David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

Suppose that when West Texas Intermediate crude fell to $26 a barrel on Feb. 11 you had a stroke of genius and figured it couldn't get much lower. Since you don't have the billion-dollar backing of a commodities-trading house, you acted in the only way you could and bought into an oil exchange-traded fund.

Nice work, you'd think. Crude is up almost 90 percent since then. Not quite so good for you, though -- ETF returns are about half that.

Dude, Where's My Profit?
WTI crude futures have gained 85 percent since a Feb. 11 trough. The oil ETF managed by Goldman Sachs returned only 44 percent
Source: Bloomberg

The devil here is in the detail. Oil ETFs generally don't track the spot price of the commodity but the total return from the futures contract. And that's a whole different kettle of fossil fuels.

Contango in the Night
Would you be better off investing in Nymex WTI when futures curves are rising, or falling?
Source: Bloomberg
Note: Based on futures curves as of the 10th of each month.

Imagine a simple strategy for investing in Nymex WTI futures. You enter a futures contract to sell 1,000 barrels of crude next month, and wait until close to the delivery date before buying crude on the spot market to fulfil the contract. Then you use your trading profit to do the same thing next month, and the month after that.

If you think that strategy would work best when the market's betting on a rising oil price, you'd be dead wrong. In the first month you make a tidy profit from the rising price of crude, but you then have to reinvest your profits at the new, higher contract price. Quite soon, the cost of rolling into the next month's contract starts to overwhelm any positive benefits you might get from the increasing price:

Roll Out the Barrel
Monthly profit from buying 1,000 barrels of Nymex WTI and rolling contracts at month-end
Source: Bloomberg
Note: Based on prices of Nymex WTI futures from September 2014 to January 2015 (backwardation) and from February 2015 to June 2015 (contango).

As a result, traders generally find life easier when futures curves are in backwardation -- with longer-dated contracts cheaper than shorter-term ones -- than the reverse situation, known as contango.

That dynamic makes life tough for oil ETFs at present. In theory, a fund like U.S. Oil, which had $3.58 billion in net assets as of March 31, tracks the movements of WTI crude. In practice, its managers are trading in the futures market just like anyone else, and as the contango on near-term contracts has gotten steeper, it's become harder and harder to match the performance of spot oil.

Winners and Losers
The U.S. 12-Month Oil ETF outperforms its bigger sister. Crude does better than both
Source: Bloomberg
Note: Figures have been rebased to inception of U.S. 12-Month Oil ETF. Dec. 6, 2007=100.

There are ways of mitigating this problem. U.S. Oil's smaller sister ETF, the U.S. 12-Month Oil Fund, tries to spread its risk from contango by betting across the first 12 months of the futures curve. Following the performance of the funds back to the U.S. 12-month Oil Fund's inception in 2007 suggests that's a smarter strategy than the more straightforward one followed by U.S. Oil, but it still trails the performance of the underlying commodity.

Unfortunately, unless you have a magic cost-free oil storage facility to hand, the muted returns from rolling futures contracts are the best you're going to get. In commodities markets, there are no free lunches. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
David Fickling in Sydney at
Christopher Langner in Singapore at

To contact the editor responsible for this story:
Katrina Nicholas at