UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x
|
Quarterly report pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934 for the
quarterly period ended September 30, 2009.
OR
|
¨
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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 .
|
Commission
File Number: 001-34371
United
States Short Oil Fund, LP
(Exact name of
registrant as specified in its charter)
Delaware
|
|
20-2939256
|
(State
or other jurisdiction of
incorporation
or organization)
|
|
(I.R.S.
Employer
Identification
No.)
|
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.
¨
Yes x 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 ¨
|
|
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|
Non-accelerated filer x
|
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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 SHORT 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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14
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Item
3. Quantitative and Qualitative Disclosures About Market
Risk.
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29
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Item
4. Controls and Procedures.
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30
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Part
II. OTHER INFORMATION
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Item
1. Legal Proceedings.
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31
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Item
1A. Risk Factors.
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31
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Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
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31
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Item
3. Defaults Upon Senior Securities.
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31
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Item
4. Submission of Matters to a Vote of Security Holders.
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31
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Item
5. Other Information.
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31
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Item
6. Exhibits.
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31
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Part I. FINANCIAL
INFORMATION
Item 1. Condensed Financial
Statements.
Index
to Condensed Financial Statements
Documents
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Page
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Condensed
Statements of Financial Condition at September 30, 2009 (Unaudited) and
December 31, 2008
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2
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Condensed
Schedule of Investments (Unaudited) at September 30, 2009
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3
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Condensed
Statement of Operations (Unaudited) for the period from September 24, 2009
(commencement of operations) to September 30, 2009
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4
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|
|
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Condensed
Statement of Changes in Partners’ Capital (Unaudited) for the period from
September 24, 2009 (commencement of operations) to September 30,
2009
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5
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|
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Condensed
Statements of Cash Flows (Unaudited) for the period from September 24,
2009 (commencement of operations) to September 30, 2009 and the period
from June 30, 2008 (inception) to December 31, 2008
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6
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Notes
to Condensed Financial Statements for the period ended September 30,
2009 (Unaudited)
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7
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United
States Short Oil Fund, LP
Condensed
Statements of Financial Condition
At
September 30, 2009 (Unaudited) and December 31, 2008
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September 30, 2009
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December 31, 2008
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Assets
|
|
|
|
|
|
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Cash
and cash equivalents
|
|
$ |
9,100,029 |
|
|
$ |
1,000 |
|
Equity
in UBS Securities LLC trading accounts:
|
|
|
|
|
|
|
|
|
Cash
|
|
|
882,433 |
|
|
|
- |
|
Unrealized
loss on open commodity futures contracts
|
|
|
(271,700 |
) |
|
|
- |
|
Receivable
from general partner
|
|
|
1,628 |
|
|
|
- |
|
Interest
receivable
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|
100 |
|
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|
- |
|
|
|
|
|
|
|
|
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Total
assets
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$ |
9,712,490 |
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|
$ |
1,000 |
|
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|
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Liabilities
and Partners’ Capital
|
|
|
|
|
|
|
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General
Partner management fees payable (Note 3)
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|
$ |
1,189 |
|
|
$ |
- |
|
Brokerage
commission fees payable
|
|
|
300 |
|
|
|
- |
|
Other
liabilities
|
|
|
1,981 |
|
|
|
- |
|
|
|
|
|
|
|
|
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Total
liabilities
|
|
|
3,470 |
|
|
|
- |
|
|
|
|
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Commitments and Contingencies
(Notes 3, 4 and 5)
|
|
|
|
|
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|
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Partners’
Capital
|
|
|
|
|
|
|
|
|
General
Partner
|
|
|
- |
|
|
|
20 |
|
Limited
Partners
|
|
|
9,709,020 |
|
|
|
980 |
|
Total
Partners’ Capital
|
|
|
9,709,020 |
|
|
|
1,000 |
|
|
|
|
|
|
|
|
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Total
liabilities and partners’ capital
|
|
$ |
9,712,490 |
|
|
$ |
1,000 |
|
|
|
|
|
|
|
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Limited
Partners’ units outstanding
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|
200,000 |
|
|
|
- |
|
Net
asset value per unit
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|
$ |
48.55 |
|
|
$ |
- |
|
Market
value per unit
|
|
$ |
48.79 |
|
|
$ |
- |
|
See
accompanying notes to condensed financial statements.
United
States Short Oil Fund, LP
Condensed
Schedule of Investments (Unaudited)
At
September 30, 2009
|
|
Number
of
|
|
|
Loss
on Open
Commodity
|
|
|
%
of
Partners’
|
|
|
|
Contracts
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Contracts
|
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|
Capital
|
|
Open
Futures Contracts – Short
|
|
|
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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 November 2009
|
|
|
138 |
|
|
$ |
(271,700 |
) |
|
|
(2.80 |
) |
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Principal
Amount
|
|
|
Market Value
|
|
|
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Cash
Equivalents
|
|
|
|
|
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United
States - Money Market Funds
|
|
|
|
|
|
|
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Fidelity
Institutional Government Portfolio – Class I
|
|
$ |
3,000,000 |
|
|
$ |
3,000,000 |
|
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|
30.90 |
|
Goldman
Sachs Financial Square Funds – Government Fund – Class SL
|
|
|
3,000,000 |
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|
3,000,000 |
|
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|
30.90 |
|
Total
Cash Equivalents
|
|
|
|
|
|
$ |
6,000,000 |
|
|
|
61.80 |
|
See
accompanying notes to condensed financial statements.
United
States Short Oil Fund, LP
Condensed
Statement of Operations (Unaudited)
For
the period from September 24, 2009 (commencement of operations) to September 30,
2009
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For
the Period from
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September
24, 2009 to
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September 30, 2009
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Income
|
|
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|
Gain
(loss) on trading of commodity futures contracts:
|
|
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|
Realized
loss on closed positions
|
|
$ |
(16,620 |
) |
Change
in unrealized loss on open positions
|
|
|
(271,700 |
) |
Interest
income
|
|
|
129 |
|
|
|
|
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|
Total
loss
|
|
|
(288,191 |
) |
|
|
|
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|
Expenses
|
|
|
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General
Partner management fees (Note 3)
|
|
|
1,189 |
|
Brokerage
commissions
|
|
|
1,247 |
|
Other
expenses
|
|
|
1,981 |
|
|
|
|
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Total
expenses
|
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|
4,417 |
|
|
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Expense
waivers
|
|
|
(1,628 |
) |
|
|
|
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|
Net
expenses
|
|
|
2,789 |
|
|
|
|
|
|
Net
loss
|
|
$ |
(290,980 |
) |
Net
loss per limited partnership unit
|
|
$ |
(1.45 |
) |
Net
loss per weighted average limited partnership unit
|
|
$ |
(1.45 |
) |
Weighted
average limited partnership units outstanding
|
|
|
200,000 |
|
See
accompanying notes to condensed financial statements.
