U.S. Natural Gas ETF: What You Need to Know 25 comments
August 23, 2009
| about: UNG
Submit
an article to
an article to
-
Font Size:
-
Print
- TweetThis
Natural Gas on Friday (August 21, 2009) closed at ~$2.80/MMBtu – a 7-year low. If we assume that the price will rise to $5 by mid-November of this year, is UNG (the Natural Gas ETF) a good way to play this increase? Here are the key things to consider:
- What does the UNG fund contain? Does it own Natural Gas? No. Instead it invests in future contracts and swaps on the NYMEX and ICE exchanges. On August 11th, it owned the September contracts. The September contracts terminate on August 26th. As specified in UNG’s prospectus, it rolls its contracts 2 weeks before termination, over a 4-day period. This means that for the 4-days starting August 12th, it sold its September contracts and bought October contracts. Currently, NatGas future contracts are under severe contango, i.e. the farther out in time you go, the higher the price. The October price for NatGas is $0.42/MMBtu higher than the September price (which is just $0.02 above the spot price, of $2.78). So, the current spot price needs to rise about ~14% to equal the current price of the October NatGas contract, which closed on Friday at $3.22/MMBtu. In a month from now, UNG will have to sell its October contracts and buy November ones. At that time the spot price will be about the same as the October contract price. If we assume that the spot price moves up to $3.22, NatGas is up $0.42, but UNG has not benefited from this, since the October Futures contract has not moved, by our assumption. Is this an isolated occurrence? Will this happen every month over the next 3 months? Look at the future prices. Today (Aug 22, 2009), the December price is ~$5.02/MMBtu.
- UNG is in a regulatory box. Before July, as the demand for UNG shares increased, UNG’s managers created more UNG shares, and to back them up, they bought more natural gas future contracts and swaps. They did this to keep the price of the shares reflective of the underlying value of the natural gas investments (futures and swaps). If UNG shares traded below the underlying value of the investments, the managers would go into the market and buy back UNG shares (and thereby reduce the outstanding share count), and at the same time sell some of their contracts and swaps. But in early July, UNG hit their maximum share count, 347.4M. They filed to expand this by 1 billion shares, and got permission by the SEC to do so a couple of weeks ago. However, since the CFTC is thinking about imposing restrictions on funds like UNG (because they are neither a consumer nor producer of NatGas), UNG is not creating new shares. In fact, the CFTC may impose restrictions that could force UNG to either resort to offshore trading vehicles or to liquidate the fund.
- There is a difference between UNG’s market price and its underlying value (NAV, or net asset value). Because of the low price of NatGas, many stock investors have been buying UNG. But because the UNG mgt is not creating more shares, the market price of UNG ($11.35) now differs from the value of its current investments, i.e. its NAV, which is $9.94. Every day UNG management posts its NAV. So UNG is currently selling at a 14% premium over NAV. Should the CFTC allow UNG to continue its strategy (or if UNG can switch to an offshore less regulated exchange, or if UNG management decides to liquidate the fund), then the NAV and market price will align. In this case, UNG longs will suffer a ~12% loss, as the market price drops to NAV.
- There is a huge supply of NatGas. This could be a long and complex discourse, and quite frankly I don’t fully understand the complete picture. But I do get the Storage situation. For this, simply look at the gov’t/DOE data. Pay particular attention to the chart. Or more simply, there is far more NatGas in storage than in any August in the last 5 years. For a simplistic commentary on this read these New York Times and Bloomberg articles.
Bottom line. I am bullish on the Natural Gas Prices over the long-term, but bearish on UNG.
Disclosure: I am short straddles on UNG (September and October). But I am short ~3X more calls than puts. In other words, I am hoping that UNG stays below ~$12.50/shr. I would prefer to simply short the stock, but cannot get the shares. I would prefer to simply short the stock, but cannot get the shares from Fidelity (even though the short-interest isn’t high – just ~12M shares vs. 347M outstanding).
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
Now I understand the dialogue as to why this ETF is trading like a 'closed end fund'. The author's bullish stance on natural gas and his bearish stance on this ETF seem justified. However, I agree with No Leaf Clover - these commodity ETFs are common, no?
Lastly, what options are there to take advantage of the low natural gas price? This ETF would seem to be a no brainer, but apparently everyone else has stumbled upon it as well. Yet, despite the demand for shares, the price still goes down...something's not adding up right.
With all the negative publicity lately - it seems now is the time to buy more, but at the same time - I don't want to get hit with a 10-15% drop in a day.
What to do?
You guys really just don't get it do you. I really feel bad for people who are taking losses in a situation like this when there are thousands of ways to put your money to better work.
If a fund like this continues to trade like a closed-end fund in a contango environment, it really doesn't matter WHERE the price of NG goes, up OR down.
