terminated
sooner upon the occurrence of one or more events as described in
its Amended and Restated Agreement of Limited Partnership dated as of
December 4, 2007 (the “LP Agreement”). The investment objective of US12OF is for
the changes in percentage terms of its units’ net asset value to reflect the
changes in percentage terms of the spot price of light, sweet crude
oil delivered to Cushing, Oklahoma, as measured by the changes in the average of
the prices of the 12 futures contracts for light, sweet crude oil traded on
the New York Mercantile Exchange (the “NYMEX”), consisting of the near
month contract to expire and the contracts for the following 11 months for a
total of 12 consecutive months’ contracts, 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 and the contracts for
the following 11 consecutive months, less US12OF’s expenses. US12OF
accomplishes its objective through investments in futures contracts for light,
sweet crude oil and other types of crude oil, heating oil, gasoline, natural gas
and other petroleum-based fuels that are traded on the NYMEX, ICE Futures or
other U.S. and foreign exchanges (collectively, “Oil Futures Contracts”) and
other oil related investments such as cash-settled options on Oil Futures
Contracts, forward contracts for oil, cleared swap contracts and
over-the-counter transactions that are based on the price of crude oil, heating
oil, gasoline, natural gas and other petroleum-based fuels, Oil Futures
Contracts and indices based on the foregoing (collectively, “Other Oil
Interests”). As of June 30, 2010, US12OF held 1,985 Oil Futures Contracts
for light, sweet crude oil traded on the NYMEX.
US12OF
commenced investment operations on December 6, 2007 and has a fiscal year ending
on December 31. United States Commodity Funds LLC (the “General Partner”)
is responsible for the management of US12OF. The General Partner 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. The General Partner is also the general
partner of the United States Oil Fund, LP (“USOF”), the United States
Natural Gas Fund, LP (“USNG”), the United States Gasoline Fund, LP (“UGA”) and
the United States Heating Oil Fund, LP (“USHO”), which listed their limited
partnership units on the AMEX under the ticker symbols “USO” on April 10,
2006, “UNG” on April 18, 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, UGA’s and USHO’s units commenced trading on the NYSE
Arca on November 25, 2008. The General Partner is also the general
partner of the United States Short Oil Fund, LP (“USSO”), 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 “DNO” on September 24, 2009, “UNL” on November 18, 2009 and
“BNO” on June 2, 2010, respectively. The General Partner has also
filed a registration statement to register units of the United States Commodity
Index Fund (“USCI”).
The
accompanying unaudited condensed financial statements have been prepared in
accordance with Rule 10-01 of Regulation S-X promulgated by the U.S.
Securities and Exchange Commission (the “SEC”) and, therefore, do not include
all information and footnote disclosure required under accounting principles
generally accepted in the United States of America (“GAAP”). The financial
information included herein is unaudited; however, such financial
information reflects all adjustments which are, in the opinion of management,
necessary for the fair presentation of the condensed financial statements
for the interim period.
US12OF issues
units to certain authorized purchasers (“Authorized Purchasers”) by offering
baskets consisting of 100,000 units (“Creation Baskets”) through ALPS
Distributors, Inc., as the marketing agent (the “Marketing Agent”). The purchase
price for a Creation Basket is based upon the net asset value 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.
7
In
addition, Authorized Purchasers pay US12OF a $1,000 fee for each order
placed to create one or more Creation Baskets or to redeem one or more
baskets consisting of 100,000 units (“Redemption Baskets”). 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
net asset value of US12OF but rather at market prices quoted on such
exchange.
On
December 4, 2008, US12OF initially registered 11,000,000 units on Form S-1 with
the SEC. On December 6, 2007, US12OF listed its units on the AMEX under the
ticker symbol “USL”. On that day, US12OF established its initial net asset value
by setting the price at $50.00 per unit and issued 300,000 units in
exchange for $15,001,000. US12OF also commenced investment operations
on December 6, 2007, by purchasing Oil Futures Contracts traded on the NYMEX
based on light, sweet crude oil. As of June 30, 2010, US12OF had
registered a total of 111,000,000 units.
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 statement of financial
condition and in 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 statement of operations. US12OF 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, US12OF earns income
on funds held at the custodian 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
US12OF 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, US12OF 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. US12OF
files an income tax return in the U.S. federal jurisdiction, and may file income
tax returns in various U.S. states. Generally, US12OF is no longer
subject to income tax return examinations by major taxing authorities for years
before 2007 (year of inception). 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 US12OF recording a tax
liability that reduces net assets. However, US12OF’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 analyses of and changes
to tax laws, regulations and interpretations thereof. US12OF
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 June 30, 2010.
Creations
and Redemptions
Authorized
Purchasers may purchase Creation Baskets or redeem Redemption Baskets only in
blocks of 100,000 units at a price equal to the net asset value of the units
calculated shortly after the close of the core trading session on the NYSE Arca
on the day the order is placed.
8
US12OF
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 US12OF’s condensed statement 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 US12OF in proportion to the number
of units each partner holds as of the close of each month. The General Partner
may revise, alter or otherwise modify this method of allocation as described in
the LP Agreement.
Calculation
of Net Asset Value
US12OF’s
net asset value is calculated on each NYSE Arca trading day by taking the
current market value of its total assets, subtracting any liabilities and
dividing the amount by the total number of units issued and outstanding. US12OF
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 net asset value per
unit 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 redeemed based on the amount of time the
units were outstanding during such period. There were no units held by the
General Partner at June 30, 2010.
Offering
Costs
Offering
costs incurred in connection with the registration of additional units after the
initial registration of units are borne by US12OF. 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 three months or less.
Reclassification
Certain
amounts in the accompanying condensed financial statements were reclassified to
conform with the current presentation.
Use
of Estimates
The
preparation of condensed financial statements in conformity with GAAP
requires US12OF’s management to make estimates and assumptions that affect the
reported amount of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the condensed financial statements, and the
reported amounts of the revenue and expenses during the reporting period. Actual
results could differ from those estimates and assumptions.
General
Partner Management Fee
Under
the LP Agreement, the General Partner is responsible for investing the
assets of US12OF in accordance with the objectives and policies of US12OF. In
addition, the General Partner has arranged for one or more third parties to
provide administrative, custody, accounting, transfer agency and other necessary
services to US12OF. For these services, US12OF is contractually obligated to pay
the General Partner a fee, which is paid monthly, that is equal to 0.60% per
annum of average daily net assets.
9
Ongoing
Registration Fees and Other Offering Expenses
US12OF
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 six
months ended June 30, 2010 and 2009, US12OF incurred $5,860 and $66,500,
respectively, in registration fees and other offering expenses.
Directors’
Fees and Expenses
US12OF is
responsible for paying its portion of the directors’ and officers’ liability
insurance of the General Partner and the fees and expenses of the independent
directors of the General Partner who are also the General Partner’s audit
committee members. These fees and expenses for the calendar year 2010 are
estimated to be a total of $1,178,870 for all funds. Effective as of
April 1, 2010, US12OF is responsible for paying its portion of any payments that
may become due to the independent directors pursuant to the deferred
compensation agreements entered into between the independent directors, the
General Partner and each of the affiliated funds. US12OF shares
all director fees and expenses, including any that may become due pursuant to
the deferred compensation agreements, with USOF, USNG, UGA, USHO, USSO, US12NG
and USBO based on the relative assets of each fund, computed on a daily
basis.
Licensing
Fees
As
discussed in Note 4, US12OF entered into a licensing agreement with the
NYMEX on January 16, 2008. Pursuant to the agreement, US12OF and the affiliated
funds managed by the General Partner, other than USBO, pay a licensing fee that
is equal to 0.04% for the first $1,000,000,000 of combined assets of the
funds and 0.02% for combined assets above $1,000,000,000. During the
six months ended June 30, 2010 and 2009, US12OF incurred $18,426 and $14,675,
respectively, under this arrangement.
Investor
Tax Reporting Cost
The fees
and expenses associated with US12OF’s audit expenses and tax accounting and
reporting requirements are paid by US12OF. These costs are estimated
to be $247,799 for the calendar year 2010.
Other
Expenses and Fees
In
addition to the fees described above, US12OF pays all brokerage fees and
other expenses in connection with the operation of US12OF, excluding costs and
expenses paid by the General Partner as outlined in Note 4.
US12OF is
party to a marketing agent agreement, dated as of November 13, 2007, as
amended from time to time, with the Marketing Agent and the General
Partner, whereby the Marketing Agent provides certain marketing services for
US12OF as outlined in the agreement. The fee of the Marketing Agent, which is
borne by the General Partner, is equal to 0.06% on US12OF’s assets up to $3
billion and 0.04% on US12OF’s assets in excess of $3 billion.
The above
fee does not include the following expenses, which are also borne by the General
Partner: the cost of placing advertisements in various periodicals; web
construction and development; or the printing and production of various
marketing materials.
10
US12OF is
also party to a custodian agreement, dated October 5, 2007, as amended from time
to time, with Brown Brothers Harriman & Co. (“BBH&Co.”) and the General
Partner, whereby BBH&Co. holds investments on behalf of US12OF. The General
Partner pays the fees of the custodian, which are determined by the parties
from time to time. In addition, US12OF is party to an administrative agency
agreement, dated October 5, 2007, as amended from time to time, with the General
Partner and BBH&Co., whereby BBH&Co. acts as the administrative agent,
transfer agent and registrar for US12OF. The General Partner also pays the
fees of BBH&Co. for its services under this agreement and such fees are
determined by the parties from time to time.