United
States Short Oil Fund, LP
Condensed
Statement of Changes in Partners’ Capital (Unaudited)
For
the period from September 24, 2009 (commencement of operations) to September 30,
2009
|
|
General Partner
|
|
|
Limited Partners
|
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Total
|
|
|
|
|
|
|
|
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Balances,
at December 31, 2008
|
|
$ |
20 |
|
|
$ |
980 |
|
|
$ |
1,000 |
|
Addition
of 200,000 partnership units
|
|
|
- |
|
|
|
10,000,000 |
|
|
|
10,000,000 |
|
Redemption
of 0 partnership units
|
|
|
(20 |
) |
|
|
(980 |
) |
|
|
(1,000 |
) |
Net
loss
|
|
|
- |
|
|
|
(290,980 |
) |
|
|
(290,980 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances,
at September 30, 2009
|
|
$ |
- |
|
|
$ |
9,709,020 |
|
|
$ |
9,709,020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
Asset Value Per Unit
|
|
|
|
|
|
|
|
|
|
|
|
|
At
September 24, 2009 (commencement of operations)
|
|
$ |
50.00 |
|
|
|
|
|
|
|
|
|
At
September 30, 2009
|
|
$ |
48.55 |
|
|
|
|
|
|
|
|
|
See
accompanying notes to condensed financial statements.
United
States Short Oil Fund, LP
Condensed
Statements of Cash Flows (Unaudited)
For
the period from September 24, 2009 (commencement of operations) to September 30,
2009
and
the period from June 30, 2008 (inception) to December 31, 2008
|
|
Period
from
|
|
|
Period
from
|
|
|
|
September 24, 2009
to
September 30, 2009
|
|
|
June 30, 2008
to
December 31, 2008
|
|
Cash
Flows from Operating Activities:
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(290,980 |
) |
|
$ |
- |
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
|
|
|
|
|
|
|
|
Increase
in commodity futures trading account – cash
|
|
|
(882,433 |
) |
|
|
- |
|
Unrealized
loss on futures contracts
|
|
|
271,700 |
|
|
|
- |
|
Increase
in receivable from general partner
|
|
|
(1,628 |
) |
|
|
- |
|
Increase
in interest receivable
|
|
|
(100 |
) |
|
|
- |
|
Increase
in management fees payable
|
|
|
1,189 |
|
|
|
- |
|
Increase
in commission fees payable
|
|
|
300 |
|
|
|
- |
|
Increase
in other liabilities
|
|
|
1,981 |
|
|
|
- |
|
Net
cash used in operating activities
|
|
|
(899,971 |
) |
|
|
- |
|
|
|
|
|
|
|
|
|
|
Cash
Flows from Financing Activities:
|
|
|
|
|
|
|
|
|
Subscription
of partnership units
|
|
|
10,000,000 |
|
|
|
1,000 |
|
Redemption
of partnership units
|
|
|
(1,000 |
) |
|
|
- |
|
|
|
|
|
|
|
|
|
|
Net
cash provided by financing activities
|
|
|
9,999,000 |
|
|
|
1,000 |
|
|
|
|
|
|
|
|
|
|
Net
Increase in Cash and Cash Equivalents
|
|
|
9,099,029 |
|
|
|
1,000 |
|
|
|
|
|
|
|
|
|
|
Cash and Cash
Equivalents, beginning of period
|
|
|
1,000 |
|
|
|
- |
|
Cash and Cash
Equivalents, end of period
|
|
$ |
9,100,029 |
|
|
$ |
1,000 |
|
See
accompanying notes to condensed financial statements.
United
States Short Oil Fund, LP
Notes
to Condensed Financial Statements
For
the period ended September 30, 2009 (Unaudited)
NOTE
1 - ORGANIZATION AND BUSINESS
The
United States Short Oil Fund, LP (“USSO”) was organized as a limited partnership
under the laws of the state of Delaware on June 30, 2008. USSO is a commodity
pool that issues limited partnership units (“units”) that may be purchased and
sold on the NYSE Arca, Inc. (the “NYSE Arca”). USSO 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 January
6, 2009 (the “LP Agreement”). The investment objective of USSO is for the
changes in percentage terms of its units’ net asset value to inversely 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 price of the
futures contract on light, sweet crude oil as traded on the New York Mercantile
Exchange (the “NYMEX”) that is the near month contract to expire, except when
the near month contract is within two weeks of expiration, in which case the
futures contract will become, over a 4-day period, the next month contract to
expire, less USSO’s expenses. USSO accomplishes its objective through
investments in short positions 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, “Futures Contracts”) and other crude
oil-related investments such as cash-settled options on Futures Contracts,
forward contracts for crude oil, and over-the-counter transactions that are
based on the price of crude oil, heating oil, gasoline, natural gas and other
petroleum-based fuels, Futures Contracts and indices based on the foregoing
(collectively, “Other Crude Oil-Related Investments”). As of September 30, 2009,
USSO held 138 Futures Contracts traded on the NYMEX.
USSO
commenced investment operations on September 24, 2009 and has a fiscal year
ending on December 31. United States Commodity Funds LLC (formerly known as
Victoria Bay Asset Management, LLC) (the “General Partner”) is responsible
for the management of USSO. 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 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 12 Month Oil Fund, LP (“US12OF”), the United States Gasoline Fund,
LP (“UGA”) and the United States Heating Oil Fund, LP (“USHO”), which listed
their limited partnership units on the American Stock Exchange (the “AMEX”)
under the ticker symbols “USO” on April 10, 2006, “UNG” on April 18, 2007,
“USL” on December 6, 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, US12OF’s, UGA’s and USHO’s units commenced trading on
the NYSE Arca on November 25, 2008. The General Partner has also filed
registration statements to register units of the United States 12 Month Natural
Gas Fund, LP and the United States Brent Oil Fund, LP.
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. 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.
USSO
issues units to certain authorized purchasers (“Authorized Purchasers”) by
offering baskets consisting of 100,000 units (“Creation Baskets”) through
ALPS Distributors, Inc. (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.
In
addition, Authorized Purchasers pay USSO a $1,000 fee for each order
to create one or more Creation Baskets or 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 USSO but rather at market prices quoted on such
exchange.
In
September 2009, USSO initially registered 25,000,000 units on Form S-1 with the
SEC. On September 24, 2009, USSO listed its units on the NYSE Arca under the
ticker symbol “DNO”. On that day, USSO established its initial net asset
value by setting the price at $50.00 per unit and issued 200,000 units in
exchange for $10,000,000. USSO also commenced investment operations on September
24, 2009 by taking short positions in Futures Contracts traded on the
NYMEX based on light, sweet crude oil. As of September 30, 2009,
USSO had registered a total of 25,000,000 units, and had 200,000 units
outstanding.
NOTE
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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. USSO 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, USSO earns interest
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
USSO 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.
Additions
and Redemptions
Authorized
Purchasers may purchase Creation Baskets or redeem Redemption Baskets only in
blocks of 100,000 units 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.
USSO
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 USSO’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 USSO 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
USSO’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. USSO
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 September 30, 2009.
