What is BNO?
The United States Brent Oil Fund,
LP (“BNO”) is a Delaware limited partnership organized on September 2, 2009. BNO maintains its main business
office at 1999 Harrison Street, Suite 1530, Oakland, California 94612. BNO is a commodity pool that issues limited partnership
interests (“shares”) traded on the NYSE Arca, Inc. (the “NYSE Arca”). It operates pursuant to the
terms of the Third Amended and Restated Agreement of Limited Partnership dated as of March 1, 2013 (as amended from time to
time, the “LP Agreement”), which grants full management control to its general partner, United States Commodity Funds
LLC (“USCF”).
The investment objective of BNO is for
the daily changes in percentage terms of its shares’ per share net asset value (“NAV”) to reflect the daily changes
in percentage terms of the spot price of Brent crude oil, as measured by the daily changes in the price of the futures contract
for Brent crude oil traded on the ICE Futures Exchange (the “ICE Futures”), 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 be measured by the futures contract
that is the next month contract to expire (the “Benchmark Futures Contract”), less BNO’s expenses. It is
not the intent of BNO to be operated in a fashion such that its per share NAV will equal, in dollar terms, the spot price of Brent
crude oil or any particular futures contract based on Brent crude oil. It is not the intent of BNO to be operated in a fashion
such that its per share NAV will reflect the percentage change of the price of any particular futures contract as measured over
a time period greater than one day. USCF believes that it is not practical to manage the portfolio to achieve such an investment
goal when investing in Futures Contracts (as defined below) and Other Crude Oil-Related Investments (as defined below). BNO’s
shares began trading on June 2, 2010. USCF is the general partner of BNO and is responsible for the management of BNO.
Who is USCF?
USCF is a single member limited liability
company that was formed in the state of Delaware on May 10, 2005. USCF maintains its main business office at 1999 Harrison
Street, Suite 1530, Oakland, California 94612. USCF is a wholly-owned subsidiary of Wainwright Holdings, Inc., a Delaware corporation
(“Wainwright”). Mr. Nicholas Gerber (discussed below) controls Wainwright by virtue of his ownership or control
of a majority of Wainwright’s shares. Wainwright is a holding company that previously owned an insurance company organized
under Bermuda law (which has been liquidated) and a registered investment adviser firm named Ameristock Corporation, which has
been distributed to the Wainwright shareholders. USCF is a member of the National Futures Association (the “NFA”) and
registered as a commodity pool operator (“CPO”) with the Commodity Futures Trading Commission (the “CFTC”)
on December 1, 2005 and as a Swaps Firm on August 8, 2013.
USCF also serves as general partner or
sponsor of the United States Oil Fund, LP (“USO”), the United States Natural Gas Fund, LP (“UNG”), the
United States 12 Month Oil Fund, LP (“USL”), the United States Gasoline Fund, LP (“UGA”), the United States
Diesel-Heating Oil Fund, LP (“UHN”), the United States Short Oil Fund, LP (“DNO”), the United States 12
Month Natural Gas Fund, LP (“UNL”), the United States Commodity Index Fund (“USCI”), the United States
Copper Index Fund (“CPER”), the United States Agriculture Index Fund (“USAG”) and the United States Metals
Index Fund (“USMI”). USO, UNG, USL, UGA, UHN, DNO, UNL, USCI, CPER, USAG and USMI are actively operating funds and
all are listed on the NYSE Arca. All funds listed previously are referred to collectively herein as the “Related Public Funds.”
The Related Public Funds are subject to reporting requirements under the Securities Exchange Act of 1934, as amended (the “Exchange
Act”). For more information about each of the Related Public Funds, investors in BNO may call 1.800.920.0259 or visit www.unitedstatescommodityfunds.com
or the U.S. Securities and Exchange Commission’s (the “SEC”) website at www.sec.gov.
USCF previously filed registration statements
to register shares of the United States Sugar Fund (“USSF”), the United States Natural Gas Double Inverse Fund (“UNGD”),
the United States Gasoil Fund (“USGO”) and the United States Asian Commodities Basket Fund (“UAC”), each
of which is a series of the United States Commodity Funds Trust I, and the US Golden Currency Fund (“HARD”), a series
of the United States Currency Funds Trust. On December 30, 2013, USCF withdrew the registration statements for USSF, UNGD, USGO
and UAC effective December 31, 2013. On January 27, 2014, USCF withdrew the registration statement for HARD. HARD was never available
to the public, and at the time of withdrawal, HARD was still in the process of review by various regulatory agencies which have
regulatory authority over USCF and HARD.
USCF is required to evaluate the credit
risk of BNO to the futures commission merchant (“FCM”), oversee the purchase and sale of BNO’s shares by certain
authorized purchasers (“Authorized Purchasers”), review daily positions and margin requirements of BNO and manage BNO’s
investments. USCF also pays the fees of ALPS Distributors, Inc., which serves as the marketing agent for BNO (the “Marketing
Agent”), and Brown Brothers Harriman & Co. (“BBH&Co.”), which serves as the administrator (the “Administrator”)
and the custodian (the “Custodian”) for BNO.
Limited partners have no right to elect
USCF as the general partner on an annual or any other continuing basis. If USCF voluntarily withdraws as general partner,
however, the holders of a majority of BNO’s outstanding shares (excluding for purposes of such determination shares owned,
if any, by the withdrawing USCF and its affiliates) may elect its successor. USCF may not be removed as general partner
except upon approval by the affirmative vote of the holders of at least 66 and 2/3 percent of BNO’s outstanding shares (excluding
shares owned, if any, by USCF and its affiliates), subject to the satisfaction of certain conditions set forth in the LP Agreement.
The business and affairs of USCF are managed
by a board of directors (the “Board”), which is comprised of three management directors (the “Management Directors”),
some of whom are also its executive officers, and three independent directors who meet the independent director requirements established
by the NYSE Arca Equities Rules and the Sarbanes-Oxley Act of 2002. The Management Directors have the authority to manage
USCF pursuant to its LLC Agreement, as amended from time to time. Through its Management Directors, USCF manages the day-to-day
operations of BNO. The Board has an audit committee which is made up of the three independent directors (Peter M. Robinson,
Gordon L. Ellis and Malcolm R. Fobes III). For additional information relating to the audit committee, please see
“Item
10. Directors, Executive Officers and Corporate Governance – Audit Committee”
in this annual report on Form 10-K.
How Does BNO Operate?
An investment in the shares provides a
means for diversifying an investor’s portfolio or hedging exposure to changes in Brent crude oil prices. An investment
in the shares allows both retail and institutional investors to easily gain this exposure to the Brent crude oil market in a transparent,
cost-effective manner.
The net assets of BNO consist primarily
of investments in futures contracts for crude oil, diesel-heating oil, gasoline, natural gas and other petroleum-based fuels that
are traded on the ICE Futures, the NYMEX, or other U.S. and foreign exchanges (collectively, “Futures Contracts”) and,
to a lesser extent, in order to comply with regulatory requirements or in view of market conditions, other crude oil-related investments
such as cash-settled options on Futures Contracts, forward contracts for oil, cleared swap contracts and non-exchange traded (“over-the-counter”)
transactions that are based on the price of crude oil, 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 annual
report on Form 10-K. BNO invests substantially the entire amount of its assets in Futures Contracts while supporting such investments
by holding the amounts of its margin, collateral and other requirements relating to these obligations-in short-term obligations
of the United States of two years or less (“Treasuries”), cash and cash equivalents. The daily holdings of BNO are
available on BNO’s website at www.unitedstatescommodityfunds.com.
The investment objective of BNO is for
the daily changes in percentage terms of its per share NAV to reflect the daily changes in percentage terms of the spot price of
Brent crude oil as measured by the daily changes in the price of the futures contract on Brent crude oil traded on the ICE Futures
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 be measured by the futures contract that is the next month contract to expire (the “Benchmark Futures Contract”),
less BNO’s expenses. It is not the intent of BNO to be operated in a fashion such that the per share NAV will equal,
in dollar terms, the spot price of Brent crude oil or any particular futures contract based on Brent crude oil. It is not the intent
of BNO to be operated in a fashion such that its per share NAV will reflect the percentage change of the price of any particular
futures contract as measured over a time period greater than one day. BNO may invest in interests other than the Benchmark Futures
Contract to comply with accountability levels and position limits. For a detailed discussion of accountability levels and position
limits, see
“Item 1. Business – What are Futures Contracts?”
below in this annual report on Form 10-K.
USCF employs a “neutral” investment
strategy in order to track changes in the price of the Benchmark Futures Contract regardless of whether the price goes up or goes
down. BNO’s “neutral” investment strategy is designed to permit investors generally to purchase and sell
BNO’s shares for the purpose of investing indirectly in Brent crude oil in a cost-effective manner, and/or to permit participants
in the oil or other industries to hedge the risk of losses in their Brent crude oil-related transactions. Accordingly, depending
on the investment objective of an individual investor, the risks generally associated with investing in Brent crude oil and/or
the risks involved in hedging may exist. In addition, an investment in BNO involves the risk that the changes in the price
of BNO’s shares will not accurately track the changes in the Benchmark Futures Contract, and that changes in the Benchmark
Futures Contract will not closely correlate with changes in the spot prices of crude oil.
The Benchmark Futures Contract is changed
from the near month contract to the next month contract over a four-day period. Each month the Benchmark Futures Contract changes
starting at the end of the day on the date two weeks prior to expiration of the near month contract for that month. During the
first three days of the period, the applicable value of the Benchmark Futures Contract is based on a combination of the near month
contract and the next month contract as follows: (1) day 1 consists of 75% of the then near month contract’s price plus
25% of the price of the next month contract, divided by 75% of the near month contract’s prior day’s price plus 25%
of the price of the next month contract, (2) day 2 consists of 50% of the then near month contract’s price plus 50%
of the price of the next month contract, divided by 50% of the near month contract’s prior day’s price plus 50% of
the price of the next month contract and (3) day 3 consists of 25% of the then near month contract’s price plus 75%
of the price of the next month contract, divided by 25% of the near month contract’s prior day’s price plus 75% of
the price of the next month contract. On day 4, the Benchmark Futures Contract is the next month contract to expire at that time
and that contract remains the Benchmark Futures Contract until the beginning of the following month’s change in the Benchmark
Futures Contract over a four-day period.
On each day during the four-day period,
USCF anticipates it will “roll” BNO’s positions in Crude Oil Interests by closing, or selling, a percentage of
BNO’s positions in Crude Oil Interests and reinvesting the proceeds from closing those positions in new Crude Oil Interests
that reflect the change in the Benchmark Futures Contract.
The anticipated dates that the monthly
four-day roll period will commence are posted on BNO’s website at www.unitedstatescommodityfunds.com, and are subject to
change without notice.
BNO’s total portfolio composition
is disclosed on its website each business day that the NYSE Arca is open for trading. The website disclosure of portfolio
holdings is made daily and includes, as applicable, the name and value of each Crude Oil Interest, the specific types of Other
Crude Oil-Related Investments and characteristics of such Other Crude Oil-Related Investments, the name and value of each Treasury
and cash equivalent, and the amount of cash held in BNO’s portfolio. BNO’s website is publicly accessible at no
charge. BNO’s assets used for margin and collateral are held in segregated accounts pursuant to the Commodity Exchange
Act (the “CEA”) and CFTC regulations.
Effective February 29, 2012, the shares
issued by BNO may only be purchased by Authorized Purchasers and only in blocks of 50,000 shares called Creation Baskets. The
amount of the purchase payment for a Creation Basket is equal to the aggregate NAV of the shares in the Creation Basket. Similarly,
only Authorized Purchasers may redeem shares and only in blocks of 50,000 shares called Redemption Baskets. Prior to February 29,
2012, Authorized Purchasers could only purchase or redeem shares in blocks of 100,000 shares. The amount of the redemption proceeds
for a Redemption Basket is equal to the aggregate NAV of shares in the Redemption Basket. The purchase price for Creation
Baskets, and the redemption price for Redemption Baskets are the actual per share NAV calculated at the end of the business day
when a request for a purchase or redemption is received by BNO. The NYSE Arca publishes an approximate per share NAV intra-day
based on the prior day’s per share NAV and the current price of the Benchmark Futures Contract, but the price of Creation
Baskets and Redemption Baskets is determined based on the actual per share NAV calculated at the end of the day.
While BNO issues shares only in Creation
Baskets, shares are listed on the NYSE Arca and investors may purchase and sell shares at market prices like any listed security.
What is BNO’s Investment Strategy?
In managing BNO’s assets, USCF does
not use a technical trading system that issues buy and sell orders. USCF instead employs a quantitative methodology whereby
each time a Creation Basket is sold, USCF purchases Crude Oil Interests, such as the Benchmark Futures Contract, that have an aggregate
market value that approximates the amount of Treasuries and/or cash received upon the issuance of the Creation Basket.
By remaining invested as fully as possible
in Futures Contracts or Other Crude Oil-Related Investments, USCF believes that the daily changes in percentage terms in BNO’s
per share NAV will continue to closely track the daily changes in percentage terms in the price of the Benchmark Futures Contract. USCF
believes that certain arbitrage opportunities result in the price of the shares traded on the NYSE Arca closely tracking the per
share NAV of BNO. Additionally, Futures Contracts traded on the ICE Futures have closely tracked the spot price of Brent crude
oil. Based on these expected interrelationships, USCF believes that the daily changes in the price of BNO’s shares traded
on the NYSE Arca have closely tracked and will continue to closely track on a daily basis, the changes in the spot price of Brent
crude oil. For performance data relating to BNO’s ability to track its benchmark, see
“Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations – Tracking BNO’s Benchmark”
in this
annual report on Form 10-K.
USCF endeavors to place BNO’s trades
in Futures Contracts and Other Crude Oil-Related Investments and otherwise manage BNO’s investments so that “A”
will be within plus/minus 10 percent of “B”, where:
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•
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A is the average daily change in BNO’s per share NAV for any period of 30 successive valuation days;
i.e
., any NYSE Arca trading day as of which BNO calculates its per share NAV; and
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•
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B is the average daily percentage change in the price of the Benchmark Futures Contract over the same period.
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USCF believes that market arbitrage opportunities
will cause the daily changes in BNO’s share price on the NYSE Arca to closely track the daily changes in BNO’s per
share NAV. USCF believes that the net effect of these two expected relationships and the relationships described above between
BNO’s per share NAV and the Benchmark Futures Contract, will be that the daily changes in the price of BNO’s shares
on the NYSE Arca will closely track, in percentage terms, the daily changes in the spot price of a barrel of Brent crude oil, less
BNO’s expenses. For performance data relating to BNO’s ability to track its benchmark, see
“Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations – Tracking BNO’s Benchmark”
in this
annual report on Form 10-K.
The specific Futures Contracts purchased
depend on various factors, including a judgment by USCF as to the appropriate diversification of BNO’s investments in futures
contracts with respect to the month of expiration, and the prevailing price volatility of particular contracts. While USCF
has made significant investments in ICE Futures Contracts, for various reasons, including the ability to enter into the precise
amount of exposure to the crude oil market, position limits or other regulatory requirements limiting BNO’s holdings, and
market conditions, it may invest in Futures Contracts traded on other exchanges or invest in Other Crude Oil-Related Investments.
To the extent that BNO invests in Crude
Oil Interests, it would prioritize investments in contracts and instruments that are economically equivalent to the Benchmark Futures
Contract, including cleared swaps that satisfy such criteria, and then, to a lesser extent, it would invest in other types of cleared
swaps and other contracts, instruments and non-cleared swaps, such as swaps in the over-the-counter market. If BNO is required
by law or regulation, or by one of its regulators, including a futures exchange, to reduce its position in the Benchmark Futures
Contracts to the applicable position limit or to a specified accountability level or if market conditions dictate it would be more
appropriate to invest in Other Crude Oil-Related Investments, a substantial portion of BNO’s assets could be invested in
accordance with such priority in Other Crude Oil-Related Investments that are intended to replicate the return on the Benchmark
Futures Contract. As BNO’s assets reach higher levels, it is more likely to exceed position limits, accountability levels
or other regulatory limits and, as a result, it is more likely that it will invest in accordance with such priority in Other Crude
Oil-Related Investments at such higher levels. In addition, market conditions that USCF currently anticipates could cause BNO to
invest in Other Crude Oil-Related Investments include those allowing BNO to obtain greater liquidity or to execute transactions
with more favorable pricing. See
“Item 1. Business – Regulation”
in this annual report on Form 10-K for
a discussion of the potential impact of regulation on BNO’s ability to invest in over-the-counter transactions and cleared
swaps.
USCF may not be able to fully invest BNO’s
assets in the Futures Contract having an aggregate notional amount exactly equal to BNO’s NAV. For example, as standardized
contracts, the Futures Contracts are for a specified amount of a particular commodity, and BNO’s NAV and the proceeds from
the sale of a Creation Basket are unlikely to be an exact multiple of the amounts of those contracts. As a result, in such circumstances,
BNO may be better able to achieve the exact amount of exposure to changes in price of the Benchmark Futures Contract through the
use of Other Crude Oil-Related Investments, such as over-the-counter contracts that have better correlation with changes in price
of the Benchmark Futures Contract.