Currently,
the General Partner 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 US12OF and each of the
affiliated funds managed by the General Partner, as well as a $20,000 annual fee
for its transfer agency services. In addition, the General Partner pays
BBH&Co. an asset-based charge of (a) 0.06% for the first $500 million of
US12OF’s, USOF’s, USNG’s, UGA’s, USHO’s, USSO’s, US12NG’s and USBO’s combined
net assets, (b) 0.0465% for US12OF’s, USOF’s, USNG’s, UGA’s, USHO’s, USSO’s,
US12NG’s and USBO’s combined net assets greater than $500 million but less than
$1 billion, and (c) 0.035% once US12OF’s, USOF’s, USNG’s, UGA’s, USHO’s, USSO’s,
US12NG’s and USBO’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. The General Partner also pays transaction fees
ranging from $7.00 to $15.00 per transaction.
US12OF
has entered into a brokerage agreement with UBS Securities LLC (“UBS
Securities”). The agreement requires UBS Securities to provide services to
US12OF in connection with the purchase and sale of Oil Futures Contracts
and Other Oil Interests that may be purchased and sold by or through UBS
Securities for US12OF’s account. In accordance with the agreement, UBS
Securities charges US12OF commissions of approximately $7 per round-turn trade,
including applicable exchange and NFA fees for Oil Futures Contracts and
options on Oil Futures Contracts.
On
January 16, 2008, US12OF and the NYMEX entered into a licensing agreement
whereby US12OF was granted a non-exclusive license to use certain of the NYMEX’s
settlement prices and service marks. The agreement has an effective date of
December 4, 2007 with respect to US12OF. Under the licensing
agreement, US12OF and the affiliated funds managed by the General Partner, other
than USBO, pay the NYMEX an asset-based fee for the license, the terms of which
are described in Note 3.
US12OF
expressly disclaims any association with the NYMEX or endorsement of US12OF by
the NYMEX and acknowledges that “NYMEX” and “New York Mercantile Exchange” are
registered trademarks of the NYMEX.
US12OF engages
in the trading of futures contracts and options on futures contracts
(collectively, “derivatives”). US12OF 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.
US12OF
may enter into futures contracts and options on futures contracts 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 and options on futures contracts 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 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
US12OF 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.
11
All of
the futures contracts currently traded by US12OF are exchange-traded. The risks
associated with exchange-traded contracts are generally perceived to be less
than those associated with over-the-counter transactions since, in
over-the-counter transactions, US12OF must rely solely on the credit of its
respective individual counterparties. However, in the future, if US12OF
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. US12OF also has credit risk 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, US12OF bears
the risk of financial failure by the clearing broker.
US12OF’s
cash and other property, such as U.S. 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 US12OF’s assets posted with that futures commission merchant;
however, the vast majority of US12OF’s assets are held in U.S. Treasuries, cash
and/or cash equivalents with US12OF’s custodian and would not be impacted by the
insolvency of a futures commission merchant. Also, the failure or insolvency of
US12OF’s custodian could result in a substantial loss of US12OF’s
assets.
The
General Partner invests a portion of US12OF’s cash in money market funds that
seek to maintain a stable net asset value. US12OF is exposed to any risk of loss
associated with an investment in these money market funds. As of June 30, 2010
and December 31, 2009, US12OF had deposits in domestic and foreign financial
institutions, including cash investments in money market funds, in the amounts
of $161,397,049 and $145,075,490, respectively. This amount is subject to loss
should these institutions cease operations.
For
derivatives, risks arise from changes in the market value of the contracts.
Theoretically, US12OF is exposed to a market risk equal to the value
of futures contracts purchased and unlimited liability on such contracts sold
short. As both a buyer and a seller of options, US12OF 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.
US12OF’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, US12OF 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 US12OF are reported in its condensed
statement of financial condition at market or fair value, or at carrying amounts
that approximate fair value, because of their highly liquid nature and
short-term maturity.
US12OF
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 US12OF (observable inputs) and (2) US12OF’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.
12
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 in 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 US12OF’s securities at December 31,
2009 using the fair value hierarchy:
|
At
December 31, 2009
|
Total
|
Level I
|
Level II
|
Level III
|
||||||||||||
|
Short-Term
Investments
|
$
|
117,532,512
|
$
|
117,532,512
|
$
|
-
|
$
|
-
|
||||||||
|
Exchange-Traded
Futures Contracts
|
||||||||||||||||
|
United
States Contracts
|
20,802,090
|
20,802,090
|
-
|
-
|
||||||||||||
During
the year ended December 31, 2009, there were no significant transfers between
Level I and Level II.
The
following table summarizes the valuation of US12OF’s securities at June 30, 2010
using the fair value hierarchy:
|
At
June 30, 2010
|
Total
|
Level I
|
Level II
|
Level III
|
||||||||||||
|
Short-Term
Investments
|
$ | 127,556,155 | $ | 127,556,155 | $ | - | $ | - | ||||||||
|
Exchange-Traded
Futures Contracts
|
||||||||||||||||
|
United
States Contracts
|
(6,474,060 | ) | (6,474,060 | ) | - | - | ||||||||||
During
the six months ended June 30, 2010, there were no significant transfers between
Level I and Level II.
Effective
January 1, 2009, US12OF 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
Hedging Instruments
|
Statement of Financial
Condition Location
|
Fair Value
At June 30,
2010 |
Fair Value
At December 31,
2009 |
|||||||
|
Futures
- Commodity Contracts
|
Assets
|
$ | (6,474,060 | ) | $ | 20,802,090 | ||||
13
The
Effect of Derivative Instruments on the Statements of Operations
|
For the six months
ended June 30, 2010
|
For the six months
ended June 30, 2009
|
|||||||||||||||||
|
Derivatives not
Accounted for as
Hedging Instruments
|
Location of Gain or
(Loss) on Derivatives
Recognized in Income
|
Realized Gain or
(Loss) on
Derivatives
Recognized in
Income
|
Change in
Unrealized Gain
or (Loss)
Recognized in
Income
|
Realized Gain or
(Loss) on
Derivatives
Recognized in
Income
|
Change in
Unrealized Gain
or (Loss)
Recognized in
Income
|
|||||||||||||
|
Futures
-
|
Realized
gain
|
$ | 14,543,180 | $ | 13,225,860 | |||||||||||||
|
Commodity
Contracts
|
(loss)
on closed
|
|||||||||||||||||
|
futures
contracts
|
||||||||||||||||||
|
Change
in unrealized gain (loss) on open futures contracts
|
$ | (27,276,150 | ) | $ | 45,577,990 | |||||||||||||
The
following table presents per unit performance data and other supplemental
financial data for the six months ended June 30, 2010 and 2009 for the
unitholders. This information has been derived from information presented in the
condensed financial statements.
|
For the six
months ended
|
For the six
months ended
|
|||||||
|
June 30, 2010
|
June 30, 2009
|
|||||||
|
(Unaudited)
|
(Unaudited)
|
|||||||
|
Per Unit Operating
Performance:
|
||||||||
|
Net
asset value, beginning of period
|
$ | 40.37 | $ | 31.24 | ||||
|
Total
income (loss)
|
(3.38 | ) | 6.66 | |||||
|
Net
expenses
|
(0.19 | ) | (0.15 | ) | ||||
|
Net
increase (decrease) in net asset value
|
(3.57 | ) | 6.51 | |||||
|
Net
asset value, end of period
|
$ | 36.80 | $ | 37.75 | ||||
|
Total
Return
|
(8.84 | )% | 20.84 | % | ||||
|
Ratios
to Average Net Assets
|
||||||||
|
Total
income (loss)
|
(8.05 | )% | 48.22 | % | ||||
|
Management
fees*
|
0.60 | % | 0.60 | % | ||||
|
Total
expenses excluding management fees*
|
0.38 | % | 0.38 | % | ||||
|
Expenses
waived*
|
- | % | (0.02 | )% | ||||
|
Net
expenses excluding management fees*
|
0.38 | % | 0.36 | % | ||||
|
Net
income (loss)
|
(8.54 | )% | 47.74 | % | ||||
|
*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
US12OF.
14
In
January 2010, the Financial Accounting Standards Board issued Accounting
Standards Update (“ASU”)
No. 2010-06 “Improving
Disclosures about Fair Value Measurements.” ASU No. 2010-06 clarifies existing
disclosure and
requires additional
disclosures regarding fair value measurements. Effective for fiscal years
beginning
after
December 15, 2010, and for interim periods within those fiscal years, entities
will need to disclose information
about purchases, sales,
issuances and settlements of Level 3 securities on a gross basis, rather than as
a net number as currently required. The implementation of ASU No. 2010-06 will
have no impact on US12OF’s financial statement disclosures.
US12OF
has performed an evaluation of subsequent events through the date the financial
statements were issued. This evaluation did not result in any subsequent events
that necessitated disclosures and/or adjustments.
15
The
following discussion should be read in conjunction with the condensed financial
statements and the notes thereto of the United States 12 Month Oil Fund, LP
(“US12OF”) 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 US12OF’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 US12OF’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
US12OF cannot assure investors that the projections included in these
forward-looking statements will come to pass. US12OF’s actual results could
differ materially from those expressed or implied by the forward-looking
statements as a result of various factors.