Offering
Costs
Offering
costs incurred in connection with the registration of additional units after the
initial registration of units are borne by USSO. These costs include
registration fees paid to regulatory agencies and all legal, accounting,
printing and other expenses associated with such offerings. These costs will be
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.
Use
of Estimates
The
preparation of condensed financial statements in conformity with accounting
principles generally accepted in the United States of America requires USSO’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.
NOTE 3
- FEES PAID BY THE FUND AND RELATED PARTY TRANSACTIONS
General
Partner Management Fee
Under the
LP Agreement, the General Partner is responsible for investing the assets of
USSO in accordance with the objectives and policies of USSO. 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 USSO. For these services, USSO is contractually obligated to pay the
General Partner a fee, which is paid monthly and based on average daily net
assets, that is equal to 0.60% per annum on average daily net
assets.
Ongoing
Registration Fees and Other Offering Expenses
USSO 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 period from September 24, 2009 through
September 30, 2009, the Fund incurred no registration fees and other offering
expenses.
Directors’
Fees
USSO 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. USSO shares these fees with USOF, USNG, US12OF, UGA and
USHO based on the relative assets of each fund, computed on a daily basis. These
fees for the calendar year 2009 are estimated to be a total of $477,000 for all
funds.
Licensing
Fees
As
discussed in Note 4, USSO entered into a licensing agreement with the NYMEX
on May 22, 2009. Pursuant to the agreement, USSO and the affiliated funds
managed by the General Partner 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 period from September 24, 2009
through September 30, 2009, USSO incurred $46 under this
arrangement.
Investor
Tax Reporting Cost
The fees
and expenses associated with USSO’s audit expenses and tax accounting and
reporting requirements, with the exception of certain initial implementation
service fees and base service fees which are borne by the General Partner, are
paid by USSO.
Other
Expenses and Fees and Expense Waivers
In
addition to the fees described above, USSO pays all brokerage fees, taxes
and other expenses in connection with the operation of USSO, excluding costs and
expenses paid by the General Partner as outlined in Note 4. The General Partner,
though under no obligation to do so, agreed to pay certain expenses, to the
extent that such expenses exceed 0.15% (15 basis points) of USSO’s NAV, on an
annualized basis, through at least December 31, 2009. The General Partner has no
obligation to continue such payment into subsequent periods.
NOTE
4 - CONTRACTS AND AGREEMENTS
USSO is
party to a marketing agent agreement, dated as of June 8, 2009,
with the Marketing Agent and the General Partner, whereby the Marketing
Agent provides certain marketing services for USSO as outlined in the agreement.
The fee of the Marketing Agent, which is borne by the General Partner, is equal
to 0.06% on USSO’s assets up to $3 billion; and 0.04% on USSO’s assets in excess
of $3 billion.
The above
fees do 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.
USSO is
also party to a custodian agreement, dated October 7, 2008, with Brown Brothers
Harriman & Co. (“BBH&Co.”) and the General Partner, whereby BBH&Co.
holds investments on behalf of USSO. The General Partner pays the fees of
the custodian, which are determined by the parties from time to time. In
addition, USSO is party to an administrative agency agreement, dated October 7,
2008, with the General Partner and BBH&Co., whereby BBH&Co. acts as the
administrative agent, transfer agent and registrar for USSO. 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 USSO 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
USOF’s, USNG’s, US12OF’s, UGA’s, USHO’s and USSO’s combined net assets, (b)
0.0465% for USOF’s, USNG’s, US12OF’s, UGA’s, USHO’s and USSO’s combined net
assets greater than $500 million but less than $1 billion, and (c) 0.035% once
USOF’s, USNG’s, US12OF’s, UGA’s, USHO’s and USSO’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.
USSO has
entered into a brokerage agreement with UBS Securities LLC (“UBS Securities”).
The agreement requires UBS Securities to provide services to USSO in connection
with the purchase and sale of Futures Contracts and Other Crude Oil-Related
Investments that may be purchased and sold by or through UBS Securities for
USSO’s account. The agreement provides that UBS Securities charge USSO
commissions of approximately $7 to $8 per round-turn trade, plus applicable
exchange and NFA fees for Futures Contracts and options on Futures
Contracts.
USSO
invests primarily in Futures Contracts traded on the NYMEX. On May 22, 2009,
USSO and the NYMEX entered into a licensing agreement whereby USSO was granted a
non-exclusive license to use certain of the NYMEX’s settlement prices and
service marks. Under the licensing agreement, USSO and the affiliated funds
managed by the General Partner pay the NYMEX an asset-based fee for the license,
the terms of which are described in Note 3.
USSO
expressly disclaims any association with the NYMEX or endorsement of USSO by the
NYMEX and acknowledges that “NYMEX” and “New York Mercantile Exchange” are
registered trademarks of the NYMEX.
NOTE
5 - FINANCIAL INSTRUMENTS, OFF-BALANCE SHEET RISKS AND
CONTINGENCIES
USSO engages
in the trading of futures contracts, options on futures contracts and cleared
swaps (collectively, “derivatives”). USSO 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.
USSO may
enter into futures contracts, options on futures contracts and cleared swaps to
gain exposure to changes in the value of an underlying commodity. Some futures
contracts may call for physical delivery of the asset, while others are settled
in cash. 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. 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, options on futures contracts and cleared
swaps 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 and cleared swaps 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 USSO 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.
All of
the futures contracts currently traded by USSO 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, USSO must rely solely on the credit of its
respective individual counterparties. However, in the future, if USSO 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. USSO also has credit risk since the sole
counterparty to all domestic and foreign futures contracts is the exchange
on which the relevant contracts are traded. In addition, USSO bears the risk of
financial failure by the clearing broker.
USSO’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 USSO’s assets posted with that futures commission merchant;
however, the vast majority of USSO’s assets are held in Treasuries, cash and/or
cash equivalents with USSO’s custodian and would not be impacted by the
insolvency of a futures commission merchant. Also, the failure or insolvency of
USSO’s custodian could result in a substantial loss of USSO’s
assets.
USSO
invests a portion of its cash in money market funds that seek to maintain a
stable net asset value. USSO is exposed to any risk of loss associated with an
investment in these money market funds. As of September 30, 2009 and December
31, 2008, USSO had deposits in domestic and foreign financial institutions,
including cash investments in money market funds, in the amounts of $9,982,462
and $1,000, 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, USSO 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, USSO 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.
USSO’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, USSO 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 USSO 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.
NOTE 6
– FAIR VALUE OF FINANCIAL INSTRUMENTS
Effective
January 1, 2008, USSO adopted 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 USSO
(observable inputs) and (2) USSO’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.
