By any rational measure, USO’s “real” expense ratio is about 6 percent. And maybe that’s OK.

We’ve written a lot about the negative impact that contango has on commodity returns over the past few years. Contango is the situation in the futures market where contracts that are expiring soon—say, oil futures contracts expiring in March—are less expensive than contracts dated later—say, those expiring in April, May or June.

When markets are in contango, investors in futures or futures-based ETFs like the United States Oil Fund (NYSEArca: USO) can lose money. It’s axiomatic, but we still get a surprising amount of e-mail from folks who simply think this is a myth. So let’s walk it through.

Let’s suppose that you (or the fund you own, such as USO) is holding the March oil contract (the “front month,” in futures terminology). As the expiration date approaches, you have to sell that contract. If you don’t, you’ll have to take delivery of physical oil in Cushing, Okla.—and let’s be honest, no one wants to do that.

So you sell the March contract and buy the April contract. This is called “rolling” the position, and it’s what most traditional commodity ETFs, including USO, do.

Now suppose that “spot” oil is trading for $75/barrel. As the March contract approaches expiration, its price will converge with the spot price. That’s the way the commodities market works. But if the markets are in contango, the April contract will cost more; say, $80/barrel.

You don’t lose any money when you sell the March contract and buy the April contract; you simply own fewer contracts at a higher price. The trouble happens over the next month. If the spot price of oil stays flat at $75/barrel, the value of that April contract will slowly decay from $80/barrel to $75/barrel.

That’s where you lose money; the asset you own—futures contracts a month out—is constantly deteriorating in value, and just as the value approaches reality, you have to sell it and buy something that costs more. In fact, unless oil rises by $5 barrel during the month, you’ll lose money.

That’s what’s happened to most commodity investors over the past year. Despite a bull market in commodities, investor returns have suffered because the market has been in heavy contango.

How heavy? Over the past year, the S&P GSCI Spot Index has outperformed the futures-based S&P GSCI Total Return Index by 26 percent.

Similarly, spot oil has beaten the futures-based USO by 68 percent.

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