BNO anticipates that to the extent it invests
in Futures Contracts other than contracts on Brent crude oil (such as futures contracts for diesel-heating oil, natural gas, and
other petroleum-based fuels) and Other Crude Oil-Related Investments, it will enter into various non-exchange-traded derivative
contracts to hedge the short-term price movements of such Futures Contracts and Other Crude Oil-Related Investments against the
current Benchmark Futures Contract.
USCF does not anticipate letting BNO’s
Futures Contracts expire and taking delivery of the underlying commodity. Instead, USCF closes existing positions,
e.g.
,
when it changes the Benchmark Futures Contract or Other Crude Oil-Related Investments or it otherwise determines it would be appropriate
to do so and reinvests the proceeds in new Futures Contracts or Other Crude Oil-Related Investments. Positions may also be
closed out to meet orders for Redemption Baskets and in such case proceeds for such baskets will not be reinvested.
What is the Crude Oil Market and the
Petroleum-Based Fuel Market?
BNO may purchase Futures Contracts traded
on the ICE Futures that are based on Brent crude oil. It may also purchase contracts on other exchanges, including the NYMEX
and the Singapore Exchange. The contracts provide for delivery of several grades of domestic and internationally traded foreign
crudes, and, among other things, serve the diverse needs of the physical market. In Europe, Brent crude oil is the standard
for futures contracts and is primarily traded on the ICE Futures. Brent crude oil is the price reference for two-thirds of the
world’s traded oil. The ICE Brent Futures is a deliverable contract with an option to cash settle which trades in units
of 1,000 barrels (42,000 U.S. gallons). The ICE Futures also offers a West Texas Intermediate (“WTI”) crude oil
futures contract which trades in units of 1,000 barrels. The WTI crude oil futures contract is cash settled against the prevailing
market price for U.S. light, sweet crude oil.
Brent Crude Oil
. Crude oil
is the world’s most actively traded commodity. The futures contracts for Brent crude oil that are traded on the ICE
Futures are the world’s second most liquid forum for crude oil trading, as well as the world’s second largest volume
futures contract trading on a physical commodity. Due to the liquidity and price transparency of light, sweet crude oil futures
contracts, they are used as a principal international pricing benchmark. The futures contracts for Brent crude oil trade on
the ICE Futures Exchange in units of 1,000 U.S. barrels and, if not closed out before maturity, will result in delivery of oil
to Sullom Voe, an oil terminal located in the Shetland Island near Scotland, which is also accessible to the international spot
markets by tanker.
The price of crude oil is established by
the supply and demand conditions in the global market overall, and more particularly, in the main refining centers of Singapore,
Northwest Europe, and the U.S. Gulf Coast. Demand for petroleum products by consumers, as well as agricultural, manufacturing
and transportation industries, determines demand for crude oil by refiners. Since the precursors of product demand are linked
to economic activity, crude oil demand will tend to reflect economic conditions. However, other factors such as weather also influence
product and crude oil demand. The price of Brent crude oil has historically exhibited periods of significant volatility.
Diesel-Heating Oil
. Diesel-heating
oil, also known as No. 2 fuel oil, accounts for 25% of the yield of a barrel of crude oil, the second largest “cut”
from oil after gasoline. The heating oil futures contract listed and traded on the NYMEX trades in units of 42,000 gallons (1,000
barrels) and is based on delivery in the New York harbor, the principal cash market center. The ICE Futures also offers a Heating
Oil Futures Contract which trades in units of 42,000 U.S. gallons (1,000 barrels). The Heating Oil Futures Contract is cash-settled
against the prevailing market price for heating oil delivered to the New York Harbor.
Gasoline.
Gasoline is the largest
single volume refined product sold in the U.S. and accounts for almost half of national oil consumption. The gasoline futures
contract listed and traded on the NYMEX, trades in units of 42,000 gallons (1,000 barrels) and is based on delivery at petroleum
products terminals in the New York harbor, the major East Coast trading center for imports and domestic shipments from refineries
in the New York harbor area or from the Gulf Coast refining centers. The price of gasoline has historically been volatile.
Natural Gas.
Natural gas accounts
for almost a quarter of U.S. energy consumption. The natural gas futures contract listed and traded on the NYMEX trades in
units of 10,000 million British thermal units and is based on delivery at the Henry Hub in Louisiana, the nexus of 16 intra-
and interstate natural gas pipeline systems that draw supplies from the region’s prolific gas deposits. The pipelines
serve markets throughout the U.S. East Coast, the Gulf Coast, the Midwest, and up to the Canadian border. The price of natural
gas has historically been volatile.
What are Futures Contracts?
Futures Contracts are agreements between
two parties. One party agrees to buy a commodity such as Brent crude oil from the other party at a later date at a price and quantity
agreed-upon when the contract is made. Futures Contracts are traded on futures exchanges, including the ICE Futures. For example,
the Benchmark Futures Contract is traded on the ICE Futures in units of 1,000 barrels. The Brent crude Futures Contracts traded
on the ICE Futures are priced by an electronic, screen-based system that determines the price by matching electronically offers
to purchase and sell. Additional risks of investing in Futures Contracts are included in
“Item 1A. Risk Factors”
in this annual report on Form 10-K.
Impact of Accountability Levels, Position
Limits and Price Fluctuation Limits
. Futures contracts include typical and significant characteristics. Most significantly,
the CFTC and U.S. designated contract markets such as the NYMEX have established accountability levels and position limits on the
maximum net long or net short futures contracts in commodity interests that any person or group of persons under common trading
control (other than as a hedge, which an investment by BNO is not) may hold, own or control. The net position is the difference
between an individual or firm’s open long contracts and open short contracts in any one commodity. In addition, most U.S.
based futures exchanges, such as the NYMEX, limit the daily price fluctuation for futures contracts. Currently, the ICE
Futures imposes position and accountability limits that are similar to those imposed by U.S. based futures exchanges and also limits
the maximum daily price fluctuation, while some other non-U.S. futures exchanges have not adopted such limits.
The accountability levels for the Benchmark
Futures Contract and other Futures Contracts traded on U.S.-based futures exchanges, such as the NYMEX, are not a fixed ceiling,
but rather a threshold above which the NYMEX may exercise greater scrutiny and control over an investor’s positions. The
current accountability level for net long or short positions at any one time in the NYMEX Contract for light, sweet crude oil Futures
Contracts is 20,000 net future contracts. In addition, the ICE Futures maintains the same accountability levels, position
limits and monitoring authority for its light, sweet crude oil contracts as the NYMEX. If BNO and the Related Public Funds exceed
this accountability level for investments in the futures contract for light, sweet crude oil, the NYMEX and ICE Futures will monitor
such exposure and may ask for further information on their activities, including the total size of all positions, investment and
trading strategy, and the extent of liquidity resources of BNO and the Related Public Funds. If deemed necessary by the NYMEX and/or
ICE Futures, BNO could be ordered to reduce its aggregate position back to the accountability level. In contrast, the position
limits for the ICE Futures maintain that when 100 lots or more are traded, the activity must be reported to the exchange on a daily
basis. ICE Futures also maintains that an Expiration Limit of 6,000 lots, long or short, will apply for the five business days
up to and including the expiration date. There are no specific position accountability levels or limits, nor are there are any
maximum daily price fluctuation limits for the ICE Brent Crude Oil (physically settled) futures contract. BNO did not exceed accountability
levels of the NYMEX or ICE Futures during the year ended December 31, 2013. As of December 31, 2013, BNO held 237 Futures
Contracts for Brent crude oil traded on the ICE Futures.
Position limits differ from accountability
levels in that they represent fixed limits on the maximum number of futures contracts that any person may hold and cannot allow
such limits to be exceeded without express CFTC authority to do so. In addition to accountability levels and position limits that
may apply at any time, the ICE Futures Exchange and the NYMEX impose position limits on contracts held in the last few days of
trading in the near month contract to expire. It is unlikely that BNO will run up against such position limits because BNO’s
investment strategy is to close out its positions and “roll” from the near month contract to expire to the next month
contract during a four-day period beginning two weeks from expiration of the contract. For the year ended December 31, 2013, BNO
did not exceed any position limits imposed by NYMEX and ICE Futures.
On November 5, 2013, the CFTC proposed
a rulemaking that would establish specific limits on speculative positions in 28 physical commodity futures and option contracts
as well as swaps that are economically equivalent to such contracts in the agriculture, energy and metals markets (the “Position
Limit Rules”). On the same date, the CFTC proposed another rule addressing the circumstances under which market participants
would be required to aggregate their positions with other persons under common ownership or control (the “Proposed Aggregation
Requirements”). Specifically, the Position Limit Rules would, among other things: identify which contracts are subject to
speculative position limits; set thresholds that restrict the number of speculative positions that a person may hold in a spot
month, individual month, and all months combined; create an exemption for positions that constitute bona fide hedging transactions;
impose responsibilities on designated contract markets (“DCMs”) and swap execution facilities (“SEFs”)
to establish position limits or, in some cases, position accountability rules; and apply to both futures and swaps across four
relevant venues: over-the-counter (“OTC”), DCMs, SEFs as well as non-U.S. located platforms. Furthermore, until such
time as the Position Limit Rules are adopted, the regulatory architecture in effect prior to the adoption of the Position Limit
Rules will govern transactions in commodities and related derivatives (collectively, “Referenced Contracts”). Under
that system, the CFTC enforces federal limits on speculation in agricultural products (e.g., corn, wheat and soy), while futures
exchanges enforce position limits and accountability levels for agricultural and certain energy products (e.g., oil and natural
gas). As a result, BNO may be limited with respect to the size of its investments in any commodities subject to these limits. Finally,
subject to certain narrow exceptions, the Position Limit Rules require the aggregation, for purposes of the position limits, of
all positions in the 28 Referenced Contracts held by a single entity and its affiliates, regardless of whether such position existed
on U.S. futures exchanges, non-U.S. futures exchanges, in cleared swaps or in over-the-counter swaps. Under the CFTC’s existing
position limits requirements and the Position Limit Rules, a market participant is generally required to aggregate all positions
for which that participant controls the trading decisions with all positions for which that participant has a 10 percent or greater
ownership interest in an account or position, as well as the positions of two or more persons acting pursuant to an express or
implied agreement or understanding. At this time, it is unclear how the Proposed Aggregation Requirements may affect BNO, but it
may be substantial and adverse. By way of example, the Proposed Aggregation Requirements in combination with the Position Limit
Rules may negatively impact the ability of BNO to meet its investment objectives through limits that may inhibit USCF’s ability
to sell additional Creation Baskets of BNO. See
“Commodity Interest Markets – Regulation”
in this annual
report on Form 10-K for additional information.
Price Volatility
. The price volatility
of Futures Contracts generally has been historically greater than that for traditional securities such as stocks and bonds.
Price volatility often is greater day-to-day as opposed to intra-day. Futures Contracts tend to be more volatile than stocks and
bonds because price movements for crude oil are more currently and directly influenced by economic factors for which current data
is available and are traded by crude oil futures traders throughout the day. Because BNO invests a significant portion of its assets
in Futures Contracts, the assets of BNO, and therefore the prices of BNO shares, may be subject to greater volatility than
traditional securities.
Marking-to-Market Futures Positions
. Futures
Contracts are marked to market at the end of each trading day and the margin required with respect to such contracts is adjusted
accordingly. This process of marking-to-market is designed to prevent losses from accumulating in any futures account. Therefore,
if BNO’s futures positions have declined in value, BNO may be required to post “variation margin” to cover this
decline. Alternatively, if BNO futures positions have increased in value, this increase will be credited to BNO’s account.
Why Does BNO Purchase and Sell Futures
Contracts?
BNO’s investment objective is for
the daily changes in percentage terms of its shares’ per share NAV to reflect the daily changes in percentage terms of the
Benchmark Futures Contract, less BNO’s expenses. BNO invests primarily in Futures Contracts. BNO seeks to have
its aggregate NAV approximate at all times the aggregate market value of the Futures Contracts and Other Crude Oil-Related Investments
it holds.
In connection with investing in Futures
Contracts and Other Crude Oil-Related Investments, BNO holds Treasuries, cash and/or cash equivalents that serve as segregated
assets supporting BNO’s positions in Futures Contracts and Other Crude Oil-Related Investments. For example, the purchase
of a Futures Contract with a notional value of $10 million would not require BNO to pay $10 million upon entering into the contract;
rather, only a margin deposit, generally of 5% to 30% of the stated value of the Futures Contract, would be required. To secure
its Futures Contract obligations, BNO would deposit the required margin with the FCM and would separately hold, through its Custodian
or FCM, Treasuries, cash and/or cash equivalents in an amount equal to the balance of the current market value of the contract,
which at the contract’s inception would be $10 million minus the amount of the margin deposit, or $9.5 million (assuming
a 5% margin).
As a result of the foregoing, typically
5% to 30% of BNO’s assets are held as margin in segregated accounts with a FCM. In addition to the Treasuries and cash
it posts with the FCM for the Futures Contracts it owns, BNO may hold, through the Custodian, Treasuries, cash and/or cash equivalents
that can be posted as additional margin or as other collateral to support its over-the-counter contracts. BNO earns income
from the Treasuries and/or cash equivalents that it purchases, and on the cash it holds through the Custodian or FCM. BNO anticipates
that the earned income will increase the NAV and limited partners’ capital contribution accounts. BNO reinvests the earned
income, holds it in cash, or uses it to pay its expenses. If BNO reinvests the earned income, it makes investments that are
consistent with its investment objective.
What are the Trading Policies of BNO?
Liquidity
BNO invests only in Futures Contracts and
Other Crude Oil-Related Investments that, in the opinion of USCF, are traded in sufficient volume to permit the ready taking and
liquidation of positions in these financial interests.
Spot Commodities
While the oil Futures Contracts traded
on the ICE Futures can be physically settled, BNO does not intend to take or make physical delivery. BNO may from time to time
trade in Other Crude Oil-Related Investments, including contracts based on the spot price of crude oil.
Leverage
USCF endeavors to have the value of BNO’s
Treasuries, cash and cash equivalents, whether held by BNO or posted as margin or other collateral, at all times approximate the
aggregate market value of its obligations under its Futures Contracts and Other Crude Oil-Related Investments. Commodity pools’
trading positions in futures contracts or other related investments are typically required to be secured by the deposit of margin
funds that represent only a small percentage of a futures contract’s (or other commodity interest’s) entire market
value. While USCF has not and does not intend to leverage BNO’s assets, it is not prohibited from doing so under the LP Agreement.
Borrowings
Borrowings are not used by BNO unless BNO
is required to borrow money in the event of physical delivery, if BNO trades in cash commodities, or for short-term needs created
by unexpected redemptions.
Over-the-Counter Derivatives (Including
Spreads and Straddles)
In addition to Futures Contracts, there
are also a number of listed options on the Futures Contracts on the principal futures exchanges. These contracts offer investors
and hedgers another set of financial vehicles to use in managing exposure to the crude oil market. Consequently, BNO may purchase
options on crude oil Futures Contracts on these exchanges in pursuing its investment objective.
In addition to the Futures Contracts and
options on the Futures Contracts, there also exists an active non-exchange-traded market in derivatives tied to crude oil. These
derivatives transactions (also known as over-the-counter contracts) are usually entered into between two parties in private contracts. Unlike
most of the exchange-traded Futures Contracts or exchange-traded options on the Futures Contracts, each party to such contract
bears the credit risk of the other party,
i.e.
, the risk that the other party may not be able to perform its obligations
under its contract.
To reduce the credit risk that arises in
connection with such contracts, BNO will generally enter into an agreement with each counterparty based on the Master Agreement
published by the International Swaps and Derivatives Association, Inc. (“ISDA”) that provides for the netting of its
overall exposure to its counterparty.
USCF assesses or reviews, as appropriate,
the creditworthiness of each potential or existing counterparty to an over-the-counter contract pursuant to guidelines approved
by USCF’s Board.
BNO may enter into certain transactions
where an over-the-counter component is exchanged for a corresponding futures contract (“Exchange for Risk” or “EFR”
transactions). These EFR transactions may expose BNO to counterparty risk during the interim period between the execution of the
over-the-counter component and the exchange for a corresponding futures contract. Generally, the counterparty risk from the EFR
transaction will exist only on the day of execution.
BNO may employ spreads or straddles in
its trading to mitigate the differences in its investment portfolio and its goal of tracking the price of the Benchmark Futures
Contract. BNO 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.
During the 12 month reporting period ended
December 31, 2013, BNO limited its derivatives activities to Futures Contracts and EFR transactions.
Pyramiding
BNO has not and will not employ the technique,
commonly known as pyramiding, in which the speculator uses unrealized profits on existing positions as variation margin for the
purchase or sale of additional positions in the same or another commodity interest.
Who are the Service Providers?
In its capacity as the Custodian for BNO,
BBH&Co. may hold BNO’s Treasuries, cash and/or cash equivalents pursuant to a custodial agreement. BBH&Co.
is also the registrar and transfer agent for the shares. In addition, in its capacity as Administrator for BNO, BBH&Co. performs
certain administrative and accounting services for BNO and prepares certain SEC, NFA and CFTC reports on behalf of BNO. USCF
pays BBH&Co.’s fees for these services.