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 USSO’s securities at September 30,
2009 using the fair value hierarchy:
At September
30, 2009
|
|
Total
|
|
|
Level I
|
|
|
Level II
|
|
|
Level III
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-Term
Investments
|
|
$ |
6,000,000 |
|
|
$ |
6,000,000 |
|
|
$ |
- |
|
|
$ |
- |
|
Exchange-Traded
Futures Contracts
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United
States Contracts
|
|
|
(271,700 |
) |
|
|
(271,700 |
) |
|
|
- |
|
|
|
- |
|
NOTE 7
- FINANCIAL HIGHLIGHTS
The
following table presents per unit performance data and other supplemental
financial data for the period from September 24, 2009 (commencement of
operations) to September 30, 2009 for the limited partners. This information has
been derived from information presented in the condensed financial
statements.
|
|
For
the period from
|
|
|
|
September
24, 2009 to September 30, 2009
|
|
|
|
(Unaudited)
|
|
Per Unit Operating
Performance:
|
|
|
|
|
|
|
|
Net
asset value, beginning of period
|
|
$ |
50.00 |
|
Total
loss
|
|
|
(1.44 |
) |
Total
expenses
|
|
|
(0.01 |
) |
Net
decrease in net asset value
|
|
|
(1.45 |
) |
Net
asset value, end of period
|
|
$ |
48.55 |
|
|
|
|
|
|
Total
Return
|
|
|
(2.90 |
)% |
|
|
|
|
|
Ratios
to Average Net Assets
|
|
|
|
|
Total
loss
|
|
|
(2.79 |
)% |
Management
fees*
|
|
|
0.60 |
% |
Total
expenses excluding management fees*
|
|
|
1.63 |
% |
Expenses
waived*
|
|
|
(0.82 |
)% |
Net
expenses excluding management fees*
|
|
|
0.81 |
% |
Net
loss
|
|
|
(2.82 |
)% |
|
|
|
|
|
*Annualized
|
|
|
|
|
Total
returns are calculated based on the change in value during the period. An
individual limited partner’s total return and ratio may vary from the above
total returns and ratios based on the timing of contributions to and withdrawals
from USSO.
NOTE
8 – RECENTLY ADOPTED ACCOUNTING STANDARDS
In March
2008, the Financial Accounting Standards Board released Accounting Standards
Codification 815 – Derivatives and Hedging (“ASC 815”). ASC 815 requires
qualitative disclosures about objectives and strategies for using derivatives,
quantitative disclosures about fair value amounts of, and gains and losses on,
derivative instruments, and disclosures about credit-risk-related contingent
features in derivative agreements. USSO adopted ASC 815 on January 1,
2009.
NOTE
9 – SUBSEQUENT EVENTS
USSO has
performed an evaluation of subsequent events through November 16, 2009, which is
the date the financial statements were issued. This evaluation did not result in
any subsequent events that necessitated disclosures and/or
adjustments.
Item 2. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations.
The
following discussion should be read in conjunction with the condensed financial
statements and the notes thereto of the United States Short Oil Fund, LP
(“USSO”) 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 USSO’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
USSO’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 USSO cannot
assure investors that the projections included in these forward-looking
statements will come to pass. USSO’s actual results could differ materially from
those expressed or implied by the forward-looking statements as a result of
various factors.
USSO 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 USSO assumes no obligation to update any such forward-looking
statements. Although USSO 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 USSO may make directly to them or through reports that USSO 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
USSO, 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 USSO is to have the changes in percentage terms of its
units’ net asset value (“NAV”) inversely 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 price of the futures contract on light, sweet
crude oil as traded on the New York Mercantile Exchange (the “NYMEX”) that
is the near month contract to expire, except when the near month contract is
within two weeks of expiration, in which case it will become, over a 4-day
period, the futures contract that is the next month contract to expire (the
“Benchmark Futures Contract”), less USSO’s expenses.
USSO
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 inverse of the changes in
the Benchmark Futures Contract, also measured in percentage terms. USSO’s
general partner believes the Benchmark Futures Contract historically
has exhibited a close correlation with the spot price of light, sweet crude
oil. It is not the intent of USSO to be operated in a fashion such that its NAV
will equal, in dollar terms, the dollar price of spot crude oil or any
particular futures contract based on crude oil. Management believes that it is
not practical to manage the portfolio to achieve such an investment goal when
investing in listed crude oil futures contracts. USSO may invest in interests
other than the Benchmark Futures Contract to comply with accountability levels
and position limits.
On any
valuation day, the Benchmark Futures Contract is the near month futures contract
for light, sweet crude oil traded on the New York Mercantile Exchange
unless the near month contract will expire within two weeks of the valuation
day, in which case the Benchmark Futures Contract becomes, over a 4-day period,
the next month contract for light, sweet crude oil traded on the NYMEX. “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.
USSO
invests in short positions in futures contracts for 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, “Futures
Contracts”). USSO may take short positions in other crude oil-related
investments such as cash-settled options on Futures Contracts, forward contracts
for crude oil and over-the-counter transactions that are based on the price of
crude oil and other petroleum-based fuels, Futures Contracts and indices based
on the foregoing (collectively, “Other Crude Oil-Related Investments”). For
convenience and unless otherwise specified, Futures Contracts and Other Crude
Oil-Related Investments collectively are referred to as “Crude Oil Interests” in
this quarterly report on Form 10-Q.
To
achieve its investment objective, USSO anticipates that it will need to maintain
“short” positions in the Futures Contracts and Other Crude-Oil Related
Investments in which it invests. A short position is one in which USSO will have
sold the Futures Contract or Other Crude-Oil Related Investment and must buy it
back or otherwise close out the position in the future. As a result, a drop in
the market value of the Crude Oil Interest would lead to a potential gain for
USSO, while an increase in the market value of the Crude Oil Interest would lead
to a potential loss for USSO. Typically a short position will produce a result
that is the inverse of buying the Futures Contract or Other Crude-Oil Related
Investment (an approach referred to as being “long” the investment). The General
Partner expects the performance of USSO to generally be inverse to the
performance of the United States Oil Fund, LP (“USOF”), another commodity pool
managed by the General Partner, which seeks to have the changes in percentage
terms of its units’ NAV track the changes in percentage terms of the spot price
of light, sweet crude oil as traded in the United States.
The
regulation of Crude Oil 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 in the section “What are the Risk Factors Involved with an
Investment in USSO?” of USSO’s registration statement as filed with the SEC,
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 USSO.
Currently,
a number of proposals to alter the regulation of Crude Oil Interests are being
considered by federal regulators and legislators. These proposals include the
imposition of hard position limits on energy-based commodity futures contracts,
the extension of position and accountability limits to futures contracts on
non-U.S. exchanges previously exempt from such limits, and the forced use of
clearinghouse mechanisms for all over-the-counter transactions. An additional
proposal would aggregate and limit all positions in energy futures held by a
single entity, whether such positions exist on U.S. futures exchanges, non-U.S.
futures exchanges, or in over-the-counter contracts. If any of the
aforementioned proposals is implemented, USSO’s ability to meet its investment
objective may be negatively impacted.