US12OF
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 US12OF assumes no obligation to update any such
forward-looking statements. Although US12OF 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 US12OF may make directly to them or through
reports that US12OF 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
US12OF, 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 US12OF is for the changes in percentage terms of its units’ net
asset value (“NAV”) to reflect the changes in percentage terms of the spot price
of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the
changes in the average of the prices of 12 futures contracts for light, sweet
crude oil traded on the New York Mercantile Exchange (the “NYMEX”) consisting of
the near month contract to expire and the contracts for the following 11 months
for a total of 12 consecutive months’ contracts, 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 and the contracts
for the following 11 consecutive months (the “Benchmark Futures Contracts”),
less US12OF’s expenses.
US12OF
invests in futures contracts for light, sweet crude oil, other types of
crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels
that are traded on the NYMEX, ICE Futures or other U.S. and foreign exchanges
(collectively, “Oil Futures Contracts”) and other oil interests such as
cash-settled options on Oil Futures Contracts, forward contracts for oil,
cleared swap contracts and over-the-counter transactions that are based on the
price of crude oil, other petroleum-based fuels, Oil Futures Contracts and
indices based on the foregoing (collectively, “Other Oil Interests”). For
convenience and unless otherwise specified, Oil Futures Contracts and Other Oil
Interests collectively are referred to as “Oil Interests” in this quarterly
report on Form 10-Q.
US12OF
seeks to achieve its investment objective by investing in a combination of Oil
Futures Contracts and Other Oil Interests such that changes in its NAV, measured
in percentage terms, will closely track the changes in the average of the prices
of the Benchmark Futures Contracts, also measured in percentage terms. US12OF’s
general partner believes the daily changes in the average of the prices of the
Benchmark Futures Contracts have historically exhibited a close correlation with
the daily changes in the spot price of light, sweet crude oil. It is
not the intent of US12OF to be operated in a fashion such that the NAV will
equal, in dollar terms, the spot price of light, sweet crude oil or any
particular futures contract based on light, sweet crude oil. Management believes
that it is not practical to manage the portfolio to achieve such an investment
goal when investing in Oil Futures Contracts and Other Oil
Interests.
16
On any
valuation day, the Benchmark Futures Contracts are the near month futures
contract for light, sweet crude oil traded on the NYMEX and the contracts
for the following 11 months for a total of 12 consecutive months’ contracts
unless the near month contract is within two weeks of expiration, in which case
the Benchmark Futures Contracts are the next month contract for light, sweet
crude oil traded on the NYMEX and the contracts for the following 11 consecutive
months. “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.
The
regulation of commodity interests in the United States is a rapidly changing
area of law and is subject to ongoing modification by governmental and judicial
action. As stated under the heading, “Risk Factors” in Item 1A of
US12OF’s annual report on Form 10-K for the year ended December 31, 2009,
regulation of the commodity interests and energy markets is extensive and
constantly changing; future regulatory developments in the commodity interests
and energy markets are impossible to predict but may significantly and adversely
affect US12OF.
On July
21, 2010, a broad financial regulatory reform bill, “The Dodd-Frank Wall Street
Reform and Consumer Protection Act,” was signed into law that includes
provisions altering the regulation of commodity interests. Provisions
in the new law include the requirement that position limits on energy-based
commodity futures contracts be established; new registration, recordkeeping,
capital and margin requirements for “swap dealers” and “major swap participants”
as determined by the new law and applicable regulations; and the forced use of
clearinghouse mechanisms for most over-the-counter transactions. Additionally,
the new law requires the aggregation, for purposes of position limits, of all
positions in energy futures held by a single entity and its affiliates, whether
such positions exist on U.S. futures exchanges, non-U.S. futures exchanges, or
in over-the-counter contracts. The U.S. Commodity Futures Trading Commission
(the “CFTC”), along with the SEC and other federal regulators, has been tasked
with developing the rules and regulations enacting the provisions noted
above. The new law and the rules to be promulgated may negatively
impact US12OF’s ability to meet its investment objective either through limits
or requirements imposed on it or upon its counterparties. In
particular, new position limits imposed on US12OF or its counterparties may
impact US12OF’s ability to invest in a manner that most efficiently meets its
investment objective, and new requirements, including capital and mandatory
clearing, may increase the cost of US12OF’s investments and doing business,
which could adversely affect US12OF’s investors.
The
general partner of US12OF, United States Commodity Funds LLC (the “General
Partner”), which is registered as a commodity pool operator (“CPO”) with
the CFTC, is authorized by the Amended and Restated Agreement of Limited
Partnership of US12OF (the “LP Agreement”) to manage US12OF. The General Partner
is authorized by US12OF in its sole judgment to employ and establish the terms
of employment for, and termination of, commodity trading advisors or futures
commission merchants.
Price
Movements
Crude oil
futures prices were volatile during the six months ended June 30, 2010 and
exhibited moderate daily swings along with an uneven upward trend between
January and late April and a downward trend from May to late June
2010. The average price of the Benchmark Futures Contracts started
the period at $82.15 per barrel. Average prices hit a peak on May 3,
2010 of $92.05 per barrel. The low of the period was on May 25,
2010 when prices reached $72.75 per barrel. The period ended with the
average price of the Benchmark Futures Contracts at $77.85 per barrel, down
approximately -5.23% over the period. Similarly, US12OF’s NAV started
the period at a level of $40.37 per unit. US12OF’s NAV rose to a high
on May 3, 2010, of $44.30 per unit and reached its low for the period on May 25,
2010 at $34.69 per unit. The NAV on June 30, 2010 was $36.80, down
approximately 8.84% over the period. The average Benchmark Futures Contract
prices listed above began with the February 2010 to January 2011 contracts and
ended with the August 2010 to July 2011 contracts. The return of approximately
-5.23% on the average price of the Benchmark Futures Contracts listed above is a
hypothetical return only and could not actually be achieved by an investor
holding Futures Contracts. An investment in Oil Futures Contracts would need to
be rolled forward during the time period described in order to achieve such a
result. Furthermore, the change in the nominal price of these differing crude
Oil Futures Contracts, measured from the start of the period to the end of the
period, does not represent the actual benchmark results that US12OF seeks to
track, which are more fully described below in the section titled “Tracking
US12OF’s Benchmark”.
17
During
the six months ended June 30, 2010, the level of contango remained mildly steep,
meaning that the price of the near month crude Oil Futures Contract is 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 for the remainder of
2009 and the beginning of 2010. During the six months ended June 30,
2010, crude oil inventories began to climb higher, which contributed to the
crude oil futures market remaining in contango through the end of June 2010. 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.”
Valuation
of Futures Contracts and the Computation of the NAV
The NAV
of US12OF’s units is calculated once each NYSE Arca trading day. The 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. US12OF’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 US12OF 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 December 6, 2007, US12OF listed its units on the
American Stock Exchange (the “AMEX”) under the ticker symbol “USL.” On that day,
US12OF established its initial offering price at $50.00 per unit and issued
300,000 units to the initial authorized purchaser, Merrill Lynch Professional
Clearing Corp., in exchange for $15,001,000 in cash. As a result of the
acquisition of the AMEX by NYSE Euronext, US12OF’s units no longer trade on the
AMEX and commenced trading on the NYSE Arca on November 25, 2008.
Since its
initial offering of 11,000,000 units, US12OF has made one subsequent offering of
its units: 100,000,000 units which were registered with the SEC on March
31, 2009. As of June 30, 2010, US12OF had issued 7,900,000 units and
had 4,200,000 units outstanding. As of June 30, 2010, there were 103,100,000
units registered but not yet issued.
More
units may have been issued by US12OF 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 US12OF cannot
be resold by US12OF. As a result, US12OF contemplates that additional offerings
of its units will be registered with the SEC in the future in anticipation
of additional issuances and redemptions.
For the Six Months Ended
June 30, 2010 Compared to the Six Months Ended June 30, 200
9
As of
June 30, 2010, the total unrealized loss on Oil Futures Contracts owned or
held on that day was $6,474,060 and US12OF established cash deposits,
including cash investments in money market funds, that were equal to
$161,397,049. US12OF held 85.17% of its cash assets in overnight deposits and
money market funds at its custodian bank, while 14.83% of the cash balance was
held as margin deposits for the Oil Futures Contracts purchased. The
ending per unit NAV on June 30, 2010 was $36.80.
By
comparison, as of June 30, 2009, the total unrealized gain on Oil Futures
Contracts owned or held on that day was $42,823,360 and US12OF established cash
deposits, including cash investments in money market funds, that were equal to
$138,381,031. US12OF held 104.74% of its cash assets in overnight
deposits and money market funds at its custodian bank, while -4.74% of the cash
balance was held as margin deposits for the Oil Futures Contracts purchased.
Margin requirements at this time were satisfied by unrealized appreciation on
investments held at the futures commission merchant, including a forward funding
excess of $17,001,780 in open equity over the required margin deposit amount.
The ending per unit NAV on June 30, 2009 was $37.75. The decrease in the per
unit NAV from June 30, 2009 compared to June 30, 2010 was primarily a result of
lower prices for crude oil and the related decrease in the value of the Oil
Futures Contracts that US12OF had invested in between the period ended June 30,
2009 and the period ended June 30, 2010.
18
Portfolio Expenses
. US12OF’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 the General Partner and expenses
relating to tax accounting and reporting requirements. The management
fee that US12OF pays to the General Partner is calculated as a percentage of the
total net assets of US12OF. US12OF pays the General Partner a
management fee of 0.60% of its average net assets. The fee is accrued daily
and paid monthly.