BBH&Co.’s principal business
address is 50 Post Office Square, Boston, MA 02110-1548. BBH&Co., a private bank founded in 1818, is neither a publicly
held company nor insured by the Federal Deposit Insurance Corporation. BBH&Co. is authorized to conduct a commercial banking
business in accordance with the provisions of Article IV of the New York State Banking Law, New York Banking Law §§160–181,
and is subject to regulation, supervision, and examination by the New York State Department of Financial Services. BBH&Co.
is also licensed to conduct a commercial banking business by the Commonwealths of Massachusetts and Pennsylvania and is subject
to supervision and examination by the banking supervisors of those states.
BNO also employs ALPS Distributors, Inc.
as the Marketing Agent. USCF pays the Marketing Agent an annual fee. In no event may the aggregate compensation paid to the
Marketing Agent and any affiliate of USCF for distribution-related services in connection with the offering of shares exceed ten
percent (10%) of the gross proceeds of the offering.
ALPS’s principal business address
is 1290 Broadway, Suite 1100, Denver, CO 80203. ALPS is the marketing agent for BNO. ALPS is a broker-dealer registered
with the Financial Industry Regulatory Authority (“FINRA”) and a member of the Securities Investor Protection Corporation.
On October 8, 2013, USCF entered into a
Futures and Cleared Derivatives Transactions Customer Account Agreement with RBC Capital Markets, LLC (“RBC Capital”
or “RBC”) to serve as BNO’s FCM, effective October 10, 2013. Prior to October 10, 2013, UBS Securities LLC (“UBS
Securities”) was BNO’s FCM. This agreement requires RBC Capital to provide services to BNO, as of October 10, 2013,
in connection with the purchase and sale of Futures Contracts and Other Crude Oil-Related Investments that may be purchased or
sold by or through RBC Capital for BNO’s account. For the period October 10, 2013 and after, BNO pays RBC Capital commissions
for executing and clearing trades on behalf of BNO. Prior to October 10, 2013, BNO paid UBS Securities commissions for executing
and clearing trades on behalf of BNO.
RBC Capital’s primary address is
500 West Madison Street, Suite 2500, Chicago, Illinois 60661. UBS Securities’ principal business address is 677 Washington
Blvd., Stamford, Connecticut 06901. From BNO’s commencement of trading to October 10, 2013, UBS Securities was a futures
clearing broker for BNO. Effective October 10, 2013, RBC Capital became the futures clearing broker for BNO. Both RBC Capital and
UBS Securities are registered in the U.S. with FINRA as a broker-dealer and with the CFTC as a FCM. RBC Capital and UBS Securities
are members of various U.S. futures and securities exchanges.
RBC is a large broker-dealer subject to
many different complex legal and regulatory requirements. As a result, certain of RBC’s regulators may from time to time
conduct investigations, initiate enforcement proceedings and/or enter into settlements with RBC with respect to issues raised in
various investigations. RBC complies fully with its regulators in all investigations being conducted and in all settlements it
reaches. In addition, RBC is and has been subject to a variety of civil legal claims in various jurisdictions, a variety of settlement
agreements and a variety of orders, awards and judgments made against it by courts and tribunals, both in regard to such claims
and investigations. RBC complies fully with all settlements it reaches and all orders, awards and judgments made against it.
RBC has been named as a defendant in various
legal actions, including arbitrations, class actions and other litigation including those described below, arising in connection
with its activities as a broker-dealer. Certain of the actual or threatened legal actions include claims for substantial compensatory
and/or punitive damages or claims for indeterminate amounts of damages. RBC is also involved, in other reviews, investigations
and proceedings (both formal and informal) by governmental and self-regulatory agencies regarding RBC’s business, including
among other matters, accounting and operational matters, certain of which may result in adverse judgments, settlements, fines,
penalties, injunctions or other relief.
RBC contests liability and/or the amount
of damages, as appropriate, in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters,
particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in
the early stages, RBC cannot predict the loss or range of loss, if any, related to such matters; how or if such matters will be
resolved; when they will ultimately be resolved; or what the eventual settlement, fine, penalty or other relief, if any, might
be. Subject to the foregoing, RBC believes, based on current knowledge and after consultation with counsel, that the outcome of
such pending matters will not have a material adverse effect on the consolidated financial condition of RBC.
On March 11, 2013, the New Jersey Bureau
of Securities entered a consent order settling an administrative complaint against RBC, which alleged that RBC failed to follow
its own procedures with respect to monthly account reviews and failed to maintain copies of the monthly account reviews with respect
to certain accounts that James Hankins Jr. maintained at the firm in violation of N.J.S.A. 49:3-58(a)(2)(xi) and 49:3-59(b). Without
admitting or denying the findings of fact and conclusions of law, RBC consented to a civil monetary penalty of $150,000 (of which
$100,000 was suspended as a result of the firm’s cooperation) and to pay disgorgement of $300,000.
On May 2, 2012, the Massachusetts Securities
Division entered a consent order settling an administrative complaint against RBC, which alleged that RBC recommended unsuitable
products to its brokerage and advisory clients and failed to supervise its registered representatives’ sales of inverse and
leveraged ETFs in violation of Section 204(a)(2) of the Massachusetts Uniform Securities Act (“MUSA”). Without admitting
or denying the allegations of fact, RBC consented to permanently cease and desist from violations of MUSA, pay restitution of $2.9
million to the investors who purchased the inverse and leveraged ETFs and pay a civil monetary penalty of $250,000.
On September 27, 2011, the SEC commenced
and settled an administrative proceeding against RBC for willful violations of Sections 17(a)(2) and 17(a)(3) of the 1933 Act for
negligently selling collateralized debt obligations to five Wisconsin school districts despite concerns about the suitability of
the product. The firm agreed to pay disgorgement of $6.6 million, prejudgment interest of $1.8 million, and a civil monetary penalty
of $22 million.
On February 24, 2009, the SEC commenced
and settled an administrative proceeding against RBC for willful violations of Section 15B(c)(1) of the 1934 Act and Municipal
Securities Rulemaking Board Rules G-17, G-20 and G-27, related to municipal expenses in connection with ratings agency trips. The
firm was censured and paid a civil monetary penalty of $125,000.
On June 9, 2009, the SEC commenced and
settled a civil action against RBC for willful violations of Section 15(c) of the 1934 Act, in connection with auction rate securities
(ARS). The firm agreed to repurchase ARS owned by certain retail customers and to use best efforts to provide ineligible customers
opportunities to liquidate ARS, and other ancillary relief.
Please see RBC’s Form BD for more
details.
RBC Capital will act only as clearing broker
for BNO and as such will be paid commissions for executing and clearing trades on behalf of BNO. Prior to October 10, 2013, UBS
Securities acted only as clearing broker for BNO and as such was paid commissions for executing and clearing trades on behalf of
BNO. Neither RBC Capital nor UBS Securities has passed upon the adequacy or accuracy of this annual report on Form 10-K. Neither
RBC Capital nor UBS Securities will act in any supervisory capacity with respect to USCF or participate in the management of USCF
or BNO.
Neither RBC Capital nor UBS Securities
is affiliated with BNO or USCF. Therefore, neither USCF nor BNO believes that there are any conflicts of interest with RBC Capital
and UBS Securities or their trading principals arising from their acting as BNO’s FCM.
Currently, USCF does not employ commodity
trading advisors for the trading of BNO contracts. USCF currently does, however, employ a trading advisor for USCI, CPER,
USAG and USMI, SummerHaven Investment Management, LLC (“SummerHaven”). If, in the future, USCF does employ commodity
trading advisors for BNO, it will choose each advisor based on arm’s-length negotiations and will consider the advisor’s
experience, fees and reputation.
Fees of BNO
Fees and Compensation Arrangements
with USCF and Non-Affiliated Service Providers
(1)
Service Provider
|
|
Compensation Paid by USCF
|
BBH&Co., Custodian and Administrator
|
|
Minimum amount of $75,000 annually for its custody, fund accounting and fund administration services rendered to all funds, as well as a $20,000 annual fee for its transfer agency services. In addition, an asset-based charge of (a) 0.06% for the first $500 million of BNO’s and the Related Public Funds’ combined net assets, (b) 0.0465% for BNO’s and the Related Public Funds’ combined net assets greater than $500 million but less than $1 billion, and (c) 0.035% once BNO’s and the Related Public Funds’ combined net assets exceed $1 billion.
(2)
|
ALPS Distributors, Inc., Marketing Agent
|
|
0.06% on BNO’s assets up to $3 billion and 0.04% on BNO’s assets in excess of $3 billion.
|
|
(1)
|
USCF
pays this compensation.
|
|
(2)
|
The
annual minimum amount will not apply if the asset-based charge for all accounts in the aggregate exceeds $75,000. USCF also
will pay transaction charge fees to BBH&Co., ranging from $7.00 to $15.00 per transaction for the funds.
|
Compensation to USCF
BNO is contractually obligated to pay USCF
a management fee based on 0.75% per annum on its average daily total net assets. Fees are calculated on a daily basis (accrued
at 1/365 of the applicable percentage of total net assets on that day) and paid on a monthly basis. Total net assets are calculated
by taking the current market value of BNO’s total assets and subtracting any liabilities.
Fees and Compensation Arrangements
between BNO and Non-Affiliated Service Providers
(3)
Service Provider
|
|
Compensation Paid by BNO
|
UBS Securities LLC, Futures Commission Merchant
|
|
Approximately $3.50 per buy or sell; charges may vary
|
RBC Capital Markets, LLC, Futures Commission Merchant
|
|
Approximately $3.50 per buy or sell; charges may vary
|
|
(3)
|
BNO
pays this compensation.
|
Expenses Paid or Accrued by BNO from
Inception through December 31, 2013 in dollar terms:
Expenses:
|
|
Amount in Dollar Terms
|
|
Amount Paid or Accrued to USCF:
|
|
$
|
1,056,827
|
|
Amount Paid or Accrued in Portfolio Brokerage Commissions:
|
|
$
|
100,769
|
|
Other Amounts Paid or Accrued
(4)
:
|
|
$
|
559,437
|
|
Total Expenses Paid or Accrued:
|
|
$
|
1,717,033
|
|
Expenses Waived
(5)
:
|
|
$
|
(346,047
|
)
|
Total Expenses Paid or Accrued Excluding Expenses Waived
(5)
:
|
|
$
|
1,370,986
|
|
|
(4)
|
Includes
expenses relating to legal fees, auditing fees, printing expenses, tax reporting fees, prepaid insurance expenses and miscellaneous
expenses and fees and expenses paid to the independent directors of USCF.
|
|
(5)
|
USCF
has voluntarily agreed to pay certain expenses typically borne by BNO, to the extent that such expenses exceeded 0.15% (15 basis
points) of BNO’s NAV, on an annualized basis, through at least June 30, 2014. USCF has no obligation to pay such expenses
in subsequent periods.
|
Expenses Paid or Accrued by BNO from
Inception through December 31, 2013 as a Percentage of Average Daily Net Assets:
Expenses:
|
|
Amount as a Percentage
of Average Daily Net Assets
|
Amount Paid or Accrued to USCF:
|
|
0.75% annualized
|
Amount Paid or Accrued in Portfolio Brokerage Commissions:
|
|
0.07% annualized
|
Other Amounts Paid or Accrued
(6)
:
|
|
0.40% annualized
|
Total Expenses Paid or Accrued:
|
|
1.22% annualized
|
Expenses Waived
(7)
:
|
|
(0.25)% annualized
|
Total Expenses Paid or Accrued Excluding Expenses Waived
(7)
:
|
|
0.97% annualized
|
|
(6)
|
Includes
expenses relating to legal fees, auditing fees, printing expenses, tax reporting fees, prepaid insurance expenses and miscellaneous
expenses and fees and expenses paid to the independent directors of USCF.
|
|
(7)
|
USCF
has voluntarily agreed to pay certain expenses typically borne by BNO, to the extent that such expenses exceeded 0.15% (15 basis
points) of BNO’s NAV, on an annualized basis, through at least June 30, 2014. USCF has no obligation to pay such expenses
in subsequent periods.
|
Other Fees.
BNO also
pays the fees and expenses associated with its tax accounting and reporting requirements. These fees were approximately $110,000
for the fiscal year ended December 31, 2013. In addition, BNO is responsible for paying its portion of the directors’
and officers’ liability insurance for BNO and the Related Public Funds and the fees and expenses of the independent directors
who also serve as audit committee members of BNO and the Related Public Funds organized as limited partnerships and, as of July 8,
2011, the Related Public Funds organized as a series of a Delaware statutory trust. BNO shares the fees and expenses on a pro rata
basis with each Related Public Fund, as described above, based on the relative assets of each fund computed on a daily basis. These
fees and expenses for the year ended December 31, 2013 were $555,465 for BNO and the Related Public Funds. BNO’s portion
of such fees and expenses for the year ended December 31, 2013 was $9,012.
Form of Shares
Registered Form
. Shares are
issued in registered form in accordance with the LP Agreement. The Administrator has been appointed registrar and transfer
agent for the purpose of transferring shares in certificated form. The Administrator keeps a record of all limited partners and
holders of the shares in certificated form in the registry (the “Register”). USCF recognizes transfers of shares
in certificated form only if done in accordance with the LP Agreement. The beneficial interests in such shares are held in
book-entry form through participants and/or accountholders in the Depository Trust Company (“DTC”).
Book Entry
. Individual certificates
are not issued for the shares. Instead, shares are represented by one or more global certificates, which are deposited by
the Administrator with DTC and registered in the name of Cede & Co., as nominee for DTC. The global certificates
evidence all of the shares outstanding at any time. Shareholders are limited to (1) participants in DTC such as banks,
brokers, dealers and trust companies (“DTC Participants”), (2) those who maintain, either directly or indirectly,
a custodial relationship with a DTC Participant (“Indirect Participants”), and (3) those banks, brokers, dealers,
trust companies and others who hold interests in the shares through DTC Participants or Indirect Participants, in each case who
satisfy the requirements for transfers of shares. DTC Participants acting on behalf of investors holding shares through such participants’
accounts in DTC will follow the delivery practice applicable to securities eligible for DTC’s Same-Day Funds Settlement System. Shares
are credited to DTC Participants’ securities accounts following confirmation of receipt of payment.
DTC
. DTC has advised BNO
as follows: It is a limited purpose trust company organized under the laws of the State of New York and is a member of the Federal
Reserve System, a “clearing corporation” within the meaning of the New York Uniform Commercial Code and a “clearing
agency” registered pursuant to the provisions of Section 17A of the Exchange Act. DTC holds securities for DTC
Participants and facilitates the clearance and settlement of transactions between DTC Participants through electronic book-entry
changes in accounts of DTC Participants.
Calculating Per Share NAV
BNO’s per share NAV is calculated
by:
|
•
|
Taking the current market value of its total assets;
|
|
•
|
Subtracting any liabilities; and
|
|
•
|
Dividing that total by the total number of outstanding shares.
|
The Administrator calculates the per share
NAV of BNO once each NYSE Arca trading day. The per share 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. The
Administrator uses the ICE Futures settlement price (a weighted average price of trades during a three minute settlement period
from 2:27 p.m. to 2:30 p.m. New York time) for the Futures Contracts traded on the ICE Futures, but calculates or determines the
value of all other BNO investments (including Futures Contracts not traded on the ICE Futures, Other Crude Oil-Related Investments
and Treasuries), using market quotations, if available, or other information customarily used to determine the fair value of such
investments as of the earlier of the close of the NYSE Arca or 4:00 p.m. New York time, in accordance with the current Administrative
Agency Agreement among BBH&Co., BNO and USCF. “Other information” customarily used in determining fair value includes
information consisting of market data in the relevant market supplied by one or more third parties including, without limitation,
relevant rates, prices, yields, yield curves, volatilities, spreads, correlations or other market data in the relevant market;
or information of the types described above from internal sources if that information is of the same type used by BNO in the regular
course of its business for the valuation of similar transactions. The information may include costs of funding, to the extent costs
of funding are not and would not be a component of the other information being utilized. Third parties supplying quotations or
market data may include, without limitation, dealers in the relevant markets, end-users of the relevant product, information vendors,
brokers and other sources of market information.
In addition, in order to provide updated
information relating to BNO for use by investors and market professionals, the NYSE Arca calculates and disseminates throughout
the core trading session on each trading day an updated indicative fund value. The indicative fund value is calculated by
using the prior day’s closing per share NAV of BNO as a base and updating that value throughout the trading day to reflect
changes in the most recently reported trade price for the active Brent crude oil Futures Contracts on the ICE Futures. The
prices reported for those Futures Contract months are adjusted based on the prior day’s spread differential between settlement
values for the relevant contract and the spot month contract. In the event that the spot month contract is also the Benchmark Futures
Contract, the last sale price for that contract is not adjusted. The indicative fund value share basis disseminated during
NYSE Arca core trading session hours should not be viewed as an actual real time update of the per share NAV, because the per share
NAV is calculated only once at the end of each trading day based upon the relevant end of day values of BNO’s investments.
The NYSE Arca disseminates the indicative
fund value through the facilities of CTA/CQ High Speed Lines. In addition, the indicative fund value is published on the NYSE Arca’s
website and is available through on-line information services such as Bloomberg and Reuters.
