Natural Gas ETF: Nowhere to Go but Up, Yet It Keeps Going Down 57 comments
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Bloomberg reported yesterday on the consensus amongst traders and investors that the price of natural gas has nowhere to go but up, yet it keeps going down ... a lot.
The United States Natural Gas Fund expanded today to the largest position in its 27-month history as investors snapped up the last of its shares and it awaited government approval to issue more units.
As of early today, the exchange-traded fund owned the equivalent of 124,926 natural gas futures contracts on the New York Mercantile Exchange. The number of shares outstanding reached a record yesterday, rising 14.5 percent to 322.3 million, more than 10 times the total at the start of the year, and worth $3.97 billion.
The fund’s natural gas position, spread across swaps and futures on the Nymex and the ICE over-the counter-market, equals the equivalent of 86 percent of the open interest in natural gas futures on the NYMEX.
“Clearly, this has become an extraordinarily attractive investment,” said Dave Nadig, an associate editor at IndexUniverse.com, in Decatur, Georgia. “There’s a lot of speculation among people like us who are wondering who is in this.”
The ETF can’t grow further for now because yesterday it ran out of new shares to issue. The ETF asked the Securities Exchange Commission on June 5 for permission to create 1 billion new shares, and is awaiting approval.
One of the interview subjects for the story noted that the total value of the futures contracts holdings for the United States Natural Gas Fund (NYSEArca:UNG) are now so large that they are creating distortions in the market. Duh...
Here's the chart - a pretty ugly picture, unless you sold last summer.
The model portfolio at Iacono Research had a small position in this ETF last year - bought it at around $45, watched it go up to over $60, and then sold it at around $25 late in the year.
Fortunately, this was the exception to the rule for energy positions last year as a number of sales of crude oil ETFs at mid-year worked out much, much better.
Little did I know there was another 50 percent to be lost with UNG if only I'd have stuck with it for just a little while longer.
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I fully expect the price of natural gas to dip into the mid $2's by October. The producing region already has more gas in storage than at the peak of last year and we still have ~3.5 months of fillup to go. You are going to get physical limitations on injection (you can't put 6 gallons of chit in a 5 gallon bag) and that will drive the spot price down hard (if you want to see how this works, just look at the November - February action on oil prices as storage in Cushing, Oklahoma was maxed out and the nymex price was crushed).
Natural gas still has plenty of downside based on fundamentals.
With the boom in prices came a boom in drilling. And, at the higher prices, the exploration plays like the Haynesville were very economic. And along with the drilling came a soaring production increase. And along with everything else came a HUGE drive up in prices for acreage (especially exploration acreage, up from $2k an acre a couple of years ago to around $30k an acre in the hottest areas).
As production soared, and demand dropped (economic downturn, mild weather), oversupply has become a HUGE issue. The storage of natural gas has just literally smashed old records. There is ~30% more natural gas in storage right now than the past 5 year average. Simple economics, supply >>>> demand = huge drop in prices.
As prices have dropped, many areas have become uneconomic. It’s pretty widely known that the breakeven economics for the Barnett is around $5 - $5.50/mcf. Right now, it is around $3.45/mcf. Thus, drilling programs have been slashed all over. The rig count is down 55% since October.
Well, you would think that the major drop in rigs would lower production and help the situation. Unfortunately, here is the kicker. These new shale plays, being drilled up through the use of horizontal wells, are bringing on MONSTER wells. A vertical well in an “average” formation might come on at 1 mmcfd. These new Haynesville wells are coming on at 15-25 mmcfd. So, one new Haynesville well basically take the place of 15 “average” wells. So while the rig count has dropped drastically, the wells coming online right now are so much stronger that production hasn’t hardly been affected.
