Traders and Investors Pile into Natural Gas ETF

The natural gas trade is getting crowded - very crowded.

Driven by the seemingly perpetual optimism that the price of natural gas can't go any lower when nearly every other commodity price is soaring, traders and investors alike have piled into the giant United States Natural Gas Fund, LP ETF (NYSEArca:UNG) in recent months, a development that has become, ironically, a bit problematic.

The first-of-its-kind ETF that holds only natural gas futures, launched just over two years ago now with average daily trading volume of over 22 million shares and boasting net assets of anywhere between $2.2 billion and $4.5 billion, depending upon where you look, seems about ready to run up against its limit in issuing shares.

This sets up all sorts of interesting possibilities.

Unlike commodity ETNs (exchange traded notes) that simply track futures markets using credit instruments, commodity ETFs (exchange trade funds) normally buy and hold futures contracts for the underlying commodity which, not only has an impact on the futures market itself, but has the added complexity of running up against real limits, self-imposed or otherwise.

This report in the Wall Street Journal has all the details:

One of the hottest investments on Wall Street may have gotten too big for its own good.

With investors betting on rising gas prices, assets in U.S. Natural Gas Fund recently swelled to almost $3.7 billion from about $670 million in February, even sparking fears it could be disrupting the futures market.

Now the popular exchange-traded fund is days away from another potential problem: Funds that hold commodities typically face stiff restrictions on the number of shares they can issue to meet investor demand, and U.S. Natural Gas is running out fast. Securities and Exchange Commission filings show managers want to increase the number of shares available nearly tenfold. But such requests can take weeks and there isn't any telling when the SEC will act.

If the fund can't issue enough shares to meet investor demand, its shares could begin trading at prices higher than the underlying value of their holdings, breaking a key promise ETFs make to investors and possibly influencing prices in the natural-gas futures markets.

This should be interesting to watch - both the response from the SEC and the futures market. Natural gas is unique in the energy commodities group, not only underperforming crude oil and distilled products lately, but doing so by a wide margin as shown below.
Of course, since last Friday, prices have moved quickly back up above the $4 per MMBtu mark to $4.21 for a gain of almost ten percent.

Here's what the ETF looks like over the last two years:
An apparent belief that the plethora of opportunities to buy high and sell low will not continue seems to have attracted millions of new investors over just the last couple months.

Comments

[Mark Anthony:]

It is true that the UNG fund is getting bigger as more investors pile into UNG play. You can not buy and hoard physical natural gas, which is a gas. So funds like UNG and stocks of actual natural gas producers are the only thing available.

But you also have to note the fact that the counter party of UNG funds, the short interest in UNG, as well as shorts in natural gas contracts, are also getting too big. Otherwise such strong investment interest in natural gas would have driven up prices of natural gas futures. There must be some big shorts desperately trying to cap the natural gas price. Their effort will be futile, the supply/demand fundamentals point to higher natural gas price very soon, as current price is way below marginal production cost.

Jun 16 03:37 PM

[Energy Trader:]

Mark,
What supply/demand fundamentals do you refer to. 1) Rig count is going down yet supply is increasing. 2) Demand is dropping (not sure if you heard but GM and most industrials, which are big users of nat gas, are slowing production over the summer). 3) Storage is about to fill up. 4) We are well ahead of the 5 year average for nat gas inventory. 5) LNG, it is highly likely we will see it dumped here in the US. 6) Well head prices in the West are in the $2-3 range and often below, that is a sign of little demand. 7) Watch this weeks build in inventory it is very possible it will be twice last years build for this week.

Also, if you pay attention to who likes this etf it is two kinds of people 1) those who think a 18:1 oil to gas ratio means something, which it does not and 2) momentum guys.

The etf has what could be considered 78% of open interest on the futures market, that is the only thing supporting nat gas.

Jun 16 09:10 PM

[Mark Anthony:]

EnergyTrader:

I am talking about the supply/demand fundamentals that any commodity can not be traded below marginal production cost for very long, regardless of demand, as when the price is too low it cuts off the supply pretty quickly.