This fund suffers a negative roll over yield due to the contango environment. This means that every month they roll into the next months contract, the fund takes a LOSS. Now if enough money were to continue to flood this fund, you might be able to make some sick, twisted profit. But...new, fresh, idiotic capital is no longer being allowed into the fund...and you are left with nothing but capital erosion. This isn't even econ 101, its more like econ 001.
Don't forget to take into account the premium it's trading at. This means that if the CFTC allows fresh dumb money to flow into the ETF, it will adjust downward, and very quickly, to its NAV. People, corpfan01 for example, really need to factor this in from a risk/reward standpoint.
If you want exposure to NG, take a look at companies, or ETF's of companies (FCG) that are levered toward natural gas, and have managed to stay profitable during this bearish NG market. Maybe try to find two or three companies that happen to pay a decent dividend and run with them. And please don't whine that the regulators are trying to take something away from us individual investors that is actually, here's the kicker, actually broken.
Definitely. Prompt month traded a quarter above that today.
So you don't realize that the supply is growing? NG is not crude; the dynamics of both discovery and depletion are different. If shale plays remain successful, the US could be over-supplied in NG for years until the declines start to aggregate, offsetting new gains.
I don't know what price you bought at, but I suggest you sell some covered calls and pull in a little cash while you wait. If you check my comments and instablogs, you'll find some information that *may* be useful. Allow some time - I'm verbose and somewhat disorganized in my use of the instablog. One of my comments tells exactly how I'm playing UNG and what I'm watching for.
Go to the UNG website www.unitedstatesnatura.../
and look at the published roll-dates (I think that's in one of my instablogs or comments somewhere). You'll have to muck around in the UNG site a little to find them - they're under one of the information drop-downs.
Anyway, plan on closing your short calls during the 4 day roll period. Then wait for a bump in the UNG market price and sell some more calls. Try to always sell at a strike that yields a profit on your underlying unit cost basis so that if a sudden rise occurs you only miss *maximizing* profit but you still take the profit of the premiums as well as profit on the units.
Rinse and repeat. At some point backwardation will set in, or at least contango will minimize. Winter should have a price rise in NG, although muted as compared to prior years (unless our stupid ligislators finally do something intelligent like passing an *effective* NG use bill ala Boone Pickens plan or similar).
NG prices traditionally most consistently begin a good increase in October. Weather will affect this. Newly opened pipe to the northeast may benefit price as well - but weather dependant again.
Risk: we don't know if UNG will liquidate or succeed in transforming itself to a good long-term viable fund. I'm betting on the latter.
Information is king here. Don't be passive. Keep on top of what's happening in the area. Keep in mind that every roll UNG owns fewer contracts as long as contango is in force. I haven't calculated the total effect but last roll in just 1 day they should have reduce held contracts around 9% based on contract price differences. Then there are the fees to add in (theres info on there website about those).
By the way, UNG is *only* a trade for now, not an investment. Handle it as such. Later it *may* become investable - depends on so many variables.
I hope this helps.
HardToLove
On Aug 24 03:09 AM corpfan1 wrote:
> I for one invest in GAS.TO - the Canadian Claymore Natural Gas Fund.
> It trades on the TSX - Toronto Stock Exchange. I think it is more
> accurate to what is going on with Nat Gas - I may be wrong. I do
> have some shares in the UNG and am wondering what to do.
>
> With all the negative publicity lately - it seems now is the time
> to buy more, but at the same time - I don't want to get hit with
> a 10-15% drop in a day.
>
> What to do?
1) Pool our cash
2) Buy a storage unit for Nat Gas
3) Play the contango ourselves
Quit pumping millions into UNG and rip the spread on the Dec contract! Meant in a light hearted way! Although if anyone has friends who are liquidating a field of Nat gas storage units then pass me on their details!
HardToLove
On Aug 24 01:50 PM WAKEUP wrote:
> Aardvark Economics: When you were a kid, did your mother have to
> tie a pork chop around your neck, to get the family dog to play with
> you?
>
They used to talk about NG being at 3.2 tcf by Nov 1st. It is there now in August.
Over the last 5 months NG in stroage has grown by 1553. The 5 year average for this time period is 1268.
The 5 year average of injection from now to Nov 13th is 723. If they add 723 to the current total of 3204 then storage will be 3927. That is far above the recent previous high in 2007 of 3545.
If they keep adding to inventory at a 22% higher than the 5 year average rate, they will add 885 to storage. That would put the total over 4000. Which, I believe, is higher than the storage capacity available.
A price crash in the Nov and Dec NG futures is coming.
Ron2008: Agree that in the next month or 2, Nat Gas prices are likely to stay low or fall. Bloomberg article is interesting: www.bloomberg.com/apps...