During
the six months ended June 30, 2010, the daily average total net assets
of US12OF were $157,830,072. The management fee paid by US12OF during the
period amounted to $469,598. By comparison, during the six months ended June 30,
2009, the daily average total net assets of US12OF were $122,252,443.
During the six months ended June 30, 2009, the management fee paid by US12OF
amounted to $363,743.
In
addition to the management fee, US12OF pays all brokerage fees and other
expenses, including certain 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 total of these fees and expenses for the six
months ended June 30, 2010 was $299,999, as compared to $229,416 for the six
months ended June 30, 2009. The increase in expenses from the six months ended
June 30, 2009 as compared to the six months ended June 30, 2010 was primarily
due to
an
increase in the management fee as a result of US12OF’s increased size
during the six months ended June 30, 2010. For the six
months ended June 30, 2010, US12OF incurred $5,860 in ongoing registration
fees and other expenses relating to the registration and offering of additional
units. By comparison, for the six months ended June 30, 2009, US12OF
incurred $66,500 in ongoing registration fees and other expenses relating to the
registration and offering of additional units.
US12OF is
responsible for paying its portion of the directors’ and officers’ liability
insurance of the General Partner and the fees and expenses of the independent
directors of the General Partner who are also the General Partner’s audit
committee members. US12OF shares these fees and expenses with the
United States Oil Fund, LP (“USOF”), the United States Natural Gas Fund, LP
(“USNG”), the United States Gasoline Fund, LP (“UGA”), the United States
Heating Oil Fund, LP (“USHO”), the United States Short Oil Fund, LP (“USSO”),
the United States 12 Month Natural Gas Fund, LP (“US12NG”) and the United States
Brent Oil Fund, LP (“USBO”), based on the relative assets of each fund computed
on a daily basis. These fees and expenses for the calendar year 2010 are
estimated to be a total of $1,178,870 for all funds. By comparison, for the year
ended December 31, 2009, these fees and expenses amounted to a total of $433,046
for all funds, and US12OF’s portion of such fees was
$12,326. Directors’ expenses are expected to increase in 2010 due to
an increase in the amount of directors’ and officers’ liability insurance
coverage and the incurrence of the independent directors’ deferred compensation
expense. Effective as of March 3, 2009, the General Partner obtained
directors’ and officers’ liability insurance covering all of the directors and
officers of the General Partner. Previously, the General Partner did not have
liability insurance for its directors and officers; instead, the independent
directors received a payment in lieu of directors’ and officers’ liability
insurance coverage. Effective as of April 1, 2010, US12OF is also responsible
for paying its portion of any payments that may become due to the independent
directors pursuant to the deferred compensation agreements entered into between
the independent directors, the General Partner and each of the
funds.
US12OF
also incurs commissions to brokers for the purchase and sale of Oil Futures
Contracts, Other Oil Interests or short-term obligations of the United
States of two years or less (“Treasuries”). During the six months ended June 30,
2010, total commissions paid to brokers amounted to $4,089. By
comparison, during the six months ended June 30, 2009, total commissions paid to
brokers amounted to $39,009. The decrease in the total commissions
paid to brokers from the six months ended June 30, 2010 compared to the six
months ended June 30, 2009 was primarily a function of the decrease in creations
and redemptions of units during the six months ended June 30,
2010. The decrease in creation and redemption activity required
US12OF to purchase fewer futures contracts and incur a lower amount of
commissions. As an annualized percentage of total net assets,
the figure for the six months ended June 30, 2010 represents approximately
0.01% of total net assets. By comparison, the figure for the six months ended
June 30, 2009 represented approximately 0.06% of total net assets. However,
there can be no assurance that commission costs and portfolio turnover will not
cause commission expenses to rise in future quarters.
The fees
and expenses associated with US12OF’s audit expenses and tax accounting and
reporting requirements are paid by US12OF. These costs are estimated
to be $247,799 for the calendar year 2010.
19
Dividend and Interest
Income
. US12OF seeks to invest its assets such that it
holds Oil Futures Contracts and Other Oil Interests in an amount equal to
the total net assets of its portfolio. Typically, such investments do not
require US12OF to pay the full amount of the contract value at the time of
purchase, but rather require US12OF to post an amount as a margin deposit
against the eventual settlement of the contract. As a result, US12OF retains an
amount that is approximately equal to its total net assets, which US12OF invests
in Treasuries, cash and/or cash equivalents. This includes both the amount
on deposit with the futures commission merchant as margin, as well as
unrestricted cash and cash equivalents held with US12OF’s custodian bank. The
Treasuries, cash and/or cash equivalents earn income that accrues on a daily
basis. For the six months ended June 30, 2010, US12OF earned $26,293 in dividend
and interest income on such cash and/or cash equivalents. Based on
US12OF’s average daily total net assets, this was equivalent to an annualized
yield of 0.03%. US12OF did not purchase Treasuries during the
six months ended June 30, 2010 and held only cash and/or cash equivalents during
this time period. By comparison, for the six months ended June 30,
2009, US12OF earned $123,589 in dividend and interest income on such cash and/or
cash equivalents. Based on US12OF’s average daily total net assets,
this was equivalent to an annualized yield of 0.20%. US12OF did not
purchase Treasuries during the six months ended June 30, 2009 and held only
cash and/or cash equivalents during this time period. Interest rates on
short-term investments, including cash, cash equivalents and Treasuries, were
sharply lower during the six months ended June 30, 2010 compared to the same
time period in 2009. As a result, the amount of income earned by US12OF as a
percentage of total net assets was lower during the six months ended June 30,
2010 compared to the six months ended June 30, 2009.
For the Three Months Ended
June 30, 2010 Compared to the Three Months Ended June 30,
2009
Portfolio
Expenses
. During the three months ended June 30, 2010, the
daily average total net assets of US12OF were $155,112,329. The management
fee paid by US12OF during the period amounted to $232,031. By comparison, during
the three months ended June 30, 2009, the daily average total net assets
of US12OF were $178,141,463. During the three months ended June 30,
2009, the management fee paid by US12OF amounted to $266,480.
In
addition to the management fee, US12OF pays all brokerage fees and other
expenses, including certain tax reporting costs, licensing fees for the use of
intellectual property, ongoing registration or other fees paid to the
SEC, 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
total of these fees and expenses for the three months ended June 30, 2010 was
$111,409, as compared to $149,313 for the three months ended June 30,
2009. The decrease in expenses from the three months ended June 30,
2009 as compared to the three months ended June 30, 2010 was primarily due to
decreased commissions, fewer creations and redemptions, and lower reporting
costs during the three months ended June 30, 2010. For the three
months ended June 30, 2010, US12OF incurred $1,820 in ongoing registration
fees and other expenses relating to the registration and offering of additional
units. By comparison, for the three months ended June 30, 2009, US12OF
incurred $45,500 in ongoing registration fees and other expenses relating to the
registration and offering of additional units.
US12OF is
responsible for paying its portion of the directors’ and officers’ liability
insurance of the General Partner and the fees and expenses of the independent
directors of the General Partner who are also the General Partner’s audit
committee members. US12OF shares these fees and expenses with USOF,
USNG, UGA, USHO, USSO, US12NG and USBO based on the relative assets of each
fund computed on a daily basis. These fees and expenses for the calendar year
2010 are estimated to be a total of $1,178,870 for all funds. By comparison, for
the year ended December 31, 2009, these fees and expenses amounted to a total of
$433,046 for all funds, and US12OF’s portion of such fees was $12,326.
Directors’ expenses are expected to increase in 2010 due to an increase in the
amount of directors’ and officers’ liability insurance coverage and the
incurrence of the independent directors’ deferred compensation expense.
Effective as of March 3, 2009, the General Partner obtained directors’ and
officers’ liability insurance covering all of the directors and officers of the
General Partner. Previously, the General Partner did not have liability
insurance for its directors and officers; instead, the independent directors
received a payment in lieu of directors’ and officers’ liability insurance
coverage. Effective as of April 1, 2010, US12OF is also responsible for paying
its portion of any payments that may become due to the independent directors
pursuant to the deferred compensation agreements entered into between the
independent directors, the General Partner and each of the
funds.
20
US12OF
also incurs commissions to brokers for the purchase and sale of Oil Futures
Contracts, Other Oil Interests or Treasuries. During the three months ended
June 30, 2010, total commissions paid to brokers amounted to
$(1,051). By comparison, during the three months ended June 30, 2009,
total commissions paid to brokers amounted to $10,242. The decrease
in the total commissions paid to brokers from the three months ended June 30,
2010 compared to the three months ended June 30, 2009 was primarily a function
of the decrease in creations and redemptions of units during the three months
ended June 30, 2010. The decrease in creation and redemption activity
required US12OF to purchase fewer futures contracts and incur a lower amount of
commissions. As an annualized percentage of total net assets, the figure
for the three months ended June 30, 2010 represents approximately 0.00% of total
net assets. By comparison, the figure for the three months ended June 30, 2009
represented approximately 0.02% of total net assets. However, there can be no
assurance that commission costs and portfolio turnover will not cause commission
expenses to rise in future quarters.
The fees
and expenses associated with US12OF’s audit expenses and tax accounting and
reporting requirements are paid by US12OF. These costs are estimated
to be $247,799 for the calendar year 2010.