To explain that, take table salt as an example. The demand of table salt is extremely weak: half a tea spoon of salt is all you need to prepare for dinners for your whole family. The supply, on the other hand, is gigantic: You can produce whole mountains of salt from the ocean if you want. But despite of the extreme disparity between supply and demand, salt producing companies can always manage to turn a profit, as they would not be producing if they could not make a profit.

North American natural gas production has been on decline before 2006. Since 2006, new technology as well as higher natural gas price made it possible to produce the so called shale gas, boosting supply. But the fact of the matter is at current low natural gas price, there is no way shale gas can be produced profitably.

Drill rig count has already dropped by half. The remaining half are still operating ONLY because producers believe they will see higher natural gas price to come in the near future. If producers do not see higher price coming, then there should be not a single drilling rig working on the field today.

Jun 17 01:16 AM

[dcb:]

On all these commodity funds you need to be aware of the roll over date. the boys pile in before and get you to invest, the also invest in futures further out. the fund then buys those futures dropping and those who bought further out make a killing. You drop the ung right before roll over. this way the UNg holders pay a premium for your futures and the fund gets killed. the fund drops as they have to pay a premium for the roll over. it is about the easiest fix in the market for traders to run on the public.
Always buy after the roll over!!!, or prepare to dump right before

Jun 17 08:11 AM

[H. T. Love:]

On Jun 16 03:37 PM Mark Anthony wrote:

> It is true that the UNG fund is getting bigger as more investors
> pile into UNG play. You can not buy and hoard physical natural gas,
> which is a gas. So funds like UNG and stocks of actual natural gas
> producers are the only thing available.
>
> But you also have to note the fact that the counter party of UNG
> funds, the short interest in UNG, as well as shorts in natural gas

I've not checked NG, but UNG seems to be only .1 day to cover at the *insane* volumes being seen.

shortsqueeze.com/short...

> contracts, are also getting too big. Otherwise such strong investment
> interest in natural gas would have driven up prices of natural gas
> futures. There must be some big shorts desperately trying to cap
> the natural gas price. Their effort will be futile, the supply/demand
> fundamentals point to higher natural gas price very soon, as current
> price is way below marginal production cost.

As yet, only 54% wells shut-in, BHO's "green" plan repeatedly mentions "coal gasification" and seldom NG, Joe Bastardi calling for milder hurricane season and summer, ... the real catalyst *may* be in the houe enrgy bills (I've yet to follow up on them).

Traders in UNG can do fine near-term, investors will get little return on their investment near-term.

I'm new at all this, but if anyone wants to see my thinking, I've got a "working document" here (intended for only my use, but if it helps someone else, feel free to browse it).

JUST REMEMBER I'M LEARNING - USE YOUR OWN JUDGEMENT

seekingalpha.com/insta...

I've another that I'm trying to shape up to post - more concise but incomplete, here.

SAME WARNING AS ABOVE

seekingalpha.com/insta...

Hope That Helps,
HardToLove

Jun 17 10:13 AM

[Energy Trader:]

Mark,
Nice comment, it is true just irrelevant. Shale plays and LNG are a game changer. If you haven't heard their are several BCF's per day in the Barnett and Fayteveille shales that have not been completed and tied into existing pipelines. It will cost almost nothing (compared to the return even at say $2-$3 nat gas) to the producer to add that supply to the market (true the well maybe a net loss but the producer still needs the cashflow). Add LNG being dumped here in the US and we are easily looking at a very high possibility of full inventory by the end of summer.

I completely agree that long-term nat gas is going up, if that is your thesis UNG is not for you. As dcb said the roll wil kill you your investment.

Also, what do you think the cost of LNG per MCF is? It is approximaely $2. The LNG owners have already sunk most of their costs into the trains, there is no way they are going to stop production while they still have positive cashflow, they have lots of debt among other things to payoff.

Jun 17 10:22 AM

[basehitz:]

Tim, thanks for the informative article. I suspected UNG size was becoming a problem but couldn't quantify. I have read a lot of different theories about prospects for NG. Much of it sounds logical but there is a convincing argument from multiple camps that the rules have changed from the norm. Here are a few with key excerpts copied and links to the full articles. My take on UNG is Da Boyz have found a new play thing and they're hoping to rip this, then dump it on unsuspecting retail investors. I expect NG to be a real investment, just not now. Also be aware of the contango in futures market and value erosion of UNG due to negative roll yield.