If that weren’t bad enough, here is kicker #2: most of that high $$$$ acreage was exploration acreage (meaning, no production to hold the leases yet). And, most of those leases were 2 year leases. Now, if you take a section (640 acres), you only need 1 well producing on that lease to hold it. And, at 40 acre spacing, there is the potential per section for 640 / 40 = 16 drill locations. Now, at $30k/acre and 640 acres in a section, you already have $19 million in sunk costs per section. You have literally hundreds of millions (billions?) of dollars tied up in non-producing acreage with a shortly expiring time clock. If they don’t get at least one well drilled and online to hold the lease, they risk losing all of that sunk money.
So, even if wells are uneconomic now, they are still drilling to get one well per section online to hold the lease. This allows them to have that backlog of the remaining 15 locations so that when prices recover, they have access to those reserves. They are willing to drill an uneconomic well today so that they don’t lose the lease that they have already spent tons of money on. And, since they have to keep drilling for this reason, it just continues to add to the current oversupply (regardless of prices).
Having said all of that, we are going to start seeing physical limitations on natural gas storage (you can’t cram 6 lbs of shit into a 5 lb bag). There is already more natural gas in storage in the central region than at the peak of last year (2nd week of November). And, we still have 3.5 months of storage to go! Yikes! Due to this, the price is going to get driven down sharply because there will be nowhere for the natural gas to go. Once natural gas prices get driven down into the low $2s, companies WILL start shutting in production and dropping even MORE rigs. This well help the oversupply get worked off, and only THEN will prices start to turn upwards.
On Jul 09 10:36 AM skrangeo wrote:
> here's the deal with natural gas (and the reason I've made money
> buying/selling puts on UNG)
>
> With the boom in prices came a boom in drilling. And, at the higher
> prices, the exploration plays like the Haynesville were very economic.
> And along with the drilling came a soaring production increase. And
> along with everything else came a HUGE drive up in prices for acreage
> (especially exploration acreage, up from $2k an acre a couple of
> years ago to around $30k an acre in the hottest areas).
>
> As production soared, and demand dropped (economic downturn, mild
> weather), oversupply has become a HUGE issue. The storage of natural
> gas has just literally smashed old records. There is ~30% more natural
> gas in storage right now than the past 5 year average. Simple economics,
> supply >>>> demand = huge drop in prices.
>
> As prices have dropped, many areas have become uneconomic. It’s pretty
> widely known that the breakeven economics for the Barnett is around
> $5 - $5.50/mcf. Right now, it is around $3.45/mcf. Thus, drilling
> programs have been slashed all over. The rig count is down 55% since
> October.
>
> Well, you would think that the major drop in rigs would lower production
> and help the situation. Unfortunately, here is the kicker. These
> new shale plays, being drilled up through the use of horizontal wells,
> are bringing on MONSTER wells. A vertical well in an “average” formation
> might come on at 1 mmcfd. These new Haynesville wells are coming
> on at 15-25 mmcfd. So, one new Haynesville well basically take the
> place of 15 “average” wells. So while the rig count has dropped drastically,
> the wells coming online right now are so much stronger that production
> hasn’t hardly been affected.
>
> If that weren’t bad enough, here is kicker #2: most of that high
> $$$$ acreage was exploration acreage (meaning, no production to hold
> the leases yet). And, most of those leases were 2 year leases. Now,
> if you take a section (640 acres), you only need 1 well producing
> on that lease to hold it. And, at 40 acre spacing, there is the potential
> per section for 640 / 40 = 16 drill locations. Now, at $30k/acre
> and 640 acres in a section, you already have $19 million in sunk
> costs per section. You have literally hundreds of millions (billions?)
> of dollars tied up in non-producing acreage with a shortly expiring
> time clock. If they don’t get at least one well drilled and online
> to hold the lease, they risk losing all of that sunk money.
>
> So, even if wells are uneconomic now, they are still drilling to
> get one well per section online to hold the lease. This allows them
> to have that backlog of the remaining 15 locations so that when prices
> recover, they have access to those reserves. They are willing to
> drill an uneconomic well today so that they don’t lose the lease
> that they have already spent tons of money on. And, since they have
> to keep drilling for this reason, it just continues to add to the
> current oversupply (regardless of prices).