Dividend and Interest
Income
. US12OF seeks to invest its assets such that it
holds Oil Futures Contracts and Other Oil Interests in an amount equal to
the total net assets of its portfolio. Typically, such investments do not
require US12OF to pay the full amount of the contract value at the time of
purchase, but rather require US12OF to post an amount as a margin deposit
against the eventual settlement of the contract. As a result, US12OF retains an
amount that is approximately equal to its total net assets, which US12OF invests
in Treasuries, cash and/or cash equivalents. This includes both the amount
on deposit with the futures commission merchant as margin, as well as
unrestricted cash and cash equivalents held with US12OF’s custodian bank. The
Treasuries, cash and/or cash equivalents earn income that accrues on a daily
basis. For the three months ended June 30, 2010, US12OF earned $16,250 in
dividend and interest income on such cash and/or cash
equivalents. Based on US12OF’s average daily total net assets, this
was equivalent to an annualized yield of 0.04%. US12OF did not
purchase Treasuries during the three months ended June 30, 2010 and held
only cash and/or cash equivalents during this time period. By
comparison, for the three months ended June 30, 2009, US12OF earned $78,968 in
dividend and interest income on such cash and/or cash
equivalents. Based on US12OF’s average daily total net assets, this
was equivalent to an annualized yield of 0.18%. US12OF did not
purchase Treasuries during the three months ended June 30, 2009 and held
only cash and/or cash equivalents during this time period. Interest
rates on short-term investments, including cash, cash equivalents, and
Treasuries, were sharply lower during the three months ended June 30, 2010
compared to the same time period in 2009. As a result, the amount of income
earned by US12OF as a percentage of total net assets was lower during the three
months ended June 30, 2010 compared to the three months ended June 30,
2009.
Tracking
US12OF’s Benchmark
US12OF’s
management seeks to manage US12OF’s portfolio such that changes in its average
daily NAV, on a percentage basis, closely track the changes in the average of
the daily prices of the Benchmark Futures Contracts, also on a percentage basis.
Specifically, US12OF’s management seeks to manage the portfolio such that over
any rolling period of 30 valuation days, the average daily change in US12OF’s
NAV is within a range of 90% to 110% (0.9 to 1.1) of the average daily change in
the prices of the Benchmark Futures Contracts. As an example, if the
average daily movement of the average of the prices of the
Benchmark Futures Contracts for a particular 30-day time period was 0.5%
per day, US12OF management would attempt to manage the portfolio such that the
average daily movement of the NAV during that same time period fell between
0.45% and 0.55% (
i.e
.,
between 0.9 and 1.1 of the benchmark’s results). US12OF’s portfolio management
goals do not include trying to make the nominal price of US12OF’s NAV equal to
the average of the nominal prices of the current Benchmark Futures
Contracts or the spot price for light, sweet crude oil. Management believes that
it is not practical to manage the portfolio to achieve such an investment goal
when investing in listed Oil Futures Contracts.
For the
30 valuation days ended June 30, 2010, the simple average daily change in the
Benchmark Futures Contracts was 0.026%, while the simple average daily change in
the NAV of US12OF over the same time period was 0.023%. The average daily
difference was -0.003% (or -0.3 basis points, where 1 basis point equals 1/100
of 1%). As a percentage of the daily movement of the Benchmark Futures
Contracts, the average error in daily tracking by the NAV was -1.270%, meaning
that over this time period US12OF’s tracking error was within the plus or minus
10% range established as its benchmark tracking goal. A significant
portion of the level of US12OF’s relative tracking error as a percentage of the
benchmark move can be explained by periods of flat price returns. The
first chart below shows the daily movement of US12OF’s NAV versus the daily
movement of the Benchmark Futures Contracts for the 30-day valuation period
ended June 30, 2010.
21
*PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
22
*PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Since the offering of US12OF units to
the public on December 6, 2007 to June 30, 2010, the simple average daily
change in the Benchmark Futures Contracts was -0.014%, while the simple
average daily change in the NAV of US12OF over the same time period was -0.014%.
There was a 0% average daily difference (or 0 basis points, where 1 basis point
equals 1/100 of 1%). As a percentage of the daily movement of the
Benchmark Futures Contracts, the average error in daily tracking by the NAV
was -0.051%, meaning that over this time period US12OF’s tracking error was
within the plus or minus 10% range established as its benchmark tracking
goa
l.
An
alternative tracking measurement of the return performance of US12OF versus the
return of its Benchmark Futures Contracts can be calculated by comparing
the actual return of US12OF, measured by changes in its NAV, versus the
expected
changes in its
NAV under the assumption that US12OF’s returns had been exactly the same as the
daily changes in its Benchmark Futures Contracts.
For the
six months ended June 30, 2010, the actual total return of US12OF as measured by
changes in its NAV was -8.84%. This is based on an initial
NAV of $40.37 on December 31, 2009 and an ending NAV as of June 30,
2010 of $36.80. During this time period, US12OF made no distributions to its
unitholders. However, if US12OF’s daily changes in its NAV had instead exactly
tracked the changes in the daily return of the Benchmark Futures Contracts,
US12OF would have had an estimated NAV of $36.98 as of June 30, 2010, for a
total return over the relevant time period of -8.40%. The difference
between the actual NAV total return of US12OF of -8.84% and the expected total
return based on the Benchmark Futures Contracts of -8.40% was an error over the
time period of -0.44%, which is to say that US12OF’s actual total return
underperformed the benchmark result by that percentage. Management believes that
a portion of the difference between the actual return and the expected benchmark
return can be attributed to the net impact of the expenses and the income that
US12OF collects on its cash and cash equivalent holdings. During the
six months ended June 30, 2010, US12OF received dividend and interest income of
$16,250, which is equivalent to a weighted average income rate of 0.04% for such
period. In addition, during the six months ended June 30, 2010, US12OF also
collected $3,000 from its Authorized Purchasers for creating or redeeming
baskets of units. This income also contributed to US12OF’s actual
return. However, if the total assets of US12OF continue to increase,
management believes that the impact on total returns of these fees from
creations and redemptions will diminish as a percentage of the total return.
During the six months ended June 30, 2010, US12OF incurred total expenses of
$768,897. Expenses net of income from dividends and interest and Authorized
Purchaser collections was $(739,604), which is equivalent to an
annualized weighted average net income rate of (0.94)% for the six months
ended June 30, 2010. These net expenses also contributed to US12OF’s
actual return trailing the benchmark results.
23
By
comparison, for the six months ended June 30, 2009, the actual total return of
US12OF as measured by changes in its NAV was 20.84%. This was based on an
initial NAV of $31.24 on December 31, 2008 and an ending NAV as of
June 30, 2009 of $37.75. During this time period, US12OF made no distributions
to its unitholders. However, if US12OF’s daily changes in its NAV had instead
exactly tracked the changes in the daily return of the Benchmark Futures
Contracts, US12OF would have had an estimated NAV of $37.84 as of June 30, 2009,
for a total return over the relevant time period of 21.13%. The difference
between the actual NAV total return of US12OF of 20.84% and the expected total
return based on the Benchmark Futures Contracts of 21.13% was an error over the
time period of -1.51%, which is to say that US12OF’s actual total return trailed
the benchmark result by that percentage. Management believes that a portion of
the difference between the actual return and the expected benchmark return can
be attributed to the net impact of the expenses and the income that US12OF
collected on its cash and cash equivalent holdings. During the six months ended
June 30, 2009, US12OF received dividend and interest income of $123,589, which
is equivalent to a weighted average income rate of 0.20% for such
period. In addition, during the six months ended June 30, 2009,
US12OF also collected $23,000 from its Authorized Purchasers for creating
or redeeming baskets of units. This income also contributed to US12OF’s actual
return. During the six months ended June 30, 2009, US12OF incurred net expenses
of $581,932. Expenses net of dividends and interest income and
Authorized Purchaser collections was $(435,343), which is equivalent to an
annualized weighted average net income rate of (0.72)% for the six months
ended June 30, 2009. These net expenses also contributed to US12OF’s
actual return trailing the benchmark results.
There are
currently three factors that have impacted or are most likely to impact
US12OF’s ability to accurately track its Benchmark Futures
Contracts.
First,
US12OF may buy or sell its holdings in the then current Benchmark Futures
Contracts at a price other than the closing settlement price of that contract on
the day during which US12OF executes the trade. In that case, US12OF may pay a
price that is higher, or lower, than that of the Benchmark Futures
Contracts, which could cause the changes in the daily NAV of US12OF to
either be too high or too low relative to the changes in the Benchmark Futures
Contracts. During the six months ended June 30, 2010, management attempted to
minimize the effect of these transactions by seeking to execute its purchase or
sale of the Benchmark Futures Contracts at, or as close as possible to, the
end of the day settlement price. However, it may not always be possible for
US12OF 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 US12OF’s attempt to track the Benchmark Futures Contracts over
time.
Second,
US12OF earns dividend and interest income on its cash and cash equivalents.
US12OF is not required to distribute any portion of its income to its
unitholders and did not make any distributions to unitholders during the six
months ended June 30, 2010. Interest payments, and any other income, were
retained within the portfolio and added to US12OF’s NAV. When this income
exceeds the level of US12OF’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 the General
Partner), US12OF will realize a net yield that will tend to cause daily
changes in the NAV of US12OF to track slightly higher than daily changes in the
average of the prices of the Benchmark Futures Contracts. During the six
months ended June 30, 2010, US12OF earned, on an annualized basis, approximately
0.03% on its cash holdings. It also incurred cash expenses on an annualized
basis of 0.60% for management fees and approximately 0.01% in brokerage
commission costs related to the purchase and sale of futures contracts, and
0.37% for other expenses. The foregoing fees and expenses resulted in a net
yield on an annualized basis of approximately -0.95% and affected US12OF’s
ability to track its benchmark. If short-term interest rates rise above the
current levels, the level of deviation created by the yield would 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 NAV to underperform the daily returns of the
Benchmark Futures Contracts.