5/21/09 No End in Sight to the Natural Gas Glut
blogs.wsj.com/environm.../
natural-gas companies are having a hard time slowing their production after years of frantic drilling. U.S. gas production was up 3.9% in February over the previous year.
Why aren’t producers doing a better job reining themselves in?
It’s hard for production to fall when companies keep announcing wells with initial production rates in excess of 20 million cubic feet per day. that’s a certifiable monster well.
The industry as a whole needs production to fall in order to push prices back up. But individual companies don’t want to stop drilling because they need the cash. So they keep on drilling, and keep on hoping that everyone else will cut back.


5/28/09 Will LNG Spell Doom For Natural Gas?
Investopedia May 28, 2009 | By Eric Fox
community.investopedia...
Although natural gas bulls are planning a comeback in 2010 on the back of declining domestic supply and a recovery-led increase in demand, the potential for LNG to flood the domestic market and depress the price is real and must be considered before investing.

5/8/09 Porter Stansberry: Sea Change in U.S. Natural Gas Industry
The Energy Report May 08, 2009 |
seekingalpha.com/artic...
TER: How do you predict the bottom then? At some point production will go so low that the price of natural gas will have to go up.
PS: You see the bottom coming when you see peaks in storage. I don’t know that we’re there yet. There’s been a lot said and written about this, that storage is way up and rigs are coming offline and these are signs of a bottom. But one thing to remember about natural gas is the size of the discoveries that have been made in the last five or six years and the amount of new production that’s come on line.
Old hands in the industry will tell you that $3.50 is the shut-in price. Once you go below $3.50, people will stop producing because it costs them more to produce than the price. The big problem with that argument is that a lot of these wells are now coal-bed methane wells, and you can’t shut them in. They get connected to pipelines and they just run. They run because each well has a very small amount of production. It doesn’t do any good to turn all these wells off. It would cost more to turn them off than to keep them running.
TER: You have built-in supply almost.
PS: People who believe that natural gas has bottomed or will see a bottom soon don’t understand the size of the pipeline that’s been built, and the amount of production that will not be shut-in, no matter how low the price goes.
I think there has been a sea change in natural gas in the United States. The best figure I can give to help people understand all of this is that in 2008 we produced an all-time high amount of natural gas in the U.S. If you’re familiar with peak oil and the idea of a fundamental scarcity of carbon-based fuel sources, that shouldn’t have happened.
It’s hard to exaggerate not only how much natural gas has been found in the last 10 years but also how much of it has been brought on line. I just don’t think the price fully reflects that yet.

Jun 17 10:31 AM

[Rob Z:]

APRIL 30, 2009 U.S. Gas Fields Go From Bust to Boom:

By BEN CASSELMAN - WSJ
CADDO PARISH, La. -- A massive natural-gas discovery here in northern Louisiana heralds a big shift in the nation's energy landscape. After an era of declining production, the U.S. is now swimming in natural gas. Even conservative estimates suggest the Louisiana discovery -- known as the Haynesville Shale, for the dense rock formation that contains the gas -- could hold some 200 trillion cubic feet of natural gas. That's the equivalent of 33 billion barrels of oil, or 18 years' worth of current U.S. oil production. Some industry executives think the field could be several times that size.

"There's no dry hole here," says Joan Dunlap, vice president of Petrohawk Energy Corp., standing beside a drilling rig near a former Shreveport amusement park.

online.wsj.com/article...

Given the glut of NatGAS and new discoveries, isn't it time to discuss converting our Busses & Trucks, and eventually passenger cars over to NatGAS and off of Oil Based fuels and Corn Ethanol????

Wake up people, the answer is jumping right out of the PC screen and we can't see it.

Jun 17 03:33 PM

[Suncatcher:]

With NG coming out of all of our orifices why in bloody hell aren't we using compressed natural gas to run our cars????

Jun 18 01:02 AM

[put_writer:]

In this market, I'd trade the volatility not the stock/ETF. Many of the puts have ridiculous implied volatility. If UNG drops, you pick it up at a good discount, if it goes up, you pocket the proceed. Writing protective put is a consistent strategy that outperforms S&P. vixandmore.blogspot.co...

Jun 18 01:44 AM