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United States Natural Gas Fund (USNGF), which trades under the ticker symbol UNG, is an ETF that tries to track, in percentage terms, the price movements of Henry Hub delivered natural gas. It opens and closes positions in front-month contracts and rolls them forward to the succeeding month as expiration of the front-month contract nears.

The details of what I describe here are garnered from many comments on SA, from SA contributors and additional investigation. Use the Securities Exchange Commission Filings for United States Natural Gas Fund L.P. and USNGF's website to confirm what I present here. If any discrepancies are found (I could easily have overlooked or mis-understood something), I would appreciate any constructive comments you might post.

OVERVIEW: USNGF is a limited partnership, with U.S. Commodity Funds L.L.C. as the master partner. It operates as an ETF that is designed to track, in percentage terms, the price movements of natural gas as delivered at the Henry Hub, based on futures contracts. The goal is to maintain NAV near 1:1 to the value of the underlying futures. On their website under Literature and then Fact Sheet, a pdf file is available that states the target is +-10% of 30 days average value). UNG is not leveraged. This same pdf file touches briefly on some of the risks and other general facts about the fund.

The front-month futures contract is the underlying asset until two weeks before expiration. At that point, over a four day period, the current contracts are rolled forward to the next following contract - 25% each day. After the fourth day, all underlying contracts are for the succeeding month.

OPERATION: USNGF has relationships with a distributor, an administrator and "authorized dealers". Dealers buy 100,000 units of UNG (a creation basket) at net asset value [NAV] and redeem those units in 100,000 unit lots, a redemption basket. A fee is paid by the dealers for each creation or redemption. In both cases, USNGF opens or closes appropriate futures contracts positions (or possibly re-sells the basket to another dealer) to maintain NAV correlation between the issued units and the underlying contract value as near as possible to a 1:1 ratio.

As mentioned above, normally two weeks before the expiration of the front-month futures contract, USNGF begins rolling its current front-month futures into the next following month's futures. This is done over 4 days in increments of 25% each day.

CONSIDERATIONS: During periods of "contango" (further-out contract prices are higher than near-month prices), the effect of roll-over will tend to cause NAV to track slightly below the underlying value. In "backwardation" (further-out contract prices are lower than near-month prices), the roll-over will cause NAV to tend to track slightly above the underlying value.

The scheduled dates for this roll (subject to arbitrary change) can be found at USNGF's Schedule of Roll Dates.

Friction in the form of necessary fees and expenses for these activities are incurred and reduce NAV.

DEALERS: When dealers buy a creation basket or redeem a redemption basket a $1,000.00 fee is paid by the dealers for each creation or redemption.

After purchasing creation baskets, dealers can sell and buy the units on the open market. This way they can recover the cost of fees paid for creation baskets and redemption baskets and make a profit via normal market trades and an "arbitrage" of NAV to market price of UNG. Dealers can profit by buying from USNGF when the futures prices are low, selling into the market high, buying from the market low and reselling into the market high or redeeming baskets when futures prices are high.

If market unit prices begin to deviate substantially higher than NAV, it is to the dealers advantage to purchase more baskets at NAV and release units into the market at the higher price. This would tend to suppress UNG unit prices. Conversely, if unit prices deviated substantially below NAV, it is to a dealer's advantage to buy the units in the market and possibly redeem their baskets, reducing supply, which tends to support higher market prices.

Dealers are likely have an advantage over retail investors in that they probably have access to (near to) real-time futures prices, and so can determine "real-time" NAV, and can take actions to benefit not only from market action, but also from issuance/redemption activities and price:NAV divergences.

To help offset this advantage, one can visit these resources. They are not real-time, but lag by a few minutes. There are probably others I've not discovered yet.

NYMEX Natural Gas Futures Page
DataTradingCharts' NYMEX Henry Hub Natural Gas Quotes

INVESTOR CONSIDERATIONS: The retail investor buys and sells their units on the open market under ticker UNG just like a normal equity.

If they are long-term investors, they may experience some loss of value due to fund management fees (estimated to be 0.6% if the fund is under $1 billion, 0.5% when over $1 billion, the current situation) and normal additional expenses, including but not limited to the roll cost, trading commissions, etc. From USNGF's 1st quarter 2009 Factsheet, "For the 1st Quarter of 2009, commission expenses were 0.22% on an annualized basis".

Further losses may occur due to the reduced number of underlying contracts that can be purchased by USNGF when rolling forward during contango.

Loss may also occur from declines in the price of the underlying futures contracts.

TAX CONSIDERATIONS: If one is invested long enough and is not in a tax-protected situation, extra tax filings will be needed since UNG is a limited partnership.

Unlike many other LPs, the fund pays no dividends and returns no capital, even though certain gains and expenses are allocated to the investor. There are other tax implications. If one is a long-term investor, one should consult their tax adviser and review the company filings carefully for the details on this.

Disclosure: Long UNG, short UNG calls

Source: A Summary of UNG for New Investors and Traders