24
Third,
US12OF may hold Other Oil Interests in its portfolio that may fail to
closely track the Benchmark Futures Contracts’ total return movements. In
that case, the error in tracking the Benchmark Futures Contracts could result in
daily changes in the NAV of US12OF that are either too high, or too low,
relative to the daily changes in the Benchmark Futures Contracts. During
the six months ended June 30, 2010, US12OF did not hold any Other Oil Interests.
If US12OF increases in size, and due to its obligations to comply with
regulatory limits, US12OF may invest in Other Oil Interests, which may have the
effect of increasing transaction related expenses and result in increased
tracking error.
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 crude
oil 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.
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 rise as it approaches expiration and becomes the new near month
contract. In this example, the value of the $50 investment would tend to rise
faster than the spot price of crude oil, or fall slower. As a result, it would
be possible in this hypothetical example for the spot price of crude oil to have
risen to $60 after some period of time, while the value of the investment in the
futures contract would have risen to $65, assuming backwardation is large enough
or enough time has elapsed. Similarly, the spot price of crude oil could have
fallen to $40 while the value of an investment in the futures contract could
have fallen to only $45. Over time, if backwardation remained constant, the
difference would continue to increase.
If the
futures market is in contango, the investor would be buying a next month
contract for a higher price than the current near month contract.
Hypothetically, and assuming no other changes to either prevailing crude oil
prices or the price relationship between the spot price, the near month contract
and the next month contract (and ignoring the impact of commission costs and
the 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. In this example, it would mean that the value of the $50
investment would tend to rise slower than the spot price of crude oil, or fall
faster. As a result, it would be possible in this hypothetical example for the
spot price of crude oil to have risen to $60 after some period of time,
while the value of the investment in the futures contract will have risen to
only $55, assuming contango is large enough or enough time has elapsed.
Similarly, the spot price of crude oil could have fallen to $45 while the value
of an investment in the futures contract could have fallen to $40. 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 (2000-2009) for 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).
25
*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 light, sweet crude oil
from the dollar price of the near month contract for 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 2000 and
2009.
26
*
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 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.
27
*PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE 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 US12OF or
any affiliated funds.
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 for the balance
of 2009 and the beginning of 2010. The crude oil futures market remained in
contango through June 30, 2010.
28
The
General Partner believes that holding futures contracts whose expiration dates
are spread out over a 12 month period of time will cause the total return of
such a portfolio to vary compared to a portfolio that holds only a single
month’s contract (such as the near month contract). In particular,
the General Partner believes that the total return of a portfolio holding
contracts with a range of expiration months will be impacted differently by the
price relationship between different contract months of the same commodity
future compared to the total return of a portfolio consisting of the near month
contract. The General Partner believes that based on historical evidence a
portfolio that held futures contracts with a range of expiration dates spread
out over a 12 month period of time would typically be impacted less by the
positive effect of backwardation, and less by the negative effect of contango,
compared to a portfolio that held contracts of a single near month. As a result,
absent the impact of any other factors, a portfolio of 12 different monthly
contracts would tend to have a lower total return than a near month only
portfolio in a backwardation market and a higher total return in a contango
market. However there can be no assurance that such historical
relationships would provide the same or similar results in the
future.
Periods
of contango or backwardation do not materially impact US12OF’s investment
objective of having the percentage changes in its per unit NAV track the
percentage changes in the average of the prices of the Benchmark Futures
Contracts since the impact of backwardation and contango tended to equally
impact the percentage changes in price of both US12OF’s units and the
Benchmark Futures Contracts. 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
six months ended June 30, 2010, crude oil prices were impacted by several
factors. On the consumption side, demand increased inside and outside the United
States as global economic growth, including emerging economies such as China and
India, improved for the second quarter of the year. On the supply side, efforts
to reduce production by the Organization of the Petroleum Exporting Countries to
more closely match global consumption were partially successful. Crude oil
prices did finish the second quarter of 2010 approximately 4.70% lower than at
the beginning of the year, though investors looked forward to continued
improvements in the global economy. Management believes, however, 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.
Crude Oil Price Movements in
Comparison to Other Energy Commodities and Investment Categories.
The
General Partner 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 indicating 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 or 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 2000 and 2009, the chart 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, heating oil, and unleaded
gasoline, as well as several major non-commodity investment asset classes, such
as large cap U.S. equities, 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 large cap U.S. equities, U.S. government bonds or global equities.
However, movements in crude oil had a strong positive correlation to movements
in heating oil and unleaded gasoline. Finally, crude oil had a positive, but
weaker, correlation with natural gas.
29
|
10 Year Correlation
Matrix 2000-2009
|
Large
Cap
U.S.
Equities
(S&P
500)
|
U.S. Gov’t.
Bonds
(EFFAS
U.S. Gov’t.
Bond Index)
|
Global
Equities
(FTSE
World
Index)
|
Unleaded
Gasoline
|
Natural
Gas
|
Heating
Oil
|
Crude
Oil
|
|||||||||||||||||||||
|
Large
Cap U.S. Equities (S&P 500)
|
1.000 | -0.259 | 0.966 | 0.135 | 0.087 | 0.023 | 0.152 | |||||||||||||||||||||
|
U.S.
Gov’t. Bonds (EFFAS U.S. Gov’t. Bond Index)
|
1.000 | -0.237 | -0.214 | -0.078 | 0.128 | -0.127 | ||||||||||||||||||||||
|
Global
Equities (FTSE World Index)
|
1.000 | 0.196 | 0.165 | 0.084 | 0.246 | |||||||||||||||||||||||
|
Unleaded
Gasoline
|
1.000 | 0.613 | 0.257 | 0.724 | ||||||||||||||||||||||||
|
Natural
Gas
|
1.000 | 0.466 | 0.334 | |||||||||||||||||||||||||
|
Heating
Oil
|
1.000 | 0.783 | ||||||||||||||||||||||||||
|
Crude
Oil
|
1.000 | |||||||||||||||||||||||||||
|
source:
Bloomberg, NYMEX
|
||||||||||||||||||||||||||||
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
The chart
below covers a more recent, but much shorter, range of dates than the above
chart. Over the one year period ended June 30, 2010, crude oil continued to have
a strong positive correlation with heating oil and unleaded gasoline. During
this period, it had no positive or negative correlation with the movements of
natural gas compared to what it had displayed over the ten year period ended
December 31, 2009. Notably, the correlation between crude oil and both large cap
U.S. equities and global equities, which had been essentially non-correlated
over the ten year period ended December 31, 2009, displayed results that
indicated that they had a mildly positive correlation over this shorter time
period. Finally, the results showed that crude oil and U.S. government bonds,
which had essentially been non-correlated for the ten year period ended December
31, 2009, were negatively correlated over this more recent time
period.
|
Correlation Matrix 12
months ended
June 30, 2010
|
Large
Cap
U.S.
Equities
(S&P
500)
|
U.S.
Gov't.
Bonds
(EFFAS
U.S.
Gov’t.
Bond
Index)
|
Global
Equities
(FTSE
World
Index)
|
Unleaded
Gasoline
|
Heating
Oil
|
Natural
Gas
|
Crude
Oil
|
|||||||||||||||||||||
|
Large
Cap U.S. Equities (S&P 500)
|
1.000 | -0.400 | 0.968 | 0.460 | 0.613 | -0.125 | 0.495 | |||||||||||||||||||||
|
U.S.
Gov't. Bonds (EFFAS U.S. Gov’t. Bond Index)
|
1.000 | -0.411 | -0.445 | -0.574 | -0.015 | -0.486 | ||||||||||||||||||||||
|
Global
Equities (FTSE World Index)
|
1.000 | 0.471 | 0.635 | -0.079 | 0.523 | |||||||||||||||||||||||
|
Unleaded
Gasoline
|
1.000 | 0.846 | -0.524 | 0.801 | ||||||||||||||||||||||||
|
Heating
Oil
|
1.000 | -0.075 | 0.941 | |||||||||||||||||||||||||
|
Natural
Gas
|
1.000 | -0.089 | ||||||||||||||||||||||||||
|
Crude
Oil
|
1.000 | |||||||||||||||||||||||||||
Source:
Bloomberg, NYMEX
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
30
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. The General Partner believes that
crude oil has historically not demonstrated a strong correlation with equities
or bonds over long periods of time. However, the General Partner 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, the General Partner 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, heating oil and gasoline are
relevant because the General Partner endeavors to invest US12OF’s assets in Oil
Futures Contracts and Other Oil Interests so that daily changes in percentage
terms in US12OF’s NAV correlate as closely as possible with daily changes in
percentage terms in the price of the Benchmark Futures Contracts. If certain
other fuel-based commodity futures contracts do not closely correlate with
the Oil Futures Contracts, then their use could lead to greater tracking error.
As noted above, the General Partner also believes that the changes in percentage
terms in the price of the Benchmark Futures Contracts will closely correlate
with changes in percentage terms in the spot price of 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. US12OF’s application of these policies involves
judgments and actual results may differ from the estimates used.