The
general partner of USSO, United States Commodity Funds LLC (formerly, Victoria
Bay Asset Management, LLC) (the “General Partner”), which is registered as
a commodity pool operator (“CPO”) with the U.S. Commodity Futures Trading
Commission (the “CFTC”), is authorized by the Amended and Restated Agreement of
Limited Partnership of USSO (the “LP Agreement”) to manage USSO. The
General Partner is authorized by USSO in its sole judgment to employ and
establish the terms of employment for, and termination of, commodity trading
advisors or futures commission merchants.
During
the period from September 24, 2009 to September 30, 2009, the price of the
Benchmark Futures Contract rose from approximately $68.97 per barrel to
approximately $70.61 per barrel, up approximately 2.38% over the period. The
high of the period was on September 30, 2009 when prices rose to $70.61 per
barrel. The low of the period was on September 24, 2009 when prices were 65.89
per barrel. USSO’s NAV fell during the period from a starting level of $50.00
per unit and reached its low for the period on September 30, 2009 at $48.55 per
unit. USSO’s NAV was at a high for the period on September 24, 2009 at $52.23
per unit. USSO’s NAV on September 30, 2009 was $48.55, down approximately 2.90%
over the period. The Benchmark Futures Contract prices focused above include
only the November 2009. The return of approximately 2.38% on the Benchmark
Futures Contract listed above is a hypothetical return only. The inverse of that
return would not necessarily be achieved by an investor holding long positions
in oil futures contracts, even if the long position was rebalanced on a daily
basis.
The
prices of front month contract was also lower than the prices of second month
contract during the period from September 24, 2009 to September 30, 2009, a
condition in the futures markets referred to as “contango”. A contango market is
one in which 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. 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 USSO 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. USSO’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
USSO investments, including ICE Futures contracts or other futures contracts, as
of the earlier of the close of the New York Stock Exchange or 4:00 p.m. New York
time.
Results
of Operations and the Crude Oil Market
Results of
Operations. On September 24, 2009, USSO listed its units on
the NYSE Arca under the ticker symbol “DNO.” On that day, USSO established its
initial offering price at $50.00 per unit and issued 200,000 units to the
initial authorized purchaser, Deutsche Bank Securities Inc., in exchange for
$10,000,000 in cash.
Since its
initial offering of 25,000,000 units, USSO has not made any subsequent offering
of its units. As of September 30, 2009, USSO had issued 200,000 units, all
of which were outstanding. As of September 30, 2009, there were 24,800,000
units registered but not yet issued.
More
units may have been issued by USSO 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 USSO cannot be resold by
USSO. As a result, USSO 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 Period from
September 24, 2009 to September 30, 2009
As of
September 30, 2009, the total unrealized loss on short positions in Futures
Contracts owned or held on that day was $271,700 and USSO established cash
deposits, including cash investments in money market funds, that were equal
to $9,982,462. USSO held 91.16% of its cash assets in overnight deposits and
money market funds at its custodian bank, while 8.84% of the cash balance was
held with the futures commission merchant as margin deposits for USSO’s short
positions in Futures Contracts. The ending per unit NAV on September 30, 2009
was $48.55.
Portfolio Expenses. USSO’s
expenses consist of investment management fees, brokerage
fees and commissions, certain offering costs, licensing fees and the fees
and expenses of the independent directors of the General Partner. The management
fee that USSO pays to the General Partner is calculated as a percentage of the
total net assets of USSO. USSO pays the General Partner a management fee of
0.60% of NAV on its average net assets. The fee is accrued daily.
During
the period from September 24, 2009 to September 30, 2009, the daily average
total net assets of USSO were $10,332,520. The management fee paid by USSO
during the period from September 24, 2009 to September 30, 2009 amounted to
$1,189, and was accrued daily. Management fees as a percentage of average net
assets were 0.60% over the course of the period from September 24, 2009 to
September 30, 2009.
In
addition to the management fee, USSO pays all brokerage fees, taxes 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, taxes and expenses for
the period from September 24, 2009 to September 30, 2009 was $3,228. For
the period from September 24, 2009 to September 30, 2009, USSO did not
incur any fees or other expenses relating to the registration and offering of
additional units.
USSO 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. USSO shares these fees with USOF, the United States
Natural Gas Fund, LP (“USNG”), the United States 12 Month Oil Fund, LP
(“US12OF”), the United States Gasoline Fund, LP (“UGA”) and the United States
Heating Oil Fund, LP (“USHO”) based on the relative assets of each fund computed
on a daily basis. These fees for calendar year 2009 are estimated to be a total
of $477,000 for all funds.
USSO also
incurs commissions to brokers for the purchase and sale of Futures Contracts,
Other Crude Oil-Related Investments or short-term obligations of the United
States of two years or less (“Treasuries”). During the period from September 24,
2009 to September 30, 2009, total commissions paid to brokers amounted to
$1,247. As an annualized percentage of total net assets, the figure for the
period from September 24, 2009 to September 30, 2009 represents approximately
0.63% 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.
Interest Income. USSO seeks
to invest its assets such that it holds short positions in Futures
Contracts and Other Crude Oil-Related Investments in an amount equal to the
total net assets of its portfolio. Typically, such investments do not require
USSO to pay the full amount of the contract value at the time of purchase, but
rather require USSO to post an amount as a margin deposit against the eventual
settlement of the short position. As a result, USSO retains an amount that is
approximately equal to its total net assets, which USSO 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 USSO’s custodian bank. The
Treasuries, cash and/or cash equivalents earn interest that accrues on a daily
basis. For the period from September 24, 2009 to September 30, 2009, USSO earned
$129 in interest income on such cash holdings. Based on USSO’s average daily
total net assets, this was equivalent to an annualized yield of 0.07%. USSO did
not purchase Treasuries during the period from September 24, 2009 to
September 30, 2009 and held all of its funds in cash and/or cash equivalents
during this time period.
Tracking
USSO’s Benchmark
USSO
seeks to manage its portfolio such that changes in its average daily NAV, on a
percentage basis, inversely track the changes in the average daily price of the
Benchmark Futures Contract, also on a percentage basis. Specifically, USSO seeks
to manage the portfolio such that over any rolling period of 30 valuation days,
the average daily change in the NAV is within a range of -90% to -110% (-0.9 to
-1.1) of the average daily change in the price of the Benchmark Futures
Contract. As an example, if the average daily movement of the price of the
Benchmark Futures Contract for a particular 30-day time period was 0.5% per day,
USSO 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). USSO’s portfolio management goals do
not include trying to make the nominal price of USSO’s NAV equal to the inverse
of the nominal price of the current Benchmark Futures Contract 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
Futures Contracts.
For the 5
valuation days ended September 30, 2009, the inverse of the simple average daily
change in the Benchmark Futures Contract was -0.525%, while the simple average
daily change in the NAV of USSO over the same time period was -0.532%. The
average daily difference was -0.0068% (or -0.68 basis points, where 1 basis
point equals 1/100 of 1%). As a percentage of the inverse of the daily movement
of the Benchmark Crude Oil Futures Contract, the average error in daily tracking
by the NAV was -1.511%, meaning that over this time period USSO’s tracking error
was within the plus or minus 10% range established as its benchmark tracking
goal. The first chart below shows the daily movement of USSO’s NAV versus the
inverse of the daily movement of the Benchmark Futures Contract for the 5-day
period ended September 30, 2009.