Dissemination of the indicative fund value
provides additional information that is not otherwise available to the public and is useful to investors and market professionals
in connection with the trading of BNO shares on the NYSE Arca. Investors and market professionals are able throughout the trading
day to compare the market price of BNO and the indicative fund value. If the market price of BNO shares diverges significantly
from the indicative fund value, market professionals will have an incentive to execute arbitrage trades. For example, if BNO
appears to be trading at a discount compared to the indicative fund value, a market professional could buy BNO shares on the NYSE
Arca and sell short Futures Contracts. Such arbitrage trades can tighten the tracking between the market price of BNO and the indicative
fund value and thus can be beneficial to all market participants.
Creation and Redemption of Shares
BNO creates and redeems shares from time
to time, but only in one or more Creation Baskets or Redemption Baskets. The creation and redemption of baskets are only made
in exchange for delivery to BNO or the distribution by BNO of the amount of Treasuries and any cash represented by the baskets
being created or redeemed, the amount of which is based on the combined NAV of the number of shares included in the baskets being
created or redeemed determined after 4:00 p.m. New York time on the day the order to create or redeem baskets is properly received.
Authorized Purchasers are the only persons
that may place orders to create and redeem baskets. Authorized Purchasers must be (1) registered broker-dealers or other securities
market participants, such as banks and other financial institutions, that are not required to register as broker-dealers to engage
in securities transactions as described below, and (2) DTC Participants. To become an Authorized Purchaser, a person
must enter into an Authorized Purchaser Agreement with USCF on behalf of BNO. The Authorized Purchaser Agreement provides
the procedures for the creation and redemption of baskets and for the delivery of the Treasuries and any cash required for such
creations and redemptions. The Authorized Purchaser Agreement and the related procedures attached thereto may be amended
by USCF, without the consent of any limited partner or shareholder or Authorized Purchaser. From July 1, 2011 through December 31,
2013 (and continuing at least through May 1, 2014), the applicable transaction fee paid by Authorized Purchasers is $350 to
BNO for each order they place to create or redeem one or more baskets; prior to July 1, 2011, this fee was $1,000. Authorized
Purchasers who make deposits with BNO in exchange for baskets receive no fees, commissions or other form of compensation or inducement
of any kind from either BNO or USCF, and no such person will have any obligation or responsibility to USCF or BNO to effect any
sale or resale of shares. As of December 31, 2013, 9 Authorized Purchasers had entered into agreements with USCF on behalf
of BNO. During the year ended December 31, 2013, BNO issued 43 Creation Baskets and redeemed 51 Redemption Baskets.
Certain Authorized Purchasers are expected
to be capable of participating directly in the physical crude oil market and the crude oil futures market. In some cases,
Authorized Purchasers or their affiliates may from time to time buy crude oil or sell crude oil or Crude Oil Interests and may
profit in these instances. USCF believes that the size and operation of the crude oil market make it unlikely that an Authorized
Purchaser’s direct activities in the crude oil or securities markets will significantly affect the price of crude oil, Crude-Oil
Interests, or the price of the shares.
Each Authorized Purchaser is required to
be registered as a broker-dealer under the Exchange Act and is a member in good standing with FINRA, or exempt from being or otherwise
not required to be registered as a broker-dealer or a member of FINRA, and qualified to act as a broker or dealer in the states
or other jurisdictions where the nature of its business so requires. Certain Authorized Purchasers may also be regulated
under federal and state banking laws and regulations. Each Authorized Purchaser has its own set of rules and procedures,
internal controls and information barriers as it determines is appropriate in light of its own regulatory regime.
Under the Authorized Purchaser Agreement,
USCF has agreed to indemnify the Authorized Purchasers against certain liabilities, including liabilities under the Securities
Act of 1933, as amended (the “Securities Act”), and to contribute to the payments the Authorized Purchasers may be
required to make in respect of those liabilities.
The following description of the procedures
for the creation and redemption of baskets is only a summary and an investor should refer to the relevant provisions of the LP
Agreement and the form of Authorized Purchaser Agreement for more detail, each of which is incorporated by reference into this
annual report on Form 10-K.
Creation Procedures
On any business day, an Authorized Purchaser
may place an order with the Marketing Agent to create one or more baskets. For purposes of processing purchase and redemption
orders, a “business day” means any day other than a day when any of the NYSE Arca, the ICE Futures or the NYSE is closed
for regular trading. Purchase orders must be placed by 12:00 p.m. New York time or the close of regular trading on the NYSE Arca,
whichever is earlier. The day on which the Marketing Agent receives a valid purchase order is referred to as the purchase
order date.
By placing a purchase order, an Authorized
Purchaser agrees to deposit Treasuries, cash, or a combination of Treasuries and cash, as described below. Prior to the delivery
of baskets for a purchase order, the Authorized Purchaser must also have wired to the Custodian the non-refundable transaction
fee due for the purchase order. Authorized Purchasers may not withdraw a creation request.
The manner by which creations are made
is dictated by the terms of the Authorized Purchaser Agreement. By placing a purchase order, an Authorized Purchaser agrees to
(1) deposit Treasuries, cash, or a combination of Treasuries and cash with the Custodian, and (2) if required by USCF
in its sole discretion, enter into or arrange for a block trade, an exchange for physical or exchange for swap, or any other over-the-counter
energy transaction (through itself or a designated acceptable broker) with BNO for the purchase of a number and type of futures
contracts at the closing settlement price for such contracts on the purchase order date. If an Authorized Purchaser fails to consummate
(1) and (2), the order shall be cancelled. The number and type of contracts specified shall be determined by USCF, in its
sole discretion, to meet BNO’s investment objective and shall be purchased as a result of the Authorized Purchaser’s
purchase of shares.
Determination of Required Deposits
The total deposit required to create each
basket (“Creation Basket Deposit”) is the amount of Treasuries and/or cash that is in the same proportion to the total
assets of BNO (net of estimated accrued but unpaid fees, expenses and other liabilities) on the purchase order date as the number
of shares to be created under the purchase order is in proportion to the total number of shares outstanding on the purchase order
dates. USCF determines, directly in its sole discretion or in consultation with the Administrator, the requirements for Treasuries
and the amount of cash, including the maximum permitted remaining maturity of a Treasury and proportions of Treasury and cash that
may be included in deposits to create baskets. The Marketing Agent will publish such requirements at the beginning of each
business day. The amount of cash deposit required is the difference between the aggregate market value of the Treasuries
required to be included in a Creation Basket Deposit as of 4:00 p.m. New York time on the date the order to purchase is properly
received and the total required deposit.
Delivery of Required Deposits
An Authorized Purchaser who places a purchase
order is responsible for transferring to BNO’s account with the Custodian the required amount of Treasuries and cash by the
end of the third business day following the purchase order date. Upon receipt of the deposit amount, the Administrator directs
DTC to credit the number of baskets ordered to the Authorized Purchaser’s DTC account on the third business day following
the purchase order date. The expense and risk of delivery and ownership of Treasuries until such Treasuries have been received
by the Custodian on behalf of BNO shall be borne solely by the Authorized Purchaser.
Because orders to purchase baskets must
be placed by 12:00 p.m., New York time, but the total payment required to create a basket during the continuous offering period
will not be determined until after 4:00 p.m. New York time on the date the purchase order is received, Authorized Purchasers will
not know the total amount of the payment required to create a basket at the time they submit an irrevocable purchase order for
the basket. BNO’s per share NAV and the total amount of the payment required to create a basket could rise or fall substantially
between the time an irrevocable purchase order is submitted and the time the amount of the purchase price in respect thereof is
determined.
Rejection of Purchase Orders
USCF acting by itself or through the Marketing
Agent shall have the absolute right but no obligation to reject a purchase order or a Creation Basket Deposit if:
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it
determines that the investment alternative available to BNO at that time will not enable it to meet its investment objective;
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it
determines that the purchase order or the Creation Basket Deposit is not in proper form;
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it
believes that the purchase order or the Creation Basket Deposit would have adverse tax consequences to BNO, the limited partners
or its shareholders;
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the
acceptance or receipt of the Creation Basket Deposit would, in the opinion of counsel to USCF, be unlawful; or
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circumstances
outside the control of USCF, Marketing Agent or Custodian make it, for all practical purposes, not feasible to process creations
of baskets.
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None of USCF, the Marketing Agent or the
Custodian will be liable for the rejection of any purchase order or Creation Basket Deposit.
Redemption Procedures
The procedures by which an Authorized Purchaser
can redeem one or more baskets mirror the procedures for the creation of baskets. On any business day, an Authorized Purchaser
may place an order with the Marketing Agent to redeem one or more baskets. Redemption orders must be placed by 12:00 p.m.
New York time or the close of regular trading on the NYSE Arca, whichever is earlier. A redemption order so received will
be effective on the date it is received in satisfactory form by the Marketing Agent. The redemption procedures allow Authorized
Purchasers to redeem baskets and do not entitle an individual shareholder to redeem any shares in an amount less than a Redemption
Basket, or to redeem baskets other than through an Authorized Purchaser.
By placing a redemption order, an Authorized
Purchaser agrees to deliver the baskets to be redeemed through DTC’s book-entry system to BNO, as described below. Prior
to the delivery of the redemption distribution for a redemption order, the Authorized Purchaser must also have wired to BNO’s
account at the Custodian the non-refundable transaction fee due for the redemption order. An Authorized Purchaser may not withdraw
a redemption order.
The manner by which redemptions are made
is dictated by the terms of the Authorized Purchaser Agreement. By placing a redemption order, an Authorized Purchaser agrees to
(1) deliver the Redemption Basket to be redeemed through DTC’s book-entry system to BNO’s account with the Custodian
not later than 3:00 p.m. New York time on the third business day following the effective date of the redemption order (“Redemption
Distribution Date”), and (2) if required by USCF in its sole discretion, enter into or arrange for a block trade, an
exchange for physical or exchange for swap, or any other over-the-counter energy transaction (through itself or a designated acceptable
broker) with BNO for the sale of a number and type of futures contracts at the closing settlement price for such contracts on the
Redemption Order Date. If an Authorized Purchaser fails to consummate (1) and (2) above, the order shall be cancelled.
The number and type of contracts specified shall be determined by USCF, in its sole discretion, to meet BNO’s investment
objective and shall be sold as a result of the Authorized Purchaser’s sale of shares.
Determination of Redemption Distribution
The redemption distribution from BNO consists
of a transfer to the redeeming Authorized Purchaser of an amount of Treasuries and/or cash that is in the same proportion to the
total assets of BNO (net of estimated accrued but unpaid fees, expenses and other liabilities) on the date the order to redeem
is properly received as the number of shares to be redeemed under the redemption order is in proportion to the total number of
shares outstanding on the date the order is received. USCF, directly or in consultation with the Administrator, determines
the requirements for Treasuries and the amounts of cash, including the maximum permitted remaining maturity of a Treasury, and
the proportions of Treasuries and cash that may be included in distributions to redeem baskets. The Marketing Agent will
publish an estimate of the redemption distribution per basket as of the beginning of each business day.
Delivery of Redemption Distribution
The redemption distribution due from BNO
will be delivered to the Authorized Purchaser by 3:00 p.m. New York time on the third business day following the redemption order
date if, by 3:00 p.m. New York time on such third business day, BNO’s DTC account has been credited with the baskets to be
redeemed. If BNO’s DTC account has not been credited with all of the baskets to be redeemed by such time, the redemption
distribution will be delivered to the extent of whole baskets received. Any remainder of the redemption distribution will
be delivered on the next business day to the extent of remaining whole baskets received if BNO receives the fee applicable to the
extension of the redemption distribution date which USCF may, from time to time, determine and the remaining baskets to be redeemed
are credited to BNO’s DTC account by 3:00 p.m. New York time on such next business day. Any further outstanding amount
of the redemption order shall be cancelled. Pursuant to information from USCF, the Custodian will also be authorized to deliver
the redemption distribution notwithstanding that the baskets to be redeemed are not credited to BNO’s DTC account by 3:00
p.m. New York time on the third business day following the redemption order date if the Authorized Purchaser has collateralized
its obligation to deliver the baskets through DTC’s book entry-system on such terms as USCF may from time to time determine.
Suspension or Rejection of Redemption
Orders
USCF may, in its discretion, suspend the
right of redemption, or postpone the redemption settlement date, (1) for any period during which the NYSE Arca or the ICE
Futures is closed other than customary weekend or holiday closings, or trading on the NYSE Arca or the ICE Futures is suspended
or restricted, (2) for any period during which an emergency exists as a result of which delivery, disposal or evaluation of
Treasuries is not reasonably practicable, or (3) for such other period as USCF determines to be necessary for the protection
of the limited partners or shareholders. For example, USCF may determine that it is necessary to suspend redemptions to allow
for the orderly liquidation of BNO’s assets at an appropriate value to fund a redemption. If USCF has difficulty liquidating
its positions,
e.g.
, because of a market disruption event in the futures markets, a suspension of trading by the exchange
where the futures contracts are listed or an unanticipated delay in the liquidation of a position in an over-the-counter contract,
it may be appropriate to suspend redemptions until such time as such circumstances are rectified. None of USCF, the Marketing
Agent, the Administrator, or the Custodian will be liable to any person or in any way for any loss or damages that may result from
any such suspension or postponement.
Redemption orders must be made in whole
baskets. USCF will reject a redemption order if the order is not in proper form as described in the Authorized Purchaser Agreement
or if the fulfillment of the order, in the opinion of its counsel, might be unlawful. USCF may also reject a redemption order
if the number of shares being redeemed would reduce the remaining outstanding shares to 100,000 shares (
i.e.
, two baskets)
or less.
Creation and Redemption Transaction
Fee
To compensate BNO for its expenses in connection
with the creation and redemption of baskets, an Authorized Purchaser is required to pay a transaction fee per order to create or
redeem baskets, regardless of the number of baskets in such order. From July 1, 2011 through December 31, 2013 (and continuing
at least through May 1, 2014), the applicable transaction fee paid by Authorized Purchasers was $350 to BNO for each order
they place to create or redeem one or more baskets; prior to July 1, 2011, this fee was $1,000. The transaction fee may be
reduced, increased or otherwise changed by USCF. USCF shall notify DTC of any change in the transaction fee and will not
implement any increase in the fee for the redemption of baskets until 30 days after the date of the notice.
Tax Responsibility
Authorized Purchasers are responsible for
any transfer tax, sales or use tax, stamp tax, recording tax, value added tax or similar tax or governmental charge applicable
to the creation or redemption of baskets, regardless of whether or not such tax or charge is imposed directly on the Authorized
Purchaser, and agree to indemnify USCF and BNO if they are required by law to pay any such tax, together with any applicable penalties,
additions to tax and interest thereon.
Secondary Market Transactions
As noted, BNO creates and redeems shares
from time to time, but only in one or more Creation Baskets or Redemption Baskets. The creation and redemption of baskets
are only made in exchange for delivery to BNO or the distribution by BNO of the amount of Treasuries and cash represented by the
baskets being created or redeemed, the amount of which will be based on the aggregate NAV of the number of shares included in the
baskets being created or redeemed determined on the day the order to create or redeem baskets is properly received.
As discussed above, Authorized Purchasers
are the only persons that may place orders to create and redeem baskets. Authorized Purchasers must be registered broker-dealers
or other securities market participants, such as banks and other financial institutions that are not required to register as broker-dealers
to engage in securities transactions. An Authorized Purchaser is under no obligation to create or redeem baskets, and an
Authorized Purchaser is under no obligation to offer to the public shares of any baskets it does create. Authorized Purchasers
that do offer to the public shares from the baskets they create will do so at per-share offering prices that are expected to reflect,
among other factors, the trading price of the shares on the NYSE Arca, the per share NAV of BNO at the time the Authorized Purchaser
purchased the Creation Baskets and the per share NAV of the shares at the time of the offer of the shares to the public, the supply
of and demand for shares at the time of sale, and the liquidity of the Futures Contract market and the market for Other Crude Oil-Related
Investments. The prices of shares offered by Authorized Purchasers are expected to fall between BNO’s per share NAV
and the trading price of the shares on the NYSE Arca at the time of sale. Shares initially comprising the same basket but
offered by Authorized Purchasers to the public at different times may have different offering prices. An order for one or more
baskets may be placed by an Authorized Purchaser on behalf of multiple clients. Authorized Purchasers who make deposits with BNO
in exchange for baskets receive no fees, commissions or other form of compensation or inducement of any kind from either BNO or
USCF, and no such person has any obligation or responsibility to USCF or BNO to effect any sale or resale of shares. Shares trade
in the secondary market on the NYSE Arca. Shares may trade in the secondary market at prices that are lower or higher relative
to their per share NAV. The amount of the discount or premium in the trading price relative to the per share NAV may be influenced
by various factors, including the number of investors who seek to purchase or sell shares in the secondary market and the liquidity
of the Futures Contracts market and the market for Other Crude Oil-Related Investments. While the shares trade during the core
trading session on the NYSE Arca until 4:00 p.m. New York time and trading in Futures Contracts on the ICE Futures Exchange continues
throughout the entire NYSE Arca trading day, liquidity in the market for Futures Contracts and Other Crude Oil-Related Investments
traded on the NYMEX may be reduced after the close of the NYMEX at 2:30 p.m. New York time. As a result, during this time,
particularly if BNO has invested in Futures Contracts and Other Crude Oil-Related Investment traded on the NYMEX, trading spreads,
and the resulting premium or discount, on the shares may widen.
Investments
USCF causes BNO to transfer the proceeds
from the sale of Creation Baskets to the Custodian or other custodian for trading activities. USCF will invest BNO’s assets
in Futures Contracts and Other Crude Oil-Related Investments and investments in Treasuries, cash and/or cash equivalents.