The
General Partner has evaluated the nature and types of estimates that
it makes in preparing US12OF’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 US12OF 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, US12OF estimates 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
US12OF
has not made, and does not anticipate making, use of borrowings or other lines
of credit to meet its obligations. US12OF has met, and it is anticipated that
US12OF 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.
US12OF’s liquidity needs include: redeeming units, providing margin deposits for
its existing Oil Futures Contracts or the purchase of additional Oil Futures
Contracts and posting collateral for its over-the-counter contracts, if
applicable, and payment of its expenses, summarized below under “Contractual
Obligations.”
US12OF
currently generates cash primarily from (i) the sale of baskets consisting of
100,000 units (“Creation Baskets”) and (ii) income earned on cash and/or
cash equivalents. US12OF has allocated substantially all of its net assets to
trading in Oil Interests. US12OF invests in Oil Interests to the fullest extent
possible without being leveraged or unable to satisfy its current or potential
margin or collateral obligations with respect to its investments in Oil Futures
Contracts and Other Oil Interests. A significant portion of US12OF’s NAV is held
in cash and cash equivalents that are used as margin and as collateral for
its trading in Oil Interests. The balance of the net assets is held in US12OF’s
account at its custodian bank. Income received from US12OF’s money market funds
is paid to US12OF. In prior periods, the amount of cash earned by US12OF from
the sale of Creation Baskets and from income earned has exceeded the amount of
cash required to pay US12OF’s expenses. However, during the six
months ended June 30, 2010, US12OF’s expenses have exceeded income US12OF earned
and the cash earned by the sale of Creation Baskets. During the six
months ended June 30, 2010, US12OF was forced to use other assets to pay cash
expenses, which could cause a drop in US12OF’s NAV over time. To the extent
expenses exceed income, US12OF’s NAV will be negatively
impacted.
31
US12OF’s
investments in 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 US12OF from promptly liquidating its
positions in Oil Futures Contracts. During the six months ended
June 30, 2010, US12OF was not forced to purchase or liquidate any of its
positions while daily limits were in effect; however, US12OF cannot predict
whether such an event may occur in the future.
Prior to
the initial offering of US12OF, all payments with respect to US12OF’s expenses
were paid by the General Partner. US12OF does not have an obligation
or intention to refund such payments by the General Partner. The
General Partner is under no obligation to pay US12OF’s current or future
expenses. Since the initial offering of units, US12OF 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 certain tax reporting costs, (vi) fees and expenses of the independent
directors of the General Partner and (vii) other extraordinary expenses not in
the ordinary course of business, while the General Partner has been responsible
for expenses relating to the fees of US12OF’s marketing agent, administrator and
custodian and registration expenses relating to the initial offering of units.
If the General Partner and US12OF are unsuccessful in raising sufficient
funds to cover these respective expenses or in locating any other source of
funding, US12OF will terminate and investors may lose all or part of their
investment.
Market
Risk
Trading
in Oil Futures Contracts and Other Oil Interests, such as
forwards, involves US12OF entering into contractual commitments to purchase
or sell oil at a specified date in the future. The aggregate market value of
the contracts will significantly exceed US12OF’s future cash requirements
since US12OF intends to close out its open positions prior to settlement. As a
result, US12OF is generally only subject to the risk of loss
arising from the change in value of the contracts. US12OF considers the “fair
value” of its derivative instruments to be the unrealized gain or loss on the
contracts. The market risk associated with US12OF’s commitments to purchase oil
is limited to the aggregate market value of the contracts held. However, should
US12OF 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 US12OF could be unlimited.
US12OF’s
exposure to market risk depends on a number of factors, including the
markets for oil, the volatility of interest rates and foreign exchange rates,
the liquidity of the Oil Futures Contracts and Other Oil Interests markets
and the relationships among the contracts held by US12OF. Drastic
market occurrences could ultimately lead to the loss of all or substantially all
of an investor’s capital.
Credit
Risk
When
US12OF enters into Oil Futures Contracts and Other Oil Interests, it is
exposed to the credit risk that the counterparty will not be able to meet its
obligations. The counterparty for the Oil Futures Contracts traded on the
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 exchange or clearinghouse in connection with trades on the
exchange or through the clearinghouse, 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 US12OF in such
circumstances.
32
The
General Partner attempts to manage the credit risk of US12OF by following
various trading limitations and policies. In particular, US12OF
generally posts margin and/or holds liquid assets that are approximately equal
to the market value of its obligations to counterparties under the Oil
Futures Contracts and Other Oil Interests it holds. The General Partner has
implemented procedures that include, but are not limited to, executing and
clearing trades only with creditworthy parties and/or requiring the posting of
collateral or margin by such parties for the benefit of US12OF to limit its
credit exposure. UBS Securities LLC, US12OF’s commodity broker, or any other
broker that may be retained by US12OF in the future, when acting as US12OF’s
futures commission merchant in accepting orders to purchase or sell Oil Futures
Contracts on United States exchanges, is required by CFTC regulations
to separately account for and segregate as belonging to US12OF, all assets of
US12OF relating to domestic Oil Futures Contracts trading. These futures
commission merchants are not allowed to commingle US12OF’s assets with their
other assets. In addition, the CFTC requires commodity brokers to hold in a
secure account US12OF’s assets related to foreign Oil Futures Contracts
trading.
If, in
the future, US12OF purchases over-the-counter contracts, see “Item 3.
Quantitative and Qualitative Disclosures About Market Risk” of this quarterly
report on Form 10-Q for a discussion of over-the-counter contracts.
As of
June 30, 2010, US12OF had deposits in domestic and foreign financial
institutions, including cash investments in money market funds, in the amount of
$161,397,049. This amount is subject to loss should these institutions cease
operations.
Off
Balance Sheet Financing
As of
June 30, 2010, US12OF has no loan guarantee, credit support or other off-balance
sheet arrangements of any kind other than agreements entered into in the normal
course of business, which may include indemnification provisions relating to
certain risks that service providers undertake in performing services which are
in the best interests of US12OF. While US12OF’s exposure under these
indemnification provisions cannot be estimated, they are not expected to have a
material impact on US12OF’s financial position.
Redemption
Basket Obligation
In order
to meet its investment objective and pay its contractual obligations described
below, US12OF requires liquidity to redeem units, which redemptions must be
in blocks of 100,000 units called “Redemption Baskets”. US12OF 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
US12OF’s
primary contractual obligations are with the General Partner. In return for its
services, the General Partner is entitled to a management fee calculated monthly
as a fixed percentage of US12OF’s NAV, currently 0.60% of NAV on its average
daily net assets.
The
General Partner agreed to pay the start-up costs associated with the
formation of US12OF, primarily its legal, accounting and other costs in
connection with the General Partner’s registration with the CFTC as a CPO and
the registration and listing of US12OF and its units with the SEC, FINRA
and the AMEX, respectively. However, since US12OF’s initial offering of units,
offering costs incurred in connection with registering and listing additional
units of US12OF have been directly borne on an ongoing basis by US12OF, and not
by the General Partner.
The
General Partner pays the fees of US12OF’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 US12OF’s condensed financial statements and its SEC and CFTC
reports. The General Partner and US12OF have also entered into a
licensing agreement with the NYMEX pursuant to which US12OF and the affiliated
funds managed by the General Partner, other than USBO, pay a licensing fee to
the NYMEX. US12OF also pays the fees and expenses associated with its tax
accounting and reporting requirements.
33
In
addition to the General Partner’s management fee, US12OF pays its brokerage fees
(including fees to a futures commission merchant), 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 US12OF’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 futures commission merchant are on a contract-by-contract, or round turn,
basis. US12OF also pays a portion of the fees and expenses of the independent
directors of the General Partner. See Note 3 to the Notes to Condensed
Financial Statements (Unaudited).
The
parties cannot anticipate the amount of payments that will be required under
these arrangements for future periods, as US12OF’s NAVs and trading levels to
meet its investment objectives will not be known until a future date. These
agreements are effective for a specific term agreed upon by the parties with an
option to renew, or, in some cases, are in effect for the duration of US12OF’s
existence. Either party may terminate these agreements earlier for
certain reasons described in the agreements.
As of
June 30, 2010, US12OF’s portfolio consisted of 1,985 Crude Oil Futures CL
Contracts traded on the NYMEX. For a list of US12OF’s current
holdings, please see US12OF’s website at
www.unitedstates12monthoilfund.com.
Over-the-Counter
Derivatives
In the
future, US12OF may purchase over-the-counter contracts. Unlike most of the
exchange-traded Oil Futures Contracts or exchange-traded options on such
futures, each party to an over-the-counter contract bears the credit risk that
the other party may not be able to perform its obligations under its
contract.
Some
crude oil-based derivatives transactions contain fairly generic terms and
conditions and are available from a wide range of participants. Other crude
oil-based derivatives have highly customized terms and conditions and are not as
widely available. Many of these over-the-counter contracts are cash-settled
forwards for the future delivery of crude oil- or petroleum-based fuels that
have terms similar to the Oil Futures Contracts. Others take the form of “swaps”
in which the two parties exchange cash flows based on pre-determined formulas
tied to the spot price of crude oil, forward crude oil prices or crude oil
futures prices. For example, US12OF may enter into over-the-counter derivative
contracts whose value will be tied to changes in the difference between
the spot price of light, sweet crude oil, the price of Oil Futures
Contracts traded on the NYMEX and the prices of other Oil Futures Contracts
in which US12OF may invest.