Since the
offering of USSO’s units to the public on September 24, 2009 to September
30, 2009, the inverse of the simple average daily change in the Benchmark
Futures Contract was -0.525%, while the simple average daily change in the NAV
of USSO over the same time period was -0.532%. The average daily difference was
-0.0068% (or -0.68 basis points, where 1 basis point equals 1/100 of 1%). As a
percentage of the inverse of the daily movement of the Benchmark Futures
Contract, the average error in daily tracking by the NAV was -1.511%, meaning
that over this time period USSO’s tracking error was within the plus or minus
10% range established as its benchmark tracking goal.
An
alternative tracking measurement of the return performance of USSO versus the
inverse of the return of its Benchmark Futures Contract can be calculated by
comparing the actual return of USSO, measured by changes in its NAV, versus
the expected changes in
its NAV under the assumption that USSO’s returns had been exactly inverse to the
daily changes in its Benchmark Futures Contract.
For the
period from September 24, 2009 to September 30, 2009, the actual total return of
USSO as measured by changes in its NAV was -2.90%. This is based on an initial
NAV of $50.00 on September 24, 2009 and an ending NAV as of September
30, 2009 of $48.55. During this time period, USSO made no distributions to its
unitholders. However, if USSO’s daily changes in its NAV had instead exactly
inversely tracked the changes in the daily return of the Benchmark Futures
Contract, USSO would have ended the period from September 24, 2009 to September
30, 2009 with an estimated NAV of $48.57, for a total return over the relevant
time period of -2.86%. The difference between the actual NAV total return of
USSO of -2.90% and the expected total return based on the inverse of changes in
the daily return of the Benchmark Futures Contract of -2.86% was an error over
the time period of -0.04%, which is to say that USSO’s actual total return
trailed the inverse of 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
that USSO pays and the interest that USSO collects on its cash and cash
equivalent holdings. During the period from September 24, 2009 to September 30,
2009, USSO received interest income of $129, which is equivalent to a weighted
average interest rate of 0.07% for the period from September 24, 2009 to
September 30, 2009. During the period from September 24, 2009 to September 30,
2009, USSO incurred net expenses of $2,789. Income from interest and
Authorized Purchaser collections net of expenses was $(2,660), which is
equivalent to a weighted average net interest rate of -1.34% for the period from
September 24, 2009 to September 30, 2009.
There are
currently three factors that have impacted or are most likely to impact, USSO’s
ability to accurately inversely track its Benchmark Futures
Contract.
First,
USSO may buy or sell its holdings in the then current Benchmark Futures Contract
at a price other than the closing settlement price of that contract on the day
during which USSO executes the trade. In that case, USSO may pay a price that is
higher, or lower, than that of the Benchmark Futures Contract, which could
cause the changes in the daily NAV of USSO to either be too high or too low
relative to the changes in the Benchmark Futures Contract. During the period
from September 24, 2009 to September 30, 2009, management attempted to minimize
the effect of these transactions by seeking to execute its purchase or sale of
the Benchmark Futures Contract at, or as close as possible to, the end of the
day settlement price. However, it may not always be possible for USSO 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 USSO’s
attempt to inversely track the Benchmark Futures Contract over
time.
Second,
USSO earns interest on its cash, cash equivalents and Treasury
holdings. USSO is not required to distribute any portion of its income to its
unitholders and did not make any distributions to unitholders during the period
from September 24, 2009 to September 30, 2009. Interest payments, and any other
income, were retained within the portfolio and added to USSO’s NAV. When this
income exceeds the level of USSO’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), USSO will realize a net yield that will tend to cause daily changes in
the NAV of USSO to track slightly higher than the inverse of daily changes in
the Benchmark Futures Contract. During the period from September 24, 2009 to
September 30, 2009, USSO earned, on an annualized basis, approximately 0.07% on
its cash holdings. It also incurred cash expenses on an annualized basis of
0.60% for management fees and approximately 0.63% in brokerage commission costs
related to the purchase and sale of futures contracts, and 0.18% for other
expenses. The foregoing fees and expenses resulted in a net yield on an
annualized basis of approximately -1.34% and affected USSO’s ability to track
the inverse of the daily changes in the Benchmark Futures Contract. 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 Contract.
Third,
USSO may hold Other Oil Interest in its portfolio that may fail to closely
inversely track the Benchmark Futures Contract’s total return movements. In that
case, the error in inversely tracking the Benchmark Futures Contract could
result in daily changes in the NAV of USSO that are either too high, or too low,
relative to the inverse of the daily changes in the Benchmark Futures Contract.
During the period from September 24, 2009 to September 30, 2009, USSO did not
hold any Other Crude Oil-Related Investments. However, there can be no assurance
that in the future USSO will not make use of such Other Crude Oil-Related
Investments.
Term Structure of Crude Oil Futures
Prices and the Impact on Total Returns. Several factors determine
the total return from investing in a futures contract position. One factor that
impacts the total return that will result from investing in near month crude oil
futures contracts and “rolling” those contracts forward each month is the price
relationship between the current near month contract and the later month
contracts. For example, if the price of the near month contract is higher than
the next month contract (a situation referred to as “backwardation” in the
futures market), then absent any other change there is a tendency for the price
of a next month contract to rise in value as it becomes the near month contract
and approaches expiration. Conversely, if the price of a near month contract is
lower than the next month contract (a situation referred to as “contango” in the
futures market), then absent any other change there is a tendency for the price
of a next month contract to decline in value as it becomes the near month
contract and approaches expiration.
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
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
interest earned on Treasuries, 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 price of spot 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
interest earned on cash), 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 months over the last 10 years (1999-2008) 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).
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 1999 and
2008.
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.
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 USSO 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 have 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. During the first two quarters of 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 appear to be the primary cause of
the steep level of contango, began to drop in March 2009 and for the balance of
the first half of 2009. The crude oil futures market remained in contango
through September 30, 2009.
Periods
of contango or backwardation do not materially impact USSO’s investment
objective of having the percentage changes in its per unit NAV inversely track
the percentage changes in the price of the Benchmark Futures Contract since the
impact of backwardation and contango tended to equally impact the percentage
changes in price of both USSO’s units and the Benchmark Futures Contract.
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
period from September 24, 2009 to September 30, 2009, crude oil prices were
impacted by several factors. On the consumption side, demand remained weak
inside and outside the United States as global economic growth, including
emerging economies such as China and India, remained weak to negative for the
first 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 only partially successful. This divergence between
production and consumption has led to large build-ups in crude oil inventories
and contributed to weak oil prices. However, crude oil prices did finish the
third quarter of 2009 approximately 58.32% higher than at the beginning of the
year, as investors looked forward to improvements in the global economy.