When BNO purchases a Futures Contract and certain exchange-traded Other Crude Oil-Related Investments, BNO is required to deposit
5% to 30% with the selling FCM on behalf of the exchange a portion of the value of the contract or other interest as security to
ensure payment for the obligation under Crude Oil Interests at maturity. This deposit is known as initial margin. Counterparties
in transactions in over-the-counter Crude Oil Interests will generally impose similar collateral requirements on BNO. USCF will
invest the assets that remain after margin and collateral are posted in Treasuries, cash and/or cash equivalents subject to these
margin and collateral requirements.
USCF has sole authority to determine the
percentage of assets that are:
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held
on deposit with the FCM or other custodian,
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used
for other investments, and
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held
in bank accounts to pay current obligations and as reserves.
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Ongoing margin and collateral payments
will generally be required for both exchange-traded and over-the-counter Crude Oil Interests based on changes in the value of the
Crude Oil Interests. Furthermore, ongoing collateral requirements with respect to over-the-counter Crude Oil Interests are negotiated
by the parties, and may be affected by overall market volatility, volatility of the underlying commodity or index, the ability
of the counterparty to hedge its exposure under a Crude Oil Interest, and each party’s creditworthiness. In light of the
differing requirements for initial payments under exchange-traded and over-the-counter Crude Oil Interests and the fluctuating
nature of ongoing margin and collateral payments, it is not possible to estimate what portion of BNO’s assets will be posted
as margin or collateral at any given time. The Treasuries, cash and cash equivalents held by BNO will constitute reserves that
will be available to meet ongoing margin and collateral requirements. All interest income will be used for BNO’s benefit.
A FCM, counterparty, government agency
or commodity exchange could increase margin or collateral requirements applicable to BNO to hold trading positions at any time.
Moreover, margin is merely a security deposit and has no bearing on the profit or loss potential for any positions held.
The assets of BNO posted as margin for
Futures Contracts are held in segregated accounts pursuant to the CEA and CFTC regulations.
The Commodity Interest Markets
General
The CEA governs the regulation of commodity
interest transactions, markets and intermediaries. The CEA provides for varying degrees of regulation of commodity interest transactions
depending upon: (1) the type of instrument being traded (
e.g.
, contracts for future delivery, options, swaps or spot
contracts), (2) the type of commodity underlying the instrument (distinctions are made between instruments based on agricultural
commodities, energy and metals commodities and financial commodities), (3) the nature of the parties to the transaction (retail,
eligible contract participant, or eligible commercial entity), (4) whether the transaction is entered into on a principal-to-principal
or intermediated basis, (5) the type of market on which the transaction occurs, and (6) whether the transaction is subject
to clearing through a clearing organization.
The offer and sale of shares of BNO, as
well as shares of each of the Related Public Funds, is registered under the Securities Act. BNO and the Related Public Funds are
subject to the requirements of the Securities Act, the Exchange Act and the rules and regulations adopted thereunder as administered
by the SEC. Firms’ participation in the distribution of shares are regulated as described above, as well as by the self regulatory
association, FINRA.
Futures Contracts
A futures contract is a standardized contract
traded on, or subject to the rules of, an exchange that calls for the future delivery of a specified quantity and type of a commodity
at a specified time and place. Futures contracts are traded on a wide variety of commodities, including agricultural products,
bonds, stock indices, interest rates, currencies, energy and metals. The size and terms of futures contracts on a particular
commodity are identical and are not subject to any negotiation, other than with respect to price and the number of contracts traded
between the buyer and seller.
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 difference between the price at which the futures contract is purchased or sold and the price paid for the offsetting sale
or purchase, after allowance for brokerage commissions, constitutes the profit or loss to the trader. Some futures contracts,
such as stock index contracts, settle in cash (reflecting the difference between the contract purchase/sale price and the contract
settlement price) rather than by delivery of the underlying commodity.
In market terminology, a trader who purchases
a futures contract is long in the market and a trader who sells a futures contract is short in the market. Before a trader
closes out his long or short position by an offsetting sale or purchase, his outstanding contracts are known as open trades or
open positions. The aggregate amount of open positions held by traders in a particular contract is referred to as the open
interest in such contract.
Forward Contracts
A forward contract is a contractual obligation
to purchase or sell a specified quantity of a commodity at or before a specified date in the future at a specified price and, therefore,
is economically similar to a futures contract. Unlike futures contracts, however, forward contracts are typically traded in
the over-the-counter markets and are not standardized contracts. Forward contracts for a given commodity are generally available
for various amounts and maturities and are subject to individual negotiation between the parties involved. Moreover, generally
there is no direct means of offsetting or closing out a forward contract by taking an offsetting position as one would a futures
contract on a U.S. exchange. If a trader desires to close out a forward contract position, he generally will establish an
opposite position in the contract but will settle and recognize the profit or loss on both positions simultaneously on the delivery
date. Thus, unlike in the futures contract market where a trader who has offset positions will recognize profit or loss immediately,
in the forward market a trader with a position that has been offset at a profit will generally not receive such profit until the
delivery date, and likewise a trader with a position that has been offset at a loss will generally not have to pay money until
the delivery date. In recent years, however, the terms of forward contracts have become more standardized, and in some instances
such contracts now provide a right of offset or cash settlement as an alternative to making or taking delivery of the underlying
commodity.
In general, the CFTC does not regulate
the interbank and forward foreign currency markets with respect to transactions in contracts between certain sophisticated counterparties
such as BNO or between certain regulated institutions and retail investors. Although U.S. banks are regulated in various ways by
the Federal Reserve Board, the Comptroller of the Currency and other U.S. federal and state banking officials, banking authorities
do not regulate the forward markets to the same extent that the swap markets are regulated by the CFTC and SEC. At a minimum, over-the-counter
currency forwards, options and swaps will be subject to heightened recordkeeping, reporting and business conduct standards.
On November 16, 2012, the Secretary of
the Treasury issued a final determination that exempts both foreign exchange swaps and foreign exchange forwards from the definition
of “swap” and, by extension, additional regulatory requirements (such as clearing and margin). The final determination
does not extend to other foreign exchange derivatives, such as foreign exchange options, currency swaps, and non-deliverable forwards.
While the U.S. government does not currently
impose any restrictions on the movements of currencies, it could choose to do so. The imposition or relaxation of exchange controls
in various jurisdictions could significantly affect the market for that and other jurisdictions’ currencies. Trading in the
interbank market also exposes BNO to a risk of default since the failure of a bank with which BNO had entered into a forward contract
would likely result in a default and thus possibly substantial losses to BNO.
Options on Futures Contracts
Options on futures contracts are standardized
contracts traded on an exchange. An option on a futures contract gives the buyer of the option the right, but not the obligation,
to take a position at a specified price (the striking, strike, or exercise price) in the underlying futures contract or underlying
interest. The buyer of a call option acquires the right, but not the obligation, to purchase or take a long position in the
underlying interest, and the buyer of a put option acquires the right, but not the obligation, to sell or take a short position
in the underlying interest.
The seller, or writer, of an option is
obligated to take a position in the underlying interest at a specified price opposite to the option buyer if the option is exercised.
The seller of a call option must stand ready to take a short position in the underlying interest at the strike price if the buyer
should exercise the option. The seller of a put option, on the other hand, must stand ready to take a long position in the
underlying interest at the strike price.
A call option is said to be in-the-money
if the strike price is below current market levels and out-of-the-money if the strike price is above current market levels.
Conversely, a put option is said to be in-the-money if the strike price is above the current market levels and out-of-the-money
if the strike price is below current market levels.
Options have limited life spans, usually
tied to the delivery or settlement date of the underlying interest. Some options, however, expire significantly in advance
of such date. The purchase price of an option is referred to as its premium, which consists of its intrinsic value (which
is related to the underlying market value) plus its time value. As an option nears its expiration date, the time value shrinks
and the market and intrinsic values move into parity. An option that is out-of-the-money and not offset by the time it expires
becomes worthless. On certain exchanges, in-the-money options are automatically exercised on their expiration date, but on
others unexercised options simply become worthless after their expiration date.
Regardless of how much the market swings,
the most an option buyer can lose is the option premium. The option buyer deposits his premium with his broker, and the money
goes to the option seller. Option sellers, on the other hand, face risks similar to participants in the futures markets.
For example, since the seller of a call option is assigned a short futures position if the option is exercised, his risk is the
same as someone who initially sold a futures contract. Because no one can predict exactly how the market will move, the option
seller posts margin to demonstrate his ability to meet any potential contractual obligations.
Options on Forward Contracts or Commodities
Options on forward contracts or commodities
operate in a manner similar to options on futures contracts. An option on a forward contract or commodity gives the buyer
of the option the right, but not the obligation, to take a position at a specified price in the underlying forward contract or
commodity. However, unlike options on futures contracts, options on forward contracts or on commodities are individually negotiated
contracts between counterparties and are typically traded in the over-the-counter market. Therefore, options on forward contracts
and physical commodities possess many of the same characteristics of forward contracts with respect to offsetting positions and
credit risk that are described above.
Swap Contracts
Swap transactions generally involve contracts
between two parties to exchange a stream of payments computed by reference to a notional amount and the price of the asset that
is the subject of the swap. Swap contracts are principally traded off-exchange, although certain swap contracts are also
being traded in electronic trading facilities and cleared through clearing organizations.
Swaps are usually entered into on a net
basis, that is, the two payment streams are netted out in a cash settlement on the payment date or dates specified in the agreement,
with the parties receiving or paying, as the case may be, only the net amount of the two payments. Swaps do not generally
involve the delivery of underlying assets or principal. Accordingly, the risk of loss with respect to swaps is generally limited
to the net amount of payments that the party is contractually obligated to make. In some swap transactions one or both parties
may require collateral deposits from the counterparty to support that counterparty’s obligation under the swap agreement.
If the counterparty to such a swap defaults, the risk of loss consists of the net amount of payments that the party is contractually
entitled to receive less any collateral deposits it is holding.
Some swap transactions are cleared through
central counterparties. These transactions, known as cleared swaps, involve two counterparties first agreeing to the terms
of a swap transaction, then submitting the transaction to a clearing house that acts as the central counterparty. Once accepted
by the clearing house, the original swap transaction is novated and the central counterparty becomes the counterparty to a trade
with each of the original parties based upon the trade terms determined in the original transaction. In this manner each
individual swap counterparty reduces its risk of loss due to counterparty nonperformance because the clearing house acts as the
counterparty to each transaction.
“Swap” Transactions
The Dodd-Frank Wall Street Reform and Consumer
Protection Act (the “Dodd-Frank Act”) imposes regulatory requirements on certain “swap” transactions that
BNO is authorized to engage in that may ultimately impact the ability of BNO to meet its investment objective. On August 13,
2012, the CFTC and the SEC published joint final rules defining the terms “swap” and “security-based swap.”
The term “swap” is broadly defined to include various types of over-the-counter derivatives, including swaps and options.
The effective date of these final rules was October 12, 2012.
The Dodd-Frank Act requires that certain
transactions ultimately falling within the definition of “swap” be executed on organized exchanges or “swap execution
facilities” and cleared through regulated clearing organizations (which are referred to in the Dodd-Frank Act as “derivative
clearing organizations” (“DCOs”)), if the CFTC mandates the central clearing of a particular contract. On November 28,
2012, the CFTC issued its final clearing determination requiring that certain credit default swaps and interest rate swaps be cleared
by registered DCOs. This is the CFTC’s first clearing determination under the Dodd-Frank Act and became effective on February 11,
2013. Beginning on March 11, 2013, “swap dealers,” “major swap participants” and certain active funds were
required to clear certain credit default swaps and interest rate swaps; and beginning on June 10, 2013, commodity pools, certain
private funds and entities predominantly engaged in financial activities were required to clear the same types of swaps. As a result,
if BNO enters into or has entered into certain interest rate and credit default swaps on or after June 10, 2013, such swaps will
be required to be centrally cleared. Determination on other types of swaps are expected in the future, and, when finalized, could
require BNO to centrally clear certain over-the-counter instruments presently entered into and settled on a bi-lateral basis. If
a swap is required to be cleared, the initial margin will be set by the clearing organizations, subject to certain regulatory requirements
and guidelines. Initial and variation margin requirements for swap dealers and major swap participants who enter into uncleared
swaps and capital requirements for swap dealers and major swap participants who enter into both cleared and uncleared trades will
be set by the CFTC, the SEC or the applicable “Prudential Regulator.”
The Dodd-Frank Act also requires that certain
swaps determined to be available to trade on a SEF must be executed over such a facility. On June 5, 2013, the CFTC published a
final rule regarding the obligations of SEFs, including the obligation for facilities offering multiple person execution services
to register as a SEF by October 2, 2013. Based upon applications filed by several SEFs with the CFTC, the CFTC has determined that
certain interest rate swaps and credit default index swaps are available to trade on SEFs and beginning on February 15, 2014, certain
interest rate swaps and credit default index swaps must be executed on a SEF.
On November 14, 2013, the CFTC’s
Division of Clearing and Risk, Division of Market Oversight and Division of Swap Dealer and Intermediary Oversight published guidance
with respect to the application of certain CFTC rules on SEFs. That guidance clarified that SEFs could not restrict access to participants
who are permitted to trade swaps and that SEFs may not require participants to have breakage agreements in place with other counterparties.
On April 11, 2013, the CFTC published a
final rule to exempt swaps between certain affiliated entities within a corporate group from the clearing requirement. The rule
permits affiliated counterparties to elect not to clear a swap subject to the clearing requirement if, among other things, the
counterparties are majority-owned affiliates whose financial statements are included in the same consolidated financial statements
and whose swaps are documented and subject to a centralized risk management program. However, the exemption does not apply to swaps
entered into by affiliated counterparties with unaffiliated counterparties.
Additionally, the CFTC published rules
on February 17, 2012 and April 3, 2012 that require “swap dealers” and “major swap participants”
to: 1) adhere to business conduct standards, 2) implement policies and procedures to ensure compliance with the CEA and 3) maintain
records of such compliance. These new requirements may impact the documentation requirements for both cleared and non-cleared swaps
and cause swap dealers and major swap participants to face increased compliance costs that, in turn, may be passed along to counterparties
(such as BNO) in the form of higher fees and expenses related to trading swaps.
On April 5, 2013, the CFTC’s Division
of Clearing and Risk issued a letter granting no-action relief from certain swap data reporting requirements for swaps entered
into between affiliated counterparties. In general, the letter grants relief from, among others: real-time, historical and regular
swap reporting (under Part 43, Part 45 and Part 46 of the CFTC’s regulations, respectively).
On April 9, 2013, the CFTC’s Division
of Market Oversight issued a letter granting time-limited no-action relief to non-swap dealer, non-major swap participant counterparties
from the real-time, regular and historical swap reporting requirements (under Part 43, Part 45 and Part 46 of the CFTC’s
regulations, respectively). The regular reporting requirements (Part 45 of the CFTC regulations) for interest rate and credit swaps
of a financial entity (including a commodity pool such as BNO) began on April 10, 2013. The letter delays implementation of the
reporting requirements based upon the asset class underlying the swap and the classification of the reporting counterparty. For
a financial entity (including a commodity pool such as BNO), regular reporting requirements for equity, foreign exchange and other
commodity swaps (including swaps on oil) began on May 29, 2013 and reporting of all historical swaps for all asset classes began
on September 30, 2013.
On November 6, 2013, the CFTC published
a final rule that imposes requirements on swap dealers and major swap participants with respect to the treatment of collateral
posted by their counterparties to margin, guarantee, or secure uncleared swaps. In other words, the rule places restrictions on
what swap dealers and major swap participants can do with collateral posted by BNO in connection with uncleared swaps.
In addition to the rules and regulations
imposed under the Dodd-Frank Act, swap dealers that are European banks may also be subject to European Market Infrastructure Regulation
(“EMIR”). These regulations have not yet been fully implemented.
General Regulation Applicable to
BNO
On August 12, 2013, the CFTC issued final
rules establishing compliance obligations for commodity pool operators (“CPOs”) of investment companies registered
under the Investment Company Act of 1940 (the “Investment Company Act”) that are required to register due to recent
changes to CFTC Regulation 4.5. The final rules were issued in a CFTC release entitled “Harmonization of Compliance Obligations
for Registered Investment Companies Required to Register as Commodity Pool Operators.” For entities that are registered with
both the CFTC and the SEC, the CFTC will accept the SEC’s disclosure, reporting and recordkeeping regime as substituted compliance
for substantially all of Part 4 of the CFTC’s regulations, so long as they comply with comparable requirements under the
SEC’s statutory and regulatory compliance regime. Thus, the final rules (the “Harmonization Rules”) allow dually
registered entities to meet certain CFTC regulatory requirements for CPOs by complying with SEC rules to which they are already
subject. Although BNO is not a registered investment company under the Investment Company Act, the Harmonization Rules amended
certain CFTC disclosure rules to make the requirements for all CPOs to periodically update their disclosure documents consistent
with those of the SEC. This change will decrease the burden to BNO and USCF of having to comply with inconsistent regulatory requirements.
It is not known whether the CFTC will make additional amendments to its disclosure, reporting and recordkeeping rules to further
harmonize these obligations with those of the SEC as they apply to BNO and USCF, but any such further rule changes could result
in additional operating efficiencies for BNO and USCF.