To
protect itself from the credit risk that arises in connection with such
contracts, US12OF may enter into agreements with each counterparty that provide
for the netting of its overall exposure to such counterparty, such as the
agreements published by the International Swaps and Derivatives Association,
Inc. US12OF also may require that the counterparty be highly rated and/or
provide collateral or other credit support to address US12OF’s exposure to the
counterparty. In addition, it is also possible for US12OF and its counterparty
to agree to clear their transactions under the agreement through an established
futures clearinghouse such as those connected to the NYMEX or the ICE Futures.
In that event, US12OF would no longer bear the credit risk of its original
counterparty, as the clearinghouse would now be US12OF’s counterparty. US12OF
would still retain any price risk associated with its
transaction.
34
The
creditworthiness of each potential counterparty is assessed by the General
Partner. The General Partner assesses or reviews, as appropriate, the
creditworthiness of each potential or existing counterparty to an
over-the-counter contract pursuant to guidelines approved by the General
Partner's board of directors (the “Board”). Furthermore, the General Partner on
behalf of US12OF only enters into over-the-counter contracts with counterparties
who are, or are affiliates of, (a) banks regulated by a United States federal
bank regulator, (b) broker-dealers regulated by the SEC, (c) insurance companies
domiciled in the United States, or (d) producers, users or traders of energy,
whether or not regulated by the CFTC. Any entity acting as a counterparty shall
be regulated in either the United States or the United Kingdom unless otherwise
approved by the Board after consultation with its legal counsel. Existing
counterparties are also reviewed periodically by the General
Partner.
US12OF
anticipates that the use of Other Oil Interests together with its investments in
Oil Futures Contracts will produce price and total return results that closely
track the investment goals of US12OF. However, there can be no
assurance of this. Over-the-counter contracts may result in higher
transaction-related expenses than the brokerage commissions paid in connection
with the purchase of Oil Futures Contracts, which may impact US12OF’s ability to
successfully track the Benchmark Futures Contracts.
US12OF
may employ spreads or straddles in its trading to mitigate the differences in
its investment portfolio and its goal of tracking the price of the
Benchmark Futures Contracts. US12OF would use a spread when it chooses to
take simultaneous long and short positions in futures written on the same
underlying asset, but with different delivery months. The effect of holding such
combined positions is to adjust the sensitivity of US12OF to changes in the
price relationship between futures contracts which will expire sooner and those
that will expire later. US12OF would use such a spread if the General Partner
felt that taking such long and short positions, when combined with the rest of
its holdings, would more closely track the investment goals of US12OF, or if the
General Partner felt it would lead to an overall lower cost of trading to
achieve a given level of economic exposure to movements in oil prices. US12OF
would enter into a straddle when it chooses to take an option position
consisting of a long (or short) position in both a call option and put option.
The economic effect of holding certain combinations of put options and call
options can be very similar to that of owning the underlying futures contracts.
US12OF would make use of such a straddle approach if, in the opinion of the
General Partner, the resulting combination would more closely track the
investment goals of US12OF or if it would lead to an overall lower cost of
trading to achieve a given level of economic exposure to movements in oil
prices.
During
the six months ended June 30, 2010, US12OF did not employ any hedging methods
such as those described above since all of its investments were made over an
exchange. Therefore, during the six months ended June 30, 2010, US12OF was not
exposed to counterparty risk.
Disclosure
Controls and Procedures
US12OF
maintains disclosure controls and procedures that are designed to ensure that
material information required to be disclosed in US12OF’s periodic reports
filed or submitted under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time period specified in
the SEC’s rules and forms.
The duly
appointed officers of the General Partner, including its chief executive
officer and chief financial officer, who perform functions equivalent
to those of a principal executive officer and principal financial officer of
US12OF if US12OF had any officers, have evaluated the effectiveness of US12OF’s
disclosure controls and procedures and have concluded that the disclosure
controls and procedures of US12OF have been effective as of the end of the
period covered by this quarterly report on Form
10-Q.
Change
in Internal Control Over Financial Reporting
There
were no changes in US12OF’s internal control over financial reporting during
US12OF’s last fiscal quarter that have materially affected, or are reasonably
likely to materially affect, US12OF’s internal control over financial
reporting.
35
Not
applicable.
There has
not been a material change from the risk factors previously disclosed in
US12OF’s Annual Report on Form 10-K for the fiscal year ended December 31, 2009,
filed on March 16, 2010, except for the update to the risk factor set forth
below to reflect the passage of The Dodd-Frank Wall Street Reform and Consumer
Protection Act.
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 US12OF.
The
futures markets are subject to comprehensive statutes, regulations, and margin
requirements. In addition, the CFTC and the exchanges are authorized to take
extraordinary actions in the event of a market emergency, including, for
example, the retroactive implementation of speculative position limits or higher
margin requirements, the establishment of daily price limits and the suspension
of trading.
The
regulation of commodity interest transactions in the United States is a rapidly
changing area of law and is subject to ongoing modification by governmental and
judicial action. Considerable regulatory attention has been focused on
non-traditional investment pools which are publicly distributed in the United
States. There is a possibility of future regulatory changes altering, perhaps to
a material extent, the nature of an investment in US12OF or the ability of
US12OF to continue to implement its investment strategy. 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
US12OF is impossible to predict, but could be substantial and
adverse.
In the
wake of the economic crisis of 2008 and 2009, the Administration, federal
regulators and Congress are revisiting the regulation of the financial sector,
including securities and commodities markets. These efforts are likely to result
in significant changes in the regulation of these markets.
On July
21, 2010, a broad financial regulatory reform bill, “The Dodd-Frank Wall Street
Reform and Consumer Protection Act,” was signed into law that includes
provisions altering the regulation of commodity interests. Provisions in the new
law include the requirement that position limits on energy-based commodity
futures contracts be established; new registration, recordkeeping, capital and
margin requirements for “swap dealers” and “major swap participants” as
determined by the new law and applicable regulations; and the forced use of
clearinghouse mechanisms for most over-the-counter transactions. Additionally,
the new law requires the aggregation, for purposes of position limits, of all
positions in energy futures held by a single entity and its affiliates, whether
such positions exist on U.S. futures exchanges, non-U.S. futures exchanges, or
in over-the-counter contracts. The CFTC, along with the SEC and other federal
regulators, has been tasked with developing the rules and regulations enacting
the provisions noted above. The new law and the rules to be promulgated may
negatively impact US12OF’s ability to meet its investment objective either
through limits or requirements imposed on it or upon its counterparties. In
particular, new position limits imposed on US12OF or its counterparties may
impact US12OF’s ability to invest in a manner that most efficiently meets its
investment objective, and new requirements, including capital and mandatory
clearing, may increase the cost of US12OF’s investments and doing business,
which could adversely affect US12OF’s investors.
Not
applicable.
Not
applicable.
Monthly
Account Statements
Pursuant
to the requirement under Rule 4.22 under the Commodity Exchange Act, each month
US12OF publishes an account statement for its unitholders, which includes a
Statement of Income (Loss) and a Statement of Changes in NAV. The account
statement is furnished to the SEC on a current report on Form 8-K pursuant to
Section 13 or 15(d) of the Exchange Act and posted each month on US12OF’s
website at www.unitedstates12monthoilfund.com.
Listed
below are the exhibits which are filed as part of this quarterly report on Form
10-Q (according to the number assigned to them in Item 601 of Regulation
S-K):
|
Exhibit
|
||
|
Number
|
Description of Document
|
|
|
10.9**
|
Form
of United States Commodity Funds LLC Director Deferred Compensation
Agreement.
|
|
|
31.1*
|
Certification
by Principal Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
31.2*
|
Certification
by Principal Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
32.1*
|
Certification
by Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
|
32.2*
|
Certification
by Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
*
|
Filed
herewith.
|
|
**
|
Incorporated
by reference to Exhibit 99.1 to the Registrant’s Current Report on Form
8-K, filed on April 1, 2010.
|
36
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
United
States 12 Month Oil Fund, LP (Registrant)
By:
United States Commodity Funds LLC, its general partner
|
By:
|
/s/
Nicholas D. Gerber
|
|
Nicholas
D. Gerber
|
|
|
President
and Chief Executive Officer
|
|
|
(Principal
executive officer)
|
|
|
Date: August
9, 2010
|
|
|
By:
|
/s/
Howard Mah
|
|
Howard
Mah
|
|
|
Chief
Financial Officer
|
|
|
(Principal
financial and accounting officer)
|
|
|
Date: August
9, 2010
|
|
37
TABLE OF CONTENTS
Part IItem 1. Condensed Financial StatementsNote 1 - Organization and BusinessNote 2 - Summary Of Significant Accounting PoliciesNote 3 - Fees Paid By The Fund and Related Party TransactionsNote 4 - Contracts and AgreementsNote 5 - Financial Instruments, Off-balance Sheet Risks and ContingenciesNote 6 Fair Value Of Financial InstrumentsNote 7 - Financial HighlightsNote 8 Recent Accounting PronouncementsNote 9 Subsequent EventsItem 2. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4 . Controls and ProceduresPart II. Other InformationPart IIItem 1. Legal ProceedingsItem 1A. Risk FactorsItem 2. Unregistered Sales Of Equity Securities and Use Of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. ReservedItem 5. Other InformationItem 6. Exhibits