Management believes, however, that should the global economic situation remain
weak, there is a meaningful possibility that crude oil prices could 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 1998 and 2008, 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.
10 Year Correlation
Matrix 1998-2008
|
|
Large
Cap
U.S.
Equities
(S&P
500)
|
|
|
U.S. Govt.
Bonds
(EFFAS
U.S.
Government
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 |
|
|
|
-0.223 |
|
|
|
0.936 |
|
|
|
0.266 |
|
|
|
0.045 |
|
|
|
0.003 |
|
|
|
0.063 |
|
U.S.
Govt. Bonds (EFFAS U.S. Government Bond Index)
|
|
|
|
|
|
|
1.000 |
|
|
|
-0.214 |
|
|
|
-0.134 |
|
|
|
0.054 |
|
|
|
0.037 |
|
|
|
-0.29 |
|
Global
Equities (FTSE World Index)
|
|
|
|
|
|
|
|
|
|
|
1.000 |
|
|
|
0.384 |
|
|
|
0.072 |
|
|
|
0.084 |
|
|
|
0.155 |
|
Unleaded
Gasoline
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000 |
|
|
|
0.254 |
|
|
|
0.787 |
|
|
|
0.747 |
|
Natural
Gas
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000 |
|
|
|
0.394 |
|
|
|
0.292 |
|
Heating
Oil
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000 |
|
|
|
0.738 |
|
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 September 30, 2009, crude oil continued to
have a strong positive correlation with heating oil and unleaded gasoline.
During this period, it also had a slightly weaker correlation with the
movements of natural gas than it had displayed over the ten year period ended
December 31, 2008. 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, 2008, displayed results that
indicated that they had a mildly positive correlation over this shorter time
period, particularly due to the recent downturn in the U.S. economy. 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, 2008,
were weakly negatively correlated over this more recent time
period.
Correlation Matrix –
12 months ended
September 30, 2009
|
|
Large
Cap
U.S.
Equities
(S&P
500)
|
|
|
U.S. Govt.
Bonds
(EFFAS
U.S.
Government
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 |
|
|
|
0.088 |
|
|
|
0.988 |
|
|
|
0.522 |
|
|
|
0.694 |
|
|
|
0.205 |
|
|
|
0.706 |
|
U.S.
Govt. Bonds (EFFAS U.S. Government Bond Index)
|
|
|
|
|
|
|
1.000 |
|
|
|
0.102 |
|
|
|
-0.423 |
|
|
|
-0.303 |
|
|
|
0.082 |
|
|
|
-0.313 |
|
Global
Equities (FTSE World Index)
|
|
|
|
|
|
|
|
|
|
|
1.000 |
|
|
|
0.552 |
|
|
|
0.697 |
|
|
|
0.205 |
|
|
|
0.705 |
|
Unleaded
Gasoline
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000 |
|
|
|
0.865 |
|
|
|
-0.089 |
|
|
|
0.768 |
|
Heating
Oil
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1.000 |
|
|
|
0.252 |
|
|
|
0.810 |
|
Natural
Gas
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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1.000 |
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0.193 |
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Crude
Oil
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1.000 |
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source:
Bloomberg, NYMEX
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PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
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 USSO’s assets in Futures Contracts and Other
Crude Oil-Related Investments so that daily changes in percentage terms in
USSO’s NAV correlate as closely as possible with the inverse of the daily
changes in percentage terms in the price of the Benchmark Futures Contract. If
certain other fuel-based commodity futures contracts do not closely
correlate with the Oil Futures Contract, then their use could lead to greater
tracking error. As noted, the General Partner also believes that the changes in
percentage terms in the price of the Benchmark Futures Contract 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. USSO’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 USSO’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 USSO for its forward
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, USSO estimates interest income on
a daily basis using prevailing interest 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
USSO has
not made, and does not anticipate making, use of borrowings or other lines of
credit to meet its obligations. USSO has met, and it is anticipated that USSO
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. USSO’s
liquidity needs include: redeeming units, providing margin deposits for its
existing Futures Contracts or the purchase of additional Futures Contracts and
posting collateral for its over-the-counter contracts and payment of its
expenses, summarized below under “Contractual Obligations.”
USSO
currently generates cash primarily from (i) the sale of baskets consisting of
100,000 units (“Creation Baskets”) and (ii) interest earned on Treasuries,
cash and/or cash equivalents. USSO has allocated substantially all of its net
assets to trading in Crude Oil Interests. USSO invests in Crude 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 Futures Contracts and Other Crude Oil-Related Investments. A
significant portion of the NAV is held in cash and cash equivalents that
are used as margin and as collateral for USSO’s trading in Crude Oil Interests.
The balance of the net assets is held in USSO’s account at its custodian bank.
Interest earned on USSO’s interest-bearing funds is paid to USSO. During the
nine months ended September 30, 2009, USSO’s expenses exceeded the interest
income USSO earned and the cash earned by the sale of Creation Baskets. To the
extent expenses have exceeded interest income, USSO’s NAV will be negatively
impacted.
USSO’s
investment in Crude 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 USSO from promptly liquidating its
positions in Futures Contracts. During the period from September 24, 2009 to
September 30, 2009, USSO was not forced to purchase or liquidate any of its
positions while daily limits were in effect; however, USSO cannot predict
whether such an event may occur in the future.
Prior to
the initial offering of USSO, all payments with respect to USSO’s expenses were
paid by the General Partner. USSO does not have an obligation or intention to
refund such payments by the General Partner. The General Partner is under no
obligation to pay USSO’s current or future expenses. Since the initial offering
of USSO, USSO 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)
taxes and 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 USSO’s
marketing agent, administrator and custodian and registration expenses relating
to the initial offering of units. If the General Partner and USSO are
unsuccessful in raising sufficient funds to cover these respective expenses or
in locating any other source of funding, USSO will terminate and investors may
lose all or part of their investment.
Market
Risk
Trading
in Futures Contracts and Other Crude Oil-Related Investments, such as
forwards, involves USSO entering into contractual commitments to purchase
or sell crude oil at a specified date in the future. The aggregate market value
of the contracts will significantly exceed USSO’s future cash requirements
since USSO intends to close out its open positions prior to settlement. As a
result, USSO is generally only subject to the risk of loss arising
from the change in value of the contracts. USSO considers the “fair value” of
its derivative instruments to be the unrealized gain or loss on the contracts.
The market risk associated with USSO’s commitments to purchase oil is limited to
the aggregate market value of the contracts held. However, should USSO 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 USSO could be unlimited.
USSO’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 Futures Contracts and Other Crude Oil-Related Investments
markets and the relationships among the contracts held by USSO. The limited
experience that USSO has had in utilizing its model to trade in Crude Oil
Interests in a manner intended to inversely track the changes in the spot price
of crude oil, as well as drastic market occurrences, could ultimately lead to
the loss of all or substantially all of an investor’s capital.