With regard to any other rules that the CFTC
may adopt in the future, the effect of any such regulatory changes on BNO is impossible to predict, but it could be substantial
and adverse.
Regulation
Futures exchanges in the United States
are subject to varying degrees of regulation under the CEA depending on whether such exchange is a designated contract market,
exempt board of trade or electronic trading facility. Clearing organizations are also subject to the CEA and the rules and regulations
adopted thereunder and administered by the CFTC. The CFTC is the governmental agency charged with responsibility for regulation
of futures exchanges and commodity interest trading conducted on those exchanges. The CFTC’s function is to implement the
CEA’s objectives of preventing price manipulation and excessive speculation and promoting orderly and efficient commodity
interest markets. In addition, the various exchanges and clearing organizations themselves exercise regulatory and supervisory
authority over their member firms.
The CFTC also regulates the activities
of “commodity trading advisors” and “commodity pool operators” and the CFTC has adopted regulations with
respect to certain of such persons’ activities. Pursuant to its authority, the CFTC requires a CPO, such as USCF, to keep
accurate, current and orderly records with respect to each pool it operates. The CFTC may suspend, modify or terminate the registration
of any registrant for failure to comply with CFTC rules or regulations. Suspension, restriction or termination of USCF’s
registration as a CPO would prevent it, until such time (if any) as such registration were to be reinstated, from managing, and
might result in the termination of, BNO or the Related Public Funds.
The CEA also gives the states certain powers
to enforce its provisions and the regulations of the CFTC.
Under certain circumstances, the CEA grants
shareholders the right to institute a reparations proceeding before the CFTC against USCF (as a registered commodity pool operator),
as well as those of their respective employees who are required to be registered under the CEA. Shareholders may also be able to
maintain a private right of action for certain violations of the CEA.
Pursuant to authority in the CEA, the NFA
has been formed and registered with the CFTC as a registered futures association. The NFA is the only self regulatory association
for commodities professionals other than the exchanges. As such, the NFA promulgates rules governing the conduct of commodity professionals
and disciplines those professionals that do not comply with such standards. The CFTC has delegated to the NFA responsibility for
the registration of commodity pool operation. USCF is a member of the NFA. As a member of the NFA, USCF is subject to NFA standards
relating to fair trade practices, financial condition, and consumer protection. The CFTC is prohibited by statute from regulating
trading on foreign commodity exchanges and markets.
The CEA requires all FCMs, such as BNO’s
clearing brokers, to meet and maintain specified fitness and financial requirements, to segregate customer funds from proprietary
funds and account separately for all customers’ funds and positions, and to maintain specified books and records open to
inspection by the staff of the CFTC. The CFTC has similar authority over introducing brokers, or persons who solicit or accept
orders for commodity interest trades but who do not accept margin deposits for the execution of trades. The CEA authorizes the
CFTC to regulate trading by FCMs and by their officers and directors, permits the CFTC to require action by exchanges in the event
of market emergencies, and establishes an administrative procedure under which customers may institute complaints for damages arising
from alleged violations of the CEA. The CEA also gives the states powers to enforce its provisions and the regulations of the CFTC.
The regulations of the CFTC and the NFA
prohibit any representation by a person registered with the CFTC or by any member of the NFA, that registration with the CFTC,
or membership in the NFA, in any respect indicates that the CFTC or the NFA, as the case may be, has approved or endorsed that
person or that person’s trading program or objectives. The registrations and memberships of the parties described in this
summary must not be considered as constituting any such approval or endorsement. Likewise, no futures exchange has given or will
give any similar approval or endorsement.
On November 14, 2013, the CFTC published
final regulations that require enhanced customer protections, risk management programs, internal monitoring and controls, capital
and liquidity standards, customer disclosures and auditing and examination programs for FCMs. The rules are intended to afford
greater assurances to market participants that customer segregated funds and secured amounts are protected, customers are provided
with appropriate notice of the risks of futures trading and of the FCMs with which they may choose to do business, FCMs are monitoring
and managing risks in a robust manner, the capital and liquidity of FCMs are strengthened to safeguard the continued operations
and the auditing and examination programs of the CFTC and the self-regulatory organizations are monitoring the activities of FCMs
in a thorough manner.
BNO’s investors are afforded prescribed
rights for reparations under the CEA against USCF (as a registered commodity pool operator), as well as its respective employees
who are required to be registered under the CEA. Investors may also be able to maintain a private right of action for violations
of the CEA. The CFTC has adopted rules implementing the reparation provisions of the CEA, which provide that any person may file
a complaint for a reparations award with the CFTC for violation of the CEA against a floor broker or a FCM, introducing broker,
commodity trading advisor, CPO and their respective associated persons.
The regulation of commodity interest trading
in the United States and other countries is an evolving area of the law, as exemplified by the various discussions of the Dodd-Frank
Act. The various statements made in this summary are subject to modification by legislative action and changes in the rules and
regulations of the CFTC, the NFA, the futures exchanges, clearing organizations and other regulatory bodies.
Futures Contracts and Position Limits
The CFTC is prohibited by statute from
regulating trading on non-U.S. futures exchanges and markets. The CFTC, however, has adopted regulations relating to the marketing
of non-U.S. futures contracts in the United States. These regulations permit certain contracts traded on non-U.S. exchanges to
be offered and sold in the United States.
On November 5, 2013, the CFTC proposed
a rulemaking that would establish specific limits on speculative positions in 28 physical commodity futures and option contracts
as well as swaps that are economically equivalent to such contracts in the agriculture, energy and metals markets (the “Position
Limit Rules”). On the same date, the CFTC proposed another rule addressing the circumstances under which market participants
would be required to aggregate their positions with other persons under common ownership or control (the “Proposed Aggregation
Requirements”). Specifically, the Position Limit Rules would, among other things: identify which contracts are subject to
speculative position limits; set thresholds that restrict the number of speculative positions that a person may hold in a spot
month, individual month, and all months combined; create an exemption for positions that constitute bona fide hedging transactions;
impose responsibilities on DCMs and SEFs to establish position limits or, in some cases, position accountability rules; and apply
to both futures and swaps across four relevant venues: OTC, DCMs, SEFs as well as non-U.S. located platforms. Furthermore, until
such time as the Position Limit Rules are adopted, the regulatory architecture in effect prior to the adoption of the Position
Limit Rules will govern transactions in commodities and related derivatives (collectively, “Referenced Contracts”).
Under that system, the CFTC enforces federal limits on speculation in agricultural products (e.g., corn, wheat and soy), while
futures exchanges enforce position limits and accountability levels for agricultural and certain energy products (e.g., oil and
natural gas). As a result, BNO may be limited with respect to the size of its investments in any commodities subject to these limits.
Finally, subject to certain narrow exceptions, the Position Limit Rules require the aggregation, for purposes of the position limits,
of all positions in the 28 Referenced Contracts held by a single entity and its affiliates, regardless of whether such position
existed on U.S. futures exchanges, non-U.S. futures exchanges, in cleared swaps or in over-the-counter swaps. Under the CFTC’s
existing position limits requirements and the Position Limit Rules, a market participant is generally required to aggregate all
positions for which that participant controls the trading decisions with all positions for which that participant has a 10 percent
or greater ownership interest in an account or position, as well as the positions of two or more persons acting pursuant to an
express or implied agreement or understanding. At this time, it is unclear how the Proposed Aggregation Requirements may affect
BNO, but it may be substantial and adverse. By way of example, the Proposed Aggregation Requirements in combination with the Position
Limit Rules may negatively impact the ability of BNO to meet its investment objectives through limits that may inhibit USCF’s
ability to sell additional Creation Baskets of BNO.
Based on its current understanding of the
final position limit regulations, USCF does not anticipate significant negative impact on the ability of BNO to achieve its investment
objective.
Commodity Margin
Original or initial margin is the minimum
amount of funds that must be deposited by a commodity interest trader with the trader’s broker to initiate and maintain an
open position in futures contracts. Maintenance margin is the amount (generally less than the original margin) to which a
trader’s account may decline before he must deliver additional margin. A margin deposit is like a cash performance bond. It
helps assure the trader’s performance of the futures contracts that he or she purchases or sells. Futures contracts are customarily
bought and sold on initial margin that represents a very small percentage (ranging upward from 5%) of the aggregate purchase or
sales price of the contract. Because of such low margin requirements, price fluctuations occurring in the futures markets
may create profits and losses that, in relation to the amount invested, are greater than are customary in other forms of investment
or speculation. As discussed below, adverse price changes in the futures contract may result in margin requirements that greatly
exceed the initial margin. In addition, the amount of margin required in connection with a particular futures contract is
set from time to time by the exchange on which the contract is traded and may be modified from time to time by the exchange during
the term of the contract.
Brokerage firms, such as BNO’s clearing
brokers, carrying accounts for traders in commodity interest contracts may not accept lower, and generally require higher, amounts
of margin as a matter of policy to further protect themselves. The clearing brokers require BNO to make margin deposits equal
to exchange minimum levels for all commodity interest contracts. This requirement may be altered from time to time in the clearing
brokers’ discretion.
Regulators have not yet finalized the Dodd-Frank
Act rules regarding initial margin levels for over-the-counter derivatives. It is possible that such levels may be higher than
those for futures contracts. Also, initial margin requirements for non-cleared swaps will be subject to higher margin requirements
than cleared swaps. And, under pending rule proposals, BNO may be required to post, but not be entitled to receive, initial and
variation margin in respect of non-cleared swaps. Until such time as the regulators finalize these margin rules, trading in the
over-the-counter markets where no clearing facility is provided generally will not require margin per se. Rather, it will involve
the extension of credit between counterparties that is secured by transfers of credit support and/or independent amounts. Credit
support is transferred between counterparties in respect of the open over-the-counter derivatives entered into between them, while
independent amounts are fixed amounts posted by one or both counterparties at the execution of a particular over-the-counter transaction.
When a trader purchases an option, there
is no margin requirement; however, the option premium must be paid in full. When a trader sells an option, on the other hand,
he or she is required to deposit margin in an amount determined by the margin requirements established for the underlying interest
and, in addition, an amount substantially equal to the current premium for the option. The margin requirements imposed on
the selling of options, although adjusted to reflect the probability that out-of-the-money options will not be exercised, can in
fact be higher than those imposed in dealing in the futures markets directly. Complicated margin requirements apply to spreads
and conversions, which are complex trading strategies in which a trader acquires a mixture of options positions and positions in
the underlying interest.
Margin requirements are computed each day
by a trader’s clearing broker. When the market value of a particular open commodity interest position changes to a point
where the margin on deposit does not satisfy maintenance margin requirements, a margin call is made by the broker. If the
margin call is not met within a reasonable time, the broker may close out the trader’s position. With respect to BNO’s
trading, BNO (and not its investors personally) is subject to margin calls.
On November 6, 2013, the CFTC published
a final rule that imposes requirements on swap dealers and major swap participants with respect to the treatment of collateral
posted by their counterparties to margin, guarantee, or secure uncleared swaps. In other words, the rule places restrictions on
what swap dealers and major swap participants can do with collateral posted by BNO in connection with uncleared swaps.
Finally, many major U.S. exchanges have
passed certain cross margining arrangements involving procedures pursuant to which the futures and options positions held in an
account would, in the case of some accounts, be aggregated and margin requirements would be assessed on a portfolio basis, measuring
the total risk of the combined positions.
SEC Reports
BNO makes available, free of charge, on
its website, its annual reports on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K and amendments
to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable
after these forms are filed with, or furnished to, the SEC. These reports are also available from the SEC though its website at:
www.sec.gov.
CFTC Reports
BNO also makes available its monthly reports
and its annual reports required to be prepared and filed with the NFA under the CFTC regulations.
Intellectual Property
USCF owns trademark registrations for BNO
UNITED STATES BRENT OIL FUND LP (and Design) (U.S. Reg. No. 3916765) for “Financial investment services in the field
of oil futures contracts, cash-settled options on oil futures contracts, forward contracts for oil, over-the-counter transactions
based on the price of oil, and indices based on the foregoing,” in use since June 2, 2010, UNITED STATES BRENT OIL FUND (U.S.
Reg. No. 4181111) for “financial investment services in the field of oil futures contracts, cash-settled options on
oil futures contracts, forward contracts for oil, over-the-counter transactions based on the price of oil, and indices based on
the foregoing,” in use since June 2, 2010, and BNO UNITED STATES BRENT OIL FUND, LP (and Flame Design), S.N. 85592286, filed
April 9, 2012. USCF relies upon these trademarks through which it markets its services and strives to build and maintain brand
recognition in the market and among current and potential investors. So long as USCF continues to use these trademarks to
identify its services, without challenge from any third party, and properly maintains and renews the trademark registrations under
applicable laws, rules and regulations; it will continue to have indefinite protection for these trademarks under current laws,
rules and regulations.
USCF owns trademark registrations for UNITED
STATES COMMODITY FUNDS (U.S. Reg. No. 3600670) for “Fund investment services,” in use since June 24, 2008, USCF
(U.S. Reg. No. 3638987) for “Fund investment services,” in use since June 24, 2008, and USCF UNITED STATES COMMODITY
FUNDS LLC & Design (U.S. Reg. No. 4304004) for “Fund investment services,” in use since June 24, 2008. USCF
relies upon these trademarks through which it markets its services and strives to build and maintain brand recognition in the market
and among current and potential investors. So long as USCF continues to use these trademarks to identify its services, without
challenge from any third party, and properly maintains and renews the trademark registrations under applicable laws, rules and
regulations; it will continue to have indefinite protection for these trademarks under current laws, rules and regulations. USCF
has been granted two patents Nos. 7,739,186 and 8,019,675, for systems and methods for an exchange traded fund (ETF) that tracks
the price of one or more commodities.
The risk factors should be read in connection
with the other information included in this annual report on Form 10-K, including Management’s Discussion and Analysis of
Financial Condition and Results of Operations and BNO’s financial statements and the related notes.
BNO’s investment objective is for
the daily percentage change in the net asset value per share to reflect the daily percentage changes of the spot price of Brent
crude oil, as measured by the daily percentage changes in the price of the Benchmark Futures Contract, less BNO’s expenses.
BNO seeks to achieve its investment objective by investing in a combination of Futures Contracts and Other Crude Oil-Related Investments
such that the daily changes in its net asset value, measured in percentage terms, will closely track the changes in the price of
the Benchmark Futures Contract, also measured in percentage terms. BNO’s investment strategy is designed to provide investors
with a cost-effective way to invest indirectly in Brent crude oil and to hedge against movements in the spot price of Brent crude
oil. An investment in BNO involves investment risk similar to a direct investment in Futures Contracts and Other Crude Oil-Related
Investments, and correlation risk, or the risk that investors purchasing shares to hedge against movements in the price of crude
oil will have an efficient hedge only if the price they pay for their shares closely correlates with the price of Brent crude oil.
In addition to investment risk and correlation risk, an investment in BNO involves tax risks, over-the-counter risks, and other
risks.
Investment Risk
The net asset value of BNO’s
shares relates directly to the value of the Benchmark Futures Contracts and other assets held by BNO and fluctuations in the prices
of these assets could materially adversely affect an investment in BNO’s shares.
BNO’s investment objective is for
the daily percentage change in net asset value of its shares to track the daily percentage changes in the price of the Benchmark
Futures Contract, less expenses. The net assets of BNO consist primarily of investments in Futures Contracts and, to a lesser extent,
in Other Crude Oil-Related Investments. The net asset value of BNO’s shares relates directly to the value of these assets
(less liabilities, including accrued but unpaid expenses), which in turn relates to the price of light, sweet crude oil in the
marketplace. Brent crude oil prices depend on local, regional and global events or conditions that affect supply and demand for
oil.
Economic conditions.
The demand for Brent crude oil correlates closely with general economic growth rates. The occurrence of recessions or other periods
of low or negative economic growth will typically have a direct adverse impact on crude oil prices. Other factors that affect general
economic conditions in the world or in a major region, such as changes in population growth rates, periods of civil unrest, government
austerity programs, or currency exchange rate fluctuations, can also impact the demand for Brent crude oil. Sovereign debt downgrades,
defaults, inability to access debt markets due to credit or legal constraints, liquidity crises, the breakup or restructuring of
fiscal, monetary, or political systems such as the European Union, and other events or conditions that impair the functioning of
financial markets and institutions also may adversely impact the demand for Brent crude oil.
Other demand-related
factors.
Other factors that may affect the demand for crude oil and therefore its price, include technological improvements
in energy efficiency; seasonal weather patterns, which affect the demand for crude oil associated with heating and cooling; increased
competitiveness of alternative energy sources that have so far generally not been competitive with oil without the benefit of government
subsidies or mandates; and changes in technology or consumer preferences that alter fuel choices, such as toward alternative fueled
vehicles.
Other supply-related
factors.
Brent crude oil prices also vary depending on a number of factors affecting supply. For example, increased supply
from the development of new oil supply sources and technologies to enhance recovery from existing sources tends to reduce crude
oil prices to the extent such supply increases are not offset by commensurate growth in demand. Similarly, increases in industry
refining or petrochemical manufacturing capacity may impact the supply of Brent crude oil. World oil supply levels can also be
affected by factors that reduce available supplies, such as adherence by member countries to OPEC production quotas and the occurrence
of wars, hostile actions, natural disasters, disruptions in competitors’ operations, or unexpected unavailability of distribution
channels that may disrupt supplies. Technological change can also alter the relative costs for companies in the petroleum industry
to find, produce, and refine oil and to manufacture petrochemicals, which in turn may affect the supply of and demand for oil.
