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Why is the return of an oil fund lower than the return on oil price? The contracts have to roll over at the end of the near expiration date. If it won't roll over then the contract oil barrels will be supplied to the fund.

The fund must sell the oil contract before expiration to companies that are willing to get the supply of oil. Is it true to say that these companies take advantage of the situation and buy the expired contracts at a lower price? This is the reason roll over of contract - contango, leading to lower return than oil itself?

Common explanations - which I think are wrong - are that rolling the contract for contracts with higher future price would lead to buying a smaller number of barrels. However this does not matter at all.

If you hold 100 barrels and the barrel price is $100, or you buy 50 barrels and the future barrel price is $200, in both scenarios you hold assets at a value of $10,000, which are similarly exposed to change in oil price.

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  • The poster might be asking, why is the one-month oil contango currently at 25% ?
    – S Spring
    Apr 17 '20 at 4:00
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I think it is helpful to look at it from a prospective futures contract seller's perspective: if the oil price today is $20, why wouldn't they sell a futures contract for $21?

To make a risk-free profit, the seller would need to buy the oil today and store it until the futures contract expires. If the storage cost is high, this does not work unless the futures price is much higher than the current price. The higher the storage costs, the higher the futures price can be relative to the current price.

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Q: Can someone explain me the mechanism behind rolling future contracts and contango influence of my investment when buying a commodity ETF (like USO)?

I think you will find the ETF does not move on contract rollover: it just switches to track the new contract.

Suppose the May contract ends at $20 and your ETF is tracking at $5, if on rollover the June contract is $25 your ETF will carry on tracking from $5.

So you would lose out on contango and gain on backwardation. I think that's how it goes.

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