Credit
Risk
When USSO
enters into Futures Contracts and Other Crude Oil-Related Investments, it is
exposed to the credit risk that the counterparty will not be able to meet its
obligations. The counterparty for the Futures Contracts traded on the NYMEX and
on most other futures exchanges is the clearinghouse associated with the
particular exchange. In general, 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 USSO in such circumstances.
The
General Partner attempts to manage the credit risk of USSO by following
various trading limitations and policies. In particular, USSO generally posts
margin and/or holds liquid assets that are approximately equal to the market
value of its obligations to counterparties under the Futures Contracts and Other
Crude Oil-Related Investments 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 USSO to limit its credit exposure. UBS
Securities LLC, USSO’s commodity broker, or any other broker that may be
retained by USSO in the future, when acting as USSO’s futures commission
merchant in accepting orders to purchase or sell Futures Contracts on United
States exchanges, is required by CFTC regulations to separately account for
and segregate as belonging to USSO, all assets of USSO relating to domestic
Futures Contracts trading. These futures commission merchants are not allowed to
commingle USSO’s assets with its other assets. In addition, the CFTC requires
commodity brokers to hold in a secure account USSO’s assets related to foreign
Futures Contracts trading.
In the
future, USSO may purchase 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
September 30, 2009, USSO had deposits in domestic and foreign financial
institutions, including cash investments in money market funds, in the amount of
$9,982,462. This amount is subject to loss should these institutions cease
operations.
Off
Balance Sheet Financing
As of
September 30, 2009, USSO 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 USSO. While USSO’s exposure under
these indemnification provisions cannot be estimated, they are not expected to
have a material impact on USSO’s financial position.
Redemption
Basket Obligation
In order
to meet its investment objective and pay its contractual obligations described
below, USSO requires liquidity to redeem units, which redemptions must be
in blocks of 100,000 units called “Redemption Baskets”. USSO 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
USSO’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 USSO’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 USSO, 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 USSO and its units with the SEC, FINRA and the
NYSE Arca, respectively. However, following USSO’s initial offering of units,
offering costs incurred in connection with registering and listing additional
units of USSO are directly borne on an ongoing basis by USSO, and not by the
General Partner.
The
General Partner pays the fees of USSO’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
USSO’s condensed financial statements and its SEC and CFTC reports. The General
Partner and USSO have also entered into a licensing agreement with the
NYMEX pursuant to which USSO and the affiliated funds managed by the General
Partner pay a licensing fee to the NYMEX. USSO also pays the fees and expenses
associated with its tax accounting and reporting requirements with the exception
of certain initial implementation service fees and base service fees which are
paid by the General Partner. The General Partner, though under no obligation to
do so, agreed to pay certain costs for tax reporting and audit expenses normally
borne by USSO to the extent that such expenses exceeded 0.15% (15 basis points)
of USSO’s NAV, on an annualized basis, through at least December 31, 2009. The
General Partner has no obligation to continue such payment into subsequent
periods.
In
addition to the General Partner’s management fee, USSO 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 USSO’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. USSO 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 USSO’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 USSO’s
existence. Either party may terminate these agreements earlier for certain
reasons described in the agreements.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
Over-the-Counter
Derivatives
In the
future, USSO may purchase over-the-counter contracts. Unlike most of the
exchange-traded 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 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, USSO 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 Futures Contracts
traded on the NYMEX and the prices of other Futures Contracts in which USSO may
invest.
To
protect itself from the credit risk that arises in connection with such
contracts, USSO 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. USSO also may require that the counterparty be highly rated and/or
provide collateral or other credit support to address USSO’s exposure to the
counterparty. In addition, it is also possible for USSO and its counterparty to
agree to clear their agreement through an established futures clearinghouse such
as those connected to the NYMEX or the ICE Futures. In that event, USSO would no
longer have credit risk of its original counterparty, as the clearinghouse would
now be USSO’s counterparty. USSO would still retain any price risk associated
with its transaction.
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 USSO 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, and (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.
USSO
anticipates that the use of Other Crude Oil-Related Investments together with
its investments in Futures Contracts will produce price and total return results
that closely track the investment goals of USSO. 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 Futures Contracts, which may impact USSO’s ability to
successfully track the Benchmark Futures Contract.
USSO may
employ spreads or straddles in its trading to mitigate the differences in its
investment portfolio and its goal of inversely tracking the price of the
Benchmark Futures Contract. USSO 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 USSO to changes in the price
relationship between futures contracts which will expire sooner and those that
will expire later. USSO 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 USSO, 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. USSO
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.
USSO 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 USSO 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 period from September 24, 2009 through September 30, 2009, USSO did not
employ any hedging methods such as those described above since all of its
investments were made over an exchange. Therefore, during the period from
September 24, 2009 through September 30, 2009, USSO was not exposed to
counterparty risk.
Item 4.
Controls and Procedures.
Disclosure
Controls and Procedures
USSO
maintains disclosure controls and procedures that are designed to ensure that
material information required to be disclosed in USSO’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 USSO if
USSO had any officers, have evaluated the effectiveness of USSO’s
disclosure controls and procedures and have concluded that the
disclosure controls and procedures of USSO 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 USSO’s internal control over financial reporting during
USSO’s last fiscal quarter that have materially affected, or are reasonably
likely to materially affect, USSO’s internal control over financial
reporting.
Part
II. OTHER INFORMATION
Item
1. Legal Proceedings.
Not
applicable.
Item
1A. Risk Factors.
There has
not been a material change from the risk factors previously disclosed in USSO’s
Registration Statement on Form S-1, which was declared effective by the SEC on
September 18, 2009.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
Not
applicable.
Item
3. Defaults Upon Senior Securities.
Not
applicable.
Item
4. Submission of Matters to a Vote of Security Holders.
Not
applicable.
Item 5.
Other Information.
Monthly
Account Statements
Pursuant
to the requirement under Rule 4.22 under the Commodity Exchange Act, each month
USSO 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 USSO’s
website at www.unitedstatesshortoilfund.com.
Item 6.
Exhibits.
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
|
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Description of Document
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3.3*
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Amended
and Restated Agreement of Limited Partnership.
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3.4**
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Fourth
Amended and Restated Limited Liability Company Agreement of the General
Partner.
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10.2*
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Marketing
Agent Agreement.
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10.3*
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Custodian
Agreement.
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10.4*
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Administrative
Agency Agreement.
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10.5*
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Indemnification
Agreement.
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31.1*
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Certification
by Principal Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
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31.2*
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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.
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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.
|
99.1*
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Customer
Agreement for Futures
Contracts.
|
**
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Incorporated
by reference to Registrant’s Registration Statement on Form S-1 (File No.
333-152386) filed on July 17,
2008.
|
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 Short Oil Fund, LP (Registrant)
By:
United States Commodity Funds LLC, its general partner
By:
|
/s/
Nicholas D. Gerber
|
Nicholas
D. Gerber
|
Chief
Executive Officer
|
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Date: November
16, 2009
|
|
By:
|
/s/
Howard Mah
|
Howard
Mah
|
Chief
Financial
Officer
|
Date: November
16, 2009