Other market
factors.
The supply of and demand for crude oil may also be impacted by changes in interest rates, inflation, and
other local or regional market conditions.
Correlation Risk
Investors purchasing shares to hedge against
movements in the price of crude oil will have an efficient hedge only if the price they pay for their shares closely correlates
with the price of crude oil. Investing in BNO’s shares for hedging purposes involves the following risks:
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The market price at which the investor
buys or sells shares may be significantly less or more than net asset value.
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Daily percentage changes in net asset
value may not closely correlate with daily percentage changes in the price of the Benchmark Futures Contract.
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Daily percentage changes in the prices
of the Benchmark Futures Contract may not closely correlate with daily percentage changes in the price of Brent crude oil.
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The market price at which investors
buy or sell shares may be significantly less or more than net asset value.
BNO’s net asset value per share will
change throughout the day as fluctuations occur in the market value of BNO’s portfolio investments. The public trading price
at which an investor buys or sells shares during the day from their broker may be different from the net asset value of the shares.
Price differences may relate primarily to supply and demand forces at work in the secondary trading market for shares that are
closely related to, but not identical to, the same forces influencing the prices of the Brent crude oil and the Benchmark Futures
Contract at any point in time. USCF expects that exploitation of certain arbitrage opportunities by Authorized Purchasers and their
clients and customers will tend to cause the public trading price to track net asset value per share closely over time, but there
can be no assurance of that.
The net asset value of BNO’s shares
may also be influenced by non-concurrent trading hours between the NYSE Arca and the various futures exchanges on which crude oil
is traded. While the shares trade on the NYSE Arca from 9:30 a.m. to 4:00 p.m. Eastern Time, the trading hours for the futures
exchanges on which Brent crude oil trade may not necessarily coincide during all of this time. For example, while the shares trade
on the NYSE Arca until 4:00 p.m. Eastern Time, liquidity in the global light sweet crude market will be reduced after the close
of the NYMEX at 2:30 p.m. Eastern Time. As a result, during periods when the NYSE Arca is open and the futures exchanges on which
Brent crude oil is traded are closed, trading spreads and the resulting premium or discount on the shares may widen and, therefore,
increase the difference between the price of the shares and the net asset value of the shares.
Daily percentage changes in BNO’s
net asset value may not correlate with daily percentage changes in the price of the Benchmark Futures Contract.
It is possible that the daily percentage
changes in BNO’s net asset value per share may not closely correlate to daily percentage changes in the price of the Benchmark
Futures Contract. Non-correlation may be attributable to disruptions in the market for Brent crude oil, the imposition of position
or accountability limits by regulators or exchanges, or other extraordinary circumstances. As BNO approaches or reaches position
limits with respect to the Benchmark Futures Contract and other Futures Contracts or in view of market conditions, BNO may begin
investing in Other Crude Oil-Related Investments. In addition, BNO is not able to replicate exactly the changes in the price of
the Benchmark Futures Contract because the total return generated by BNO is reduced by expenses and transaction costs, including
those incurred in connection with BNO’s trading activities, and increased by interest income from BNO’s holdings of
Treasury securities. Tracking the Benchmark Futures Contract requires trading of BNO’s portfolio with a view to tracking
the Benchmark Futures Contract over time and is dependent upon the skills of USCF and its trading principals, among other factors.
Daily percentage changes in the price
of the Benchmark Futures Contract may not correlate with daily percentage changes in the spot price of Brent crude oil.
The correlation between changes in prices
of the Benchmark Futures Contract and the spot price of Brent crude oil may at times be only approximate. The degree of imperfection
of correlation depends upon circumstances such as variations in the speculative oil market, supply of and demand for Futures Contracts
(including the Benchmark Futures Contract) and Other Crude Oil-Related Investments, and technical influences in oil futures trading.
Natural forces in the oil futures
market known as “backwardation” and “contango” may increase BNO’s tracking error and/or negatively
impact total return.
The design of BNO’s Benchmark Futures
Contract is such that every month it begins by using the near month contract to expire until the near month contract is within
two weeks of expiration, when, over a four day period, it transitions to the next month contract to expire as its benchmark contract
and keeps that contract as its benchmark until it becomes the near month contract and close to expiration. In the event of a crude
oil futures market where near month contracts trade at a higher price than next month to expire contracts, a situation described
as “backwardation” in the futures market, then absent the impact of the overall movement in crude oil prices the value
of the benchmark contract would tend to rise as it approaches expiration. Conversely, in the event of a crude oil futures market
where near month contracts trade at a lower price than next month contracts, a situation described as “contango” in
the futures market, then absent the impact of the overall movement in crude oil prices the value of the benchmark contract would
tend to decline as it approaches expiration. When compared to total return of other price indices, such as the spot price of crude
oil, the impact of backwardation and contango may cause the total return of BNO’s per share net asset value to vary significantly.
Moreover, absent the impact of rising or falling oil prices, a prolonged period of contango could have a significant negative impact
on BNO’s per share net asset value and total return and investors could lose part or all of their investment. See “Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report on
Form 10-K for a discussion of the potential effects of contango and backwardation.
Accountability levels, position limits,
and daily price fluctuation limits set by the exchanges have the potential to cause tracking error, which could cause the price
of shares to substantially vary from the price of the Benchmark Futures Contract.
Designated contract markets, such as the
NYMEX and ICE Futures, have established accountability levels and position limits on the maximum net long or net short futures
contracts in commodity interests that any person or group of persons under common trading control (other than as a hedge,
which an investment by BNO is not) may hold, own or control. In addition to accountability levels and position limits, the NYMEX
and ICE Futures also set daily price fluctuation limits on futures contracts. The daily price fluctuation limit establishes the
maximum amount that the price of a futures contract may vary either up or down from the previous day’s settlement price.
Once the daily price fluctuation limit has been reached in a particular futures contract, no trades may be made at a price beyond
that limit.
On November 5, 2013, the CFTC proposed
a rulemaking that would establish specific limits on speculative positions in 28 physical commodity futures and option contracts
as well as swaps that are economically equivalent to such contracts in the agriculture, energy and metals markets (the “Position
Limit Rules”). On the same date, the CFTC proposed another rule addressing the circumstances under which market participants
would be required to aggregate their positions with other persons under common ownership or control (the “Proposed Aggregation
Requirements”). Specifically, the Position Limit Rules would, among other things: identify which contracts are subject to
speculative position limits; set thresholds that restrict the number of speculative positions that a person may hold in a spot
month, individual month, and all months combined; create an exemption for positions that constitute
bona fide
hedging transactions;
impose responsibilities on DCMs and SEFs to establish position limits or, in some cases, position accountability rules; and apply
to both futures and swaps across four relevant venues — OTC, DCMs, SEFs as well as non-U.S. located trading platforms.
Until such time as the Position Limit Rules
are adopted, the regulatory architecture in effect prior to the adoption of the Position Limit Rules will govern transactions in
commodities and related derivatives (collectively, “Referenced Contracts”). Under that system, the CFTC enforces federal
limits on speculation in agricultural products (
e.g.,
corn, wheat and soy), while futures exchanges enforce position limits
and accountability levels for agricultural and certain energy products (
e.g.,
oil and natural gas). As a result, BNO may
be limited with respect to the size of its investments in Futures Contracts and Other Crude Oil-Related Investment subject to these
limits. Finally, subject to certain narrow exceptions, the Position Limit Rules require the aggregation, for purposes of the position
limits, of all positions in the 28 Referenced Contracts held by a single entity and its affiliates, regardless of whether such
position existed on U.S. futures exchanges, non-U.S. futures exchanges, in cleared swaps or in over-the-counter swaps. Under the
CFTC’s existing position limits requirements and the Position Limit Rules, a market participant is generally required to
aggregate all positions for which that participant controls the trading decisions with all positions for which that participant
has a 10 percent or greater ownership interest in an account or position, as well as the positions of two or more persons acting
pursuant to an express or implied agreement or understanding. At this time, it is unclear how the Proposed Aggregation Requirements
may affect BNO, but it may be substantial and adverse. By way of example, the Proposed Aggregation Requirements in combination
with the Position Limit Rules may negatively impact the ability of BNO to meet its investment objectives through limits that may
inhibit USCF’s ability to sell additional Creation Baskets of BNO.
All of these limits may potentially cause
a tracking error between the price of BNO’s shares and the price of the Benchmark Futures Contract. This may in turn prevent
investors from being able to effectively use BNO as a way to hedge against crude oil-related losses or as a way to indirectly invest
in crude oil.
BNO has not limited the size of its offering
and is committed to utilizing substantially all of its proceeds to purchase Futures Contracts and Other Crude Oil-Related Investments.
If BNO encounters accountability levels, position limits, or price fluctuation limits for Futures Contracts on the NYMEX or ICE
Futures, it may then, if permitted under applicable regulatory requirements, purchase Futures Contracts on other exchanges that
trade listed crude oil futures. In addition, if BNO exceeds accountability levels on either the NYMEX or ICE Futures and is required
by such exchanges to reduce its holdings, such reduction could potentially cause a tracking error between the price of BNO’s
shares and the price of the Benchmark Futures Contract.
Tax Risk
An investor’s tax liability
may exceed the amount of distributions, if any, on its shares.
Cash or property will be distributed at
the sole discretion of USCF. USCF has not and does not currently intend to make cash or other distributions with respect to shares.
Investors will be required to pay U.S. federal income tax and, in some cases, state, local, or foreign income tax, on their allocable
share of BNO’s taxable income, without regard to whether they receive distributions or the amount of any distributions. Therefore,
the tax liability of an investor with respect to its shares may exceed the amount of cash or value of property (if any) distributed.
An investor’s allocable share
of taxable income or loss may differ from its economic income or loss on its shares.
Due to the application of the assumptions
and conventions applied by BNO in making allocations for tax purposes and other factors, an investor’s allocable share of
BNO’s income, gain, deduction or loss may be different than its economic profit or loss from its shares for a taxable year.
This difference could be temporary or permanent and, if permanent, could result in it being taxed on amounts in excess of its economic
income.
Items of income, gain, deduction,
loss and credit with respect to shares could be reallocated if the U.S. Internal Revenue Service (“IRS”) does not accept
the assumptions and conventions applied by BNO in allocating those items, with potential adverse consequences for an investor.
The U.S. tax rules pertaining to partnerships
are complex and their application to large, publicly traded partnerships such as BNO is in many respects uncertain. BNO applies
certain assumptions and conventions in an attempt to comply with the intent of the applicable rules and to report taxable income,
gains, deductions, losses and credits in a manner that properly reflects shareholders’ economic gains and losses. These assumptions
and conventions may not fully comply with all aspects of the Internal Revenue Code (the “Code”) and applicable Treasury
Regulations, however, and it is possible that the IRS will successfully challenge BNO’s allocation methods and require BNO
to reallocate items of income, gain, deduction, loss or credit in a manner that adversely affects investors. If this occurs, investors
may be required to file an amended tax return and to pay additional taxes plus deficiency interest.
BNO could be treated as a corporation
for federal income tax purposes, which may substantially reduce the value of the shares.
BNO has received an opinion of counsel
that, under current U.S. federal income tax laws, BNO will be treated as a partnership that is not taxable as a corporation for
U.S. federal income tax purposes, provided that (i) at least 90 percent of BNO’s annual gross income consists of “qualifying
income” as defined in the Code, (ii) BNO is organized and operated in accordance with its governing agreements and applicable
law and (iii) BNO does not elect to be taxed as a corporation for federal income tax purposes. Although USCF anticipates that
BNO has satisfied and will continue to satisfy the “qualifying income” requirement for all of its taxable years, that
result cannot be assured. BNO has not requested and will not request any ruling from the IRS with respect to its classification
as a partnership not taxable as a corporation for federal income tax purposes. If the IRS were to successfully assert that BNO
is taxable as a corporation for federal income tax purposes in any taxable year, rather than passing through its income, gains,
losses and deductions proportionately to shareholders, BNO would be subject to tax on its net income for the year at corporate
tax rates. In addition, although USCF does not currently intend to make distributions with respect to shares, any distributions
would be taxable to shareholders as dividend income. Taxation of BNO as a corporation could materially reduce the after-tax return
on an investment in shares and could substantially reduce the value of the shares.
BNO is organized and operated as
a limited partnership in accordance with the provisions of the LP Agreement and applicable state law, and therefore, BNO has a
more complex tax treatment than traditional mutual funds.
BNO is organized and operated as a limited
partnership in accordance with the provisions of the LP Agreement and applicable state law. No U.S. federal income tax is paid
by BNO on its income. Instead, BNO will furnish shareholders each year with tax information on IRS Schedule K-1 (Form 1065) and
each U.S. shareholder is required to report on its U.S. federal income tax return its allocable share of the income, gain, loss
and deduction of BNO.
This must be reported without regard to
the amount (if any) of cash or property the shareholder receives as a distribution from BNO during the taxable year. A shareholder,
therefore, may be allocated income or gain by BNO but receive no cash distribution with which to pay the tax liability resulting
from the allocation, or may receive a distribution that is insufficient to pay such liability.
In addition to federal income taxes, shareholders
may be subject to other taxes, such as state and local income taxes, unincorporated business taxes, business franchise taxes and
estate, inheritance or intangible taxes that may be imposed by the various jurisdictions in which BNO does business or owns property
or where the shareholders reside. Although an analysis of those various taxes is not presented here, each prospective shareholder
should consider their potential impact on its investment in BNO. It is each shareholder’s responsibility to file the appropriate
U.S. federal, state, local and foreign tax returns.
Over-the-Counter Contract Risk
Currently, over-the-counter transactions
are subject to changing regulation.
A portion of BNO’s assets may be
used to trade over-the-counter contracts, such as forward contracts or swap or spot contracts. Currently, over-the-counter contracts
are typically contracts traded on a principal-to-principal, non-cleared basis through dealer markets that are dominated by major
money center and investment banks and other institutions and that prior to the passage of the Dodd-Frank Act had been essentially
unregulated by the CFTC. The markets for over-the-counter contracts have relied upon the integrity of market participants in lieu
of the additional regulation imposed by the CFTC on participants in the futures markets. To date, the forward markets have been
largely unregulated, forward contracts have been executed bi-laterally and, in general, forward contracts have not been cleared
or guaranteed by a third party. On November 16, 2012, the Secretary of the Treasury issued a final determination that exempts
both foreign exchange swaps and foreign exchange forwards from the definition of “swap” and, by extension, additional
regulatory requirements (such as clearing and margin). The final determination does not extend to other foreign exchange derivatives,
such as foreign exchange options, certain currency swaps and non-deliverable forwards. While the Dodd-Frank Act and certain regulations
adopted thereunder are intended to provide additional protections to participants in the over-the-counter market, the current regulation
of the over-the-counter contracts could expose BNO in certain circumstances to significant losses in the event of trading abuses
or financial failure by participants. On November 28, 2012, the CFTC issued its final clearing determination requiring that
certain credit default swaps and interest rate swaps be cleared by registered DCM’s. This is the CFTC’s first clearing
determination under the Dodd-Frank Act and became effective on February 11, 2013. Beginning on March 11, 2013, “swap
dealers,” “major swap participants” and certain active funds were required to clear certain credit default swaps
and interest rate swaps; and beginning on June 10, 2013, commodity pools, certain private funds and entities predominantly engaged
in financial activities were required to clear the same types of swaps. As a result, if BNO enters into or has entered into certain
interest rate and credit default swaps on or after June 10, 2013, such swaps will be required to be centrally cleared. Determination
on other types of swaps are expected in the future, and, when finalized, could require BNO to centrally clear certain over-the-counter
instruments presently entered into and settled on a bi-lateral basis. See
“Item 1. Business – Regulation”
for a discussion of how the over-the-counter market will be subject to much more extensive CFTC oversight and regulation after
the implementation of the Dodd-Frank Act.
BNO will be subject to credit risk
with respect to counterparties to over-the-counter contracts entered into by BNO or held by special purpose or structured vehicles.
BNO faces the risk of non-performance by
the counterparties to the over-the-counter contracts. Unlike in futures contracts, the counterparty to these contracts is generally
a single bank or other financial institution, rather than a clearing organization backed by a group of financial institutions.
As a result, there will be greater counterparty credit risk in these transactions. A counterparty may not be able to meet its obligations
to BNO, in which case BNO could suffer significant losses on these contracts.
If a counterparty becomes bankrupt or otherwise
fails to perform its obligations due to financial difficulties, BNO may experience significant delays in obtaining any recovery
in a bankruptcy or other reorganization proceeding. BNO may obtain only limited recovery or may obtain no recovery in such circumstances.
Valuing over-the-counter derivatives
may be less certain that actively traded financial instruments.
In general, valuing over-the-counter derivatives
is less certain than valuing actively traded financial instruments such as exchange traded futures contracts and securities or
cleared swaps because the price and terms on which such over-the-counter derivatives are entered into or can be terminated are
individually negotiated, and those prices and terms may not reflect the best price or terms available from other sources. In addition,
while market makers and dealers generally quote indicative prices or terms for entering into or terminating over-the-counter contracts,
they typically are not contractually obligated to do so, particularly if they are not a party to the transaction. As a result,
it may be difficult to obtain an independent value for an outstanding over-the-counter derivatives transaction.