>
> Having said all of that, we are going to start seeing physical limitations
> on natural gas storage (you can’t cram 6 lbs of shit into a 5 lb
> bag). There is already more natural gas in storage in the central
> region than at the peak of last year (2nd week of November). And,
> we still have 3.5 months of storage to go! Yikes! Due to this, the
> price is going to get driven down sharply because there will be nowhere
> for the natural gas to go. Once natural gas prices get driven down
> into the low $2s, companies WILL start shutting in production and
> dropping even MORE rigs. This well help the oversupply get worked
> off, and only THEN will prices start to turn upwards.
The market "forward looking" is priced into the out months which is why the natural gas curve is in such a contango (out pricing greater than near term). But, that doesn't help the near term issues (60 - 120 days). While the out months are "currently" higher, if the supply/demand issue isn't resolved, they will get pushed down just like August contracts currently are. For reference, on Jan 14th August contracts were $5.47. On March 3rd, August was $4.69. On May 19th, August was $4.38. And today, sub $3.50.
The prompt month being driven down is a function of FUNDAMENTALS. And right now, the FUNDAMENTALS are quite bearish. And as more gas goes into storage and PHSYSICAL LIMITATIONS become an issue, watch Henry Hub sink like the Titanic.
So...forget the fundies of nat gas....isn't it crazy that someone can keep printing futures contracts for an entity to buy that has an open intention NOT to take delivery of those contracts?
Isn't this bad? Kind of like sub-prime bad?
It's exactly the same thing. Securitization of commodities, then selling those securities to an insatiable entity that is open about it NOT TAKING DELIVERY...
This is dilutive to both the futures contracts themselves...and of course if you are holding UNG shares...and they have to keep making more shares...your shares are being diluted too.
Isn't this illegal? If not why not?
UNG holders are nothing but rubes...you aren't holding an asset that will appreciate any time soon even if fundies improve.
On Jul 09 04:51 PM pintelho wrote:
> Elephant in the room here.
>
> So...forget the fundies of nat gas....isn't it crazy that someone
> can keep printing futures contracts for an entity to buy that has
> an open intention NOT to take delivery of those contracts?
>
> Isn't this bad? Kind of like sub-prime bad?
>
> It's exactly the same thing. Securitization of commodities, then
> selling those securities to an insatiable entity that is open about
> it NOT TAKING DELIVERY...
>
> This is dilutive to both the futures contracts themselves...and of
> course if you are holding UNG shares...and they have to keep making
> more shares...your shares are being diluted too.
>
> Isn't this illegal? If not why not?
>
> UNG holders are nothing but rubes...you aren't holding an asset that
> will appreciate any time soon even if fundies improve.
On Jul 09 10:36 AM skrangeo wrote:
> here's the deal with natural gas (and the reason I've made money
> buying/selling puts on UNG)
>
> With the boom in prices came a boom in drilling. And, at the higher
> prices, the exploration plays like the Haynesville were very economic.
> And along with the drilling came a soaring production increase. And
> along with everything else came a HUGE drive up in prices for acreage
> (especially exploration acreage, up from $2k an acre a couple of
> years ago to around $30k an acre in the hottest areas).
>
> As production soared, and demand dropped (economic downturn, mild
> weather), oversupply has become a HUGE issue. The storage of natural
> gas has just literally smashed old records. There is ~30% more natural
> gas in storage right now than the past 5 year average. Simple economics,
> supply >>>> demand = huge drop in prices.
>
> As prices have dropped, many areas have become uneconomic. It’s pretty
> widely known that the breakeven economics for the Barnett is around
> $5 - $5.50/mcf. Right now, it is around $3.45/mcf. Thus, drilling
> programs have been slashed all over. The rig count is down 55% since
> October.
>
> Well, you would think that the major drop in rigs would lower production
> and help the situation. Unfortunately, here is the kicker. These
> new shale plays, being drilled up through the use of horizontal wells,
> are bringing on MONSTER wells. A vertical well in an “average” formation
> might come on at 1 mmcfd. These new Haynesville wells are coming
> on at 15-25 mmcfd. So, one new Haynesville well basically take the
> place of 15 “average” wells. So while the rig count has dropped drastically,
> the wells coming online right now are so much stronger that production
> hasn’t hardly been affected.
