Sept. 16 (Bloomberg) -- Investing in clean energy was easy when my wind-and-solar fund was handing out 40 percent returns. But after it went into the toilet last year, I started looking for other ways to combine profit and virtue.

That’s when I got seduced by the “Widow Maker” -- the U.S. Natural Gas Fund -- and learned that environmentally responsible investing and commodity exchange-traded funds don’t mix. The fund is supposed to let small investors bet on the price of natural gas futures, which seemed like a solid long- term play when I started looking at it last year.

Natural gas would be an important bridge fuel to a cleaner future. It has about half the carbon footprint of coal, so it would benefit from any federal emissions-reduction program. Vast new domestic gas fields were being developed, and oilman T. Boone Pickens was pushing to use the stuff for transportation.

So last fall, as natural gas fell along with other commodities -- losing almost two-thirds of its value from July to December 2008 -- I watched and waited. Sure enough, the number of rigs drilling for gas declined as well, from more than 1,600 in September 2008 to about 800 in late March 2009. It would be only a matter of time before production cratered, the price spiked, and I could make money investing in a cleaner fuel.

I was fooling myself, of course. Speculating on natural gas isn’t responsible investing; it is trading, plain and simple. That didn’t stop me from establishing a position in May. But a cool summer and the Great Recession slaughtered demand, and while rigs crashed, production didn’t.

Going Long

The major players were nicely hedged and pumping for all they were worth even though prices were at or below the cost of production. So the U.S. Natural Gas Fund kept dropping. I didn’t have a stop-loss in place because this was a long-term investment. I was willing to ride it down and, I hoped, back up.

That’s when I discovered what makes the fund a terrible buy-and-hold. With the natural-gas futures market in contango, that is, when distant futures contracts command higher prices than the near month, the fund makes a tough market worse. It buys only the front-month contract and rolls it over every 30 days, losing a bit more money for investors each month as it buys the next, more expensive contract.

It wasn’t just a bad trade. It was a crowded one. Average daily volume quadrupled as the fund’s assets grew from $700 million in March to $4.5 billion in June. People started calling the Natural Gas Fund “the Widow Maker,” but many of us kept dancing as it fell: $15 … $14 … $12….

Controlling Speculation

In July, with the fund estimated to be controlling more than a quarter of all natural-gas contracts, and the Commodity Futures Trading Commission threatening to clamp down on commodity speculation, the fund’s managers, U.S. Commodity Fund LLC, stopped issuing new shares. It had grown so big that they feared running afoul of any new position limits. Suddenly the fund wasn’t an ETF anymore; it was a closed-end fund with a limited pool of shares.

Investors kept piling in, so demand drove the share price higher than the value of the underlying contracts. That’s still the case; anyone who buys the fund now pays a premium to net asset value. That violates the fundamental purpose of a commodity ETF, which is to accurately track the price of the asset.

It got worse. To reduce their stake in the futures market, the managers started buying risky over-the-counter natural gas swaps. As summer drew to a close, the natural gas glut got so huge that it looked as if the U.S. would run out of places to store the stuff. The fund’s share price, which closed at a low of $9.01 in early September, would fall more if that happened. Blogs filled with predictions that the fund was about to implode, but many investors stayed put.

Fundamental Misread

I was one of them. We had gotten in too early because we misread the fundamentals. We saw a lush green valley on the horizon and stepped off a cliff. We’re still down in the canyon, but we’re not ready to quit; the fundamentals are about to turn. We can feel it.

Natural gas production has finally started to drop, and last week the market responded with its biggest weekly gain since May, a rally that continued early this week. The fund rose as well, suggesting that those of us who got in too soon may survive, if it doesn’t get shut down before supply and demand stabilize.

On Sept. 11, the fund’s managers announced that they would start issuing new shares again. That may be a sign of confidence that it won’t be shuttered, though it’s also likely to drive down the premium, causing the fund to underperform. And there may be one more great flush in the market over the next month, as natural gas storage either maxes out or comes very close.

For anyone looking to go long, that would be the time. But tread carefully. Natural gas is the last undervalued commodity, but there are better ways to play it than the Widow Maker.

(Eric Pooley, a former managing editor of Fortune magazine who is writing a book about the politics of global warming, is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Eric Pooley at epooley2@bloomberg.net

Last Updated: September 15, 2009 21:00 EDT