The regulatory requirements for posting
margin in uncleared swap transactions is evolving.
The Dodd-Frank Act requires the CFTC and
SEC to establish “both initial and variation margin requirements on all swaps that are not cleared by a registered clearing
organization” (
i.e.,
uncleared swaps). In addition, the Dodd-Frank Act provides parties who post initial margin to
a swap dealer or major swap participant with a statutory right to insist that such margin be held in a segregated account with
an independent custodian. On November 6, 2013, the CFTC published a final rule that imposes requirements on swap dealers and major
swap participants with respect to the treatment of collateral posted by their counterparties to margin, guarantee, or secure uncleared
swaps. The rule places restrictions on what swap dealers and major swap participants can do with collateral posted by BNO in connection
with uncleared swaps.
Other Risks
Certain of BNO’s investments
could be illiquid, which could cause large losses to investors at any time or from time to time.
Futures positions cannot always be liquidated
at the desired price. It is difficult to execute a trade at a specific price when there is a relatively small volume of buy and
sell orders in a market. A market disruption, such as a foreign government taking political actions that disrupt the market for
its currency, its crude oil production or exports, or another major export, can also make it difficult to liquidate a position.
Because both Futures Contracts and Other Crude Oil-Related Investments may be illiquid, BNO's Crude Oil Interests may be more difficult
to liquidate at favorable prices in periods of illiquid markets and losses may be incurred during the period in which positions
are being liquidated. The large size of the positions that BNO may acquire increases the risk of illiquidity both by making its
positions more difficult to liquidate and by potentially increasing losses while trying to do so.
Over-the-counter contracts that are not
subject to clearing may be even less marketable than futures contracts because they are not traded on an exchange, do not have
uniform terms and conditions, and are entered into based upon the creditworthiness of the parties and the availability of credit
support, such as collateral, and in general, they are not transferable without the consent of the counterparty. These conditions
make such contracts less liquid than standardized futures contracts traded on a commodities exchange and could adversely impact
BNO’s ability to realize the full value of such contracts. In addition, even if collateral is used to reduce counterparty
credit risk, sudden changes in the value of over-the-counter transactions may leave a party open to financial risk due to a counterparty
default since the collateral held may not cover a party’s exposure on the transaction in such situations.
BNO is not actively managed and tracks
the Benchmark Futures Contract during periods in which the price of the Benchmark Futures Contract is flat or declining as well
as when the price is rising.
BNO is not actively managed by conventional
methods. Accordingly, if BNO’s investments in Crude Oil Interests are declining in value, BNO will not close out such positions
except in connection with paying the proceeds to an Authorized Purchaser upon the redemption of a basket or closing out futures
positions in connection with the monthly change in the Benchmark Futures Contract. USCF will seek to cause the net asset value
of BNO’s shares to track the Benchmark Futures Contract during periods in which its price is flat or declining as well as
when the price is rising.
The NYSE Arca may halt trading in
BNO’s shares, which would adversely impact an investor’s ability to sell shares.
BNO’s shares are listed for trading
on the NYSE Arca under the market symbol “BNO.” Trading in shares may be halted due to market conditions or, in light
of NYSE Arca rules and procedures, for reasons that, in the view of the NYSE Arca, make trading in shares inadvisable. In addition,
trading is subject to trading halts caused by extraordinary market volatility pursuant to “circuit breaker” rules that
require trading to be halted for a specified period based on a specified market decline. Additionally, there can be no assurance
that the requirements necessary to maintain the listing of BNO’s shares will continue to be met or will remain unchanged.
The lack of an active trading market
for BNO’s shares may result in losses on an investor’s investment in BNO at the time the investor sells the shares.
Although BNO’s shares are listed
and traded on the NYSE Arca, there can be no guarantee that an active trading market for the shares will be maintained. If an investor
needs to sell shares at a time when no active trading market for them exists, the price the investor receives upon sale of the
shares, assuming they were able to be sold, likely would be lower than if an active market existed.
USCF is leanly staffed and relies
heavily on key personnel to manage BNO and other funds.
USCF was formed to be the sponsor and manager
of investment vehicles such as BNO and has been managing such investment vehicles since April 2006. In managing and directing the
day-to-day activities and affairs of BNO, USCF relies heavily on Messrs. Howard Mah and John Hyland. If Messrs. Mah or Hyland were
to leave or be unable to carry out their present responsibilities, it may have an adverse effect on the management of BNO.
There is a risk that BNO will not
earn trading gains sufficient to compensate for the fees and expenses that it must pay and as such BNO may not earn any profit.
BNO pays brokerage charges of approximately
0.08% of average total net assets based on brokerage fees of $3.50 per buy or sell, management fees of 0.75% of net asset value
on its average net assets, and over-the-counter spreads and extraordinary expenses (
e.g.,
subsequent offering expenses,
other expenses not in the ordinary course of business, including the indemnification of any person against liabilities and obligations
to the extent permitted by law and required under the LP Agreement and under agreements entered into by USCF on BNO’s behalf
and the bringing and defending of actions at law or in equity and otherwise engaging in the conduct of litigation and the incurring
of legal expenses and the settlement of claims and litigation) that cannot be quantified.
These fees and expenses must be paid in
all cases regardless of whether BNO’s activities are profitable. Accordingly, BNO must earn trading gains sufficient to compensate
for these fees and expenses before it can earn any profit.
Regulation of the commodity interests
and energy markets is extensive and constantly changing; future regulatory developments are impossible to predict but may significantly
and adversely affect BNO.
The futures markets are subject to comprehensive
statutes, regulations, and margin requirements. In addition, the CFTC and futures exchanges are authorized to take extraordinary
actions in the event of a market emergency, including, for example, the retroactive implementation of speculative position limits
or higher margin requirements, the establishment of daily price limits and the suspension of trading. Regulation of commodity interest
transactions in the United States is a rapidly changing area of law and is subject to ongoing modification by governmental and
judicial action. Considerable regulatory attention has been focused on non-traditional investment pools that are publicly distributed
in the United States. In addition, various national governments outside of the United States have expressed concern regarding the
disruptive effects of speculative trading in the energy markets and the need to regulate the derivatives markets in general. The
effect of any future regulatory change on BNO is impossible to predict, but it could be substantial and adverse. For a more detailed
discussion of the regulations to be imposed by the CFTC and the SEC and the potential impacts thereof on BNO, please see
“Item
1. Business – Regulation”
in this annual report on Form 10-K.
An investment in BNO may provide
little or no diversification benefits. Thus, in a declining market, BNO may have no gains to offset losses from other investments,
and an investor may suffer losses on an investment in BNO while incurring losses with respect to other asset classes.
Historically, Futures Contracts and Other
Crude Oil-Related Investments have generally been non-correlated to the performance of other asset classes such as stocks and bonds.
Non-correlation means that there is a low statistically valid relationship between the performance of futures and other commodity
interest transactions, on the one hand, and stocks or bonds, on the other hand.
However, there can be no assurance that
such non-correlation will continue during future periods. If, contrary to historic patterns, BNO’s performance were to move
in the same general direction as the financial markets, investors will obtain little or no diversification benefits from an investment
in BNO’s shares. In such a case, BNO may have no gains to offset losses from other investments, and investors may suffer
losses on their investment in BNO at the same time they incur losses with respect to other investments.
Variables such as drought, floods, weather,
embargoes, tariffs and other political events may have a larger impact on crude oil prices and crude oil-linked instruments, including
Futures Contracts and Other Crude Oil-Related Investments, than on traditional securities. These additional variables may create
additional investment risks that subject BNO's investments to greater volatility than investments in traditional securities.
Non-correlation should not be confused
with negative correlation, where the performance of two asset classes would be opposite of each other. There is no historical evidence
that the spot price of crude oil and prices of other financial assets, such as stocks and bonds, are negatively correlated. In
the absence of negative correlation, BNO cannot be expected to be automatically profitable during unfavorable periods for the stock
market, or vice versa.
BNO is not a registered investment
company so shareholders do not have the protections of the 1940 Act.
BNO is not an investment company subject
to the 1940 Act. Accordingly, investors do not have the protections afforded by that statute, which, for example, requires
investment companies to have a majority of disinterested directors and regulates the relationship between the investment company
and its investment manager.
Trading in international markets
could expose BNO to credit and regulatory risk.
BNO invests primarily in Futures Contracts,
a significant portion of which are traded on United States exchanges, including the NYMEX. However, a portion of BNO’s trades
may take place on markets and exchanges outside the United States. Some non-U.S. markets present risks because they are not subject
to the same degree of regulation as their U.S. counterparts. Trading in non-U.S. markets also leaves BNO susceptible to swings
in the value of the local currency against the U.S. dollar. Additionally, trading on non-U.S. exchanges is subject to the risks
presented by exchange controls, expropriation, increased tax burdens and exposure to local economic declines and political instability.
An adverse development with respect to any of these variables could reduce the profit or increase the loss earned on trades in
the affected international markets.
BNO and USCF may have conflicts of
interest, which may permit them to favor their own interests to the detriment of shareholders.
BNO is subject to actual and potential
inherent conflicts involving USCF, various commodity futures brokers and Authorized Purchasers. USCF’s officers, directors
and employees do not devote their time exclusively to BNO. These persons are directors, officers or employees of other entities
that may compete with BNO for their services. They could have a conflict between their responsibilities to BNO and to those other
entities. As a result of these and other relationships, parties involved with BNO have a financial incentive to act in a manner
other than in the best interests of BNO and the shareholders. USCF has not established any formal procedure to resolve conflicts
of interest. Consequently, investors are dependent on the good faith of the respective parties subject to such conflicts of interest
to resolve them equitably. Although USCF attempts to monitor these conflicts, it is extremely difficult, if not impossible, for
USCF to ensure that these conflicts do not, in fact, result in adverse consequences to the shareholders.
BNO may also be subject to certain conflicts
with respect to the FCM, including, but not limited to, conflicts that result from receiving greater amounts of compensation from
other clients, or purchasing opposite or competing positions on behalf of third party accounts traded through the FCM. In addition,
USCF’s principals, officers, directors or employees may trade futures and related contracts for their own account. A conflict
of interest may exist if their trades are in the same markets and at the same time as BNO trades using the clearing broker to be
used by BNO. A potential conflict also may occur if USCF’s principals, officers, directors or employees trade their accounts
more aggressively or take positions in their accounts which are opposite, or ahead of, the positions taken by BNO.
BNO could terminate at any time and
cause the liquidation and potential loss of an investor’s investment and could upset the overall maturity and timing of an
investor’s investment portfolio.
BNO may terminate at any time, regardless
of whether BNO has incurred losses, subject to the terms of the LP Agreement. In particular, unforeseen circumstances, including
the death, adjudication of incompetence, bankruptcy, dissolution, or removal of USCF as the general partner of BNO could cause
BNO to terminate unless a majority interest of the limited partners within 90 days of the event elects to continue the partnership
and appoints a successor general partner, or the affirmative vote of a majority in interest of the limited partners subject to
certain conditions. However, no level of losses will require USCF to terminate BNO. BNO’s termination would cause the liquidation
and potential loss of an investor’s investment. Termination could also negatively affect the overall maturity and timing
of an investor’s investment portfolio.
BNO does not expect to make cash
distributions.
BNO has not previously made any cash distributions
and intends to reinvest any realized gains in additional Crude Oil Interests rather than distributing cash to limited partners.
Therefore, unlike mutual funds, commodity pools or other investment pools that actively manage their investments in an attempt
to realize income and gains from their investing activities and distribute such income and gains to their investors, BNO generally
does not expect to distribute cash to limited partners. An investor should not invest in BNO if the investor will need cash distributions
from BNO to pay taxes on its share of income and gains of BNO, if any, or for any other reason. Nonetheless, although BNO does
not intend to make cash distributions, the income earned from its investments held directly or posted as margin may reach levels
that merit distribution,
e.g.
, at levels where such income is not necessary to support its underlying investments in Crude
Oil Interests and investors adversely react to being taxed on such income without receiving distributions that could be used to
pay such tax. If this income becomes significant then cash distributions may be made.
An unanticipated number of redemption
requests during a short period of time could have an adverse effect on BNO’s net asset value.
If a substantial number of requests for
redemption of Redemption Baskets are received by BNO during a relatively short period of time, BNO may not be able to satisfy the
requests from BNO’s assets not committed to trading. As a consequence, it could be necessary to liquidate positions in BNO’s
trading positions before the time that the trading strategies would otherwise dictate liquidation.
The financial markets are currently
in a slow period of recovery and the financial markets are still relatively fragile.
Since 2008, the financial markets have
experienced very difficult conditions and volatility as well as significant adverse trends. The conditions in these markets have
resulted in a decrease in availability of corporate credit and liquidity and have led indirectly to the insolvency, closure or
acquisition of a number of major financial institutions and have contributed to further consolidation within the financial services
industry. In addition, the current administration and Congress have periodically been reaching impasses in passing a fiscal budget,
which could create long-term concerns regarding the credit of the United States and interest earned, as well as the United States
Government’s ability to pay its obligations to holders of Treasuries. If low interest rates on Treasuries continue or if
BNO is not able to redeem its investments in Treasuries prior to maturity and the U.S. Government cannot pay its obligations, BNO
would be negatively impacted. In addition, BNO might also be negatively impacted by its use of money market mutual funds to the
extent those funds might themselves be using Treasuries. Although the financial markets saw signs of recovery beginning in late
2010 and 2011, economic growth in 2012 was slow and the financial markets are still fragile. A poor financial recovery could adversely
affect the financial condition and results of operations of BNO’s service providers and Authorized Purchasers, which would
impact the ability of USCF to achieve BNO’s investment objective.
The failure or bankruptcy of a clearing
broker or BNO’s Custodian could result in a substantial loss of BNO’s assets and could impair BNO in its ability to
execute trades.
Under CFTC regulations, a clearing broker
maintains customers’ assets in a bulk segregated account. If a clearing broker fails to do so, or even if the customers’
funds are segregated by the clearing broker but the clearing broker is unable to satisfy a substantial deficit in a customer account,
the clearing broker’s other customers may be subject to risk of a substantial loss of their funds in the event of that clearing
broker’s bankruptcy. In that event, the clearing broker’s customers, such as BNO, are entitled to recover, even in
respect of property specifically traceable to them, only a proportional share of all property available for distribution to all
of that clearing broker’s customers. The bankruptcy of a clearing broker could result in the complete loss of BNO’s
assets posted with the clearing broker, although the majority of BNO’s assets are held in Treasuries, cash and/or cash equivalents
with the Custodian and would not be impacted by the bankruptcy of a clearing broker. BNO may also be subject to the risk of the
failure of, or delay in performance by, any exchanges and markets and their clearing organizations, if any, on which commodity
interest contracts are traded.
In addition, to the extent BNO’s
clearing broker is required to post BNO’s assets as margin to a clearinghouse, the margin will be maintained in an omnibus
account containing the margin of all the clearing broker’s customers. If BNO’s clearing broker defaults to a clearinghouse
because of a default by one of the clearing broker’s other customers or otherwise, then the clearinghouse can look to all
of the margin in the omnibus account, including margin posted by BNO and any other non-defaulting customers of the clearing broker
to satisfy the obligations of the clearing broker.
From time to time, clearing brokers may
be subject to legal or regulatory proceedings in the ordinary course of their business. A clearing broker’s involvement in
costly or time-consuming legal proceedings may divert financial resources or personnel away from the clearing broker’s trading
operations, which could impair the clearing broker’s ability to successfully execute and clear BNO’s trades.
In addition, the majority of BNO’s
assets are held in Treasuries, cash and/or cash equivalents with the Custodian. The insolvency of the Custodian could result in
a complete loss of BNO’s assets held by that Custodian, which, at any given time, would likely comprise a substantial portion
of BNO’s total assets.
Third parties may infringe upon or
otherwise violate intellectual property rights or assert that USCF has infringed or otherwise violated their intellectual property
rights, which may result in significant costs and diverted attention.
It is possible that third parties might
utilize BNO’s intellectual property or technology, including the use of its business methods, trademarks and trading program
software, without permission. USCF has a patent for BNO’s business method and has registered its trademarks. BNO does not
currently have any proprietary software. However, if it obtains proprietary software in the future, any unauthorized use of BNO’s
proprietary software and other technology could also adversely affect its competitive advantage. BNO may not have adequate resources
to implement procedures for monitoring unauthorized uses of its patents, trademarks, proprietary software and other technology.
Also, third parties may independently develop business methods, trademarks or proprietary software and other technology similar
to that of USCF or claim that USCF has violated their intellectual property rights, including their copyrights, trademark rights,
trade names, trade secrets and patent rights. As a result, USCF may have to litigate in the future to protect its trade secrets,
determine the validity and scope of other parties’ proprietary rights, defend itself against claims that it has infringed
or otherwise violated other parties’ rights, or defend itself against claims that its rights are invalid. Any litigation
of this type, even if USCF is successful and regardless of the merits, may result in significant costs, divert its resources from
BNO, or require it to change its proprietary software and other technology or enter into royalty or licensing agreements.