>
> If that weren’t bad enough, here is kicker #2: most of that high
> $$$$ acreage was exploration acreage (meaning, no production to hold
> the leases yet). And, most of those leases were 2 year leases. Now,
> if you take a section (640 acres), you only need 1 well producing
> on that lease to hold it. And, at 40 acre spacing, there is the potential
> per section for 640 / 40 = 16 drill locations. Now, at $30k/acre
> and 640 acres in a section, you already have $19 million in sunk
> costs per section. You have literally hundreds of millions (billions?)
> of dollars tied up in non-producing acreage with a shortly expiring
> time clock. If they don’t get at least one well drilled and online
> to hold the lease, they risk losing all of that sunk money.
>
> So, even if wells are uneconomic now, they are still drilling to
> get one well per section online to hold the lease. This allows them
> to have that backlog of the remaining 15 locations so that when prices
> recover, they have access to those reserves. They are willing to
> drill an uneconomic well today so that they don’t lose the lease
> that they have already spent tons of money on. And, since they have
> to keep drilling for this reason, it just continues to add to the
> current oversupply (regardless of prices).
>
> Having said all of that, we are going to start seeing physical limitations
> on natural gas storage (you can’t cram 6 lbs of shit into a 5 lb
> bag). There is already more natural gas in storage in the central
> region than at the peak of last year (2nd week of November). And,
> we still have 3.5 months of storage to go! Yikes! Due to this, the
> price is going to get driven down sharply because there will be nowhere
> for the natural gas to go. Once natural gas prices get driven down
> into the low $2s, companies WILL start shutting in production and
> dropping even MORE rigs. This well help the oversupply get worked
> off, and only THEN will prices start to turn upwards.
www.eia.doe.gov/emeu/s...
It seems now that natural gas price has dropped so low, in comparison to coal price, that there is now incentive for electricity generators to burn natural gas instead of coal, for electricity generation.
This would seem to put a very very very solid bottom on natural gas price at current level. Burning natural gas instead of coal, on a regular basis, instead of only durign peak hours, to generate electricity, is a tremendous amount of demand boost.
seekingalpha.com/autho...
Even if UNG were to go below $10, $5........and I will say, "Dude! Buy as much as you can afford! And hold it for your retirement" At below $10, it is a screaming buy!
The contango from August to Jan or Feb also makes a huge negative yield roll. If bought the front contract and rolled in to the next month when the front expired you would eventually buy up to 50% less contracts. It is difficult to overcome this negative yield. Also the same months a year forward are substantially higher than this years prices. The market has made two large assumptions. it has assumed the supply overhang is temporary and it has assumed the there will be a substantial economic rebound increasing industrial demand. Sadly, the reality is that neither of those two scenarios are likely.
UNG is not an investment that is to be held for the above reasons. It is merely a trading instrument. If the ETF doesn't jump 10-25% during the first large hurricane warning then there is no relief in sight until the start of the peak winter heating demand (December/January.) North America is awash in natural gas. It isn't in oil. All the fuel switchability from oil to NG has already occurred so no one can capitalize to the relative differences. Investors shouldn't think NG is cheap because the NG/WTI spread is at record levels. If anything WTI is overpriced and NG is accurately priced give record storage, large reductions in industrial demand and new supply.
After all, how many times have we seen 'fundamentals be damned' in commodity movements??
I think UNG has tracked ng somewhat accurately up to this point, but with the popularity of the fund, I think it will veer off course going forward. I see the same scenario happening to UNG that happened to USO. Both are supposed to be tracking the front month of their respective commodities (UNG:natural gas, USO:oil). However, look what happened to USO. Oil went from the $30's in January to over $70 and now sits close to $60. Meanwhile, over the same time frame, USO has not tracked oil very well at all.