Natural Gas ETF: The Short-Term Story

This is just an update on the Natural Gas ETF (UNG); I'll assume that you understand the basics which I described last week (see U.S. Natural Gas ETF: What You Need to Know).

Over the last week (8/21 to 8/28), the spot price of natural gas (Henry Hub) dropped from $2.80/MMBtu to $2.50, the October futures contract dropped from $3.22 to $3.03, UNG’s stock price dropped from $11.35 to $11.13, and UNG’s NAV dropped from $9.94 to $9.35.

So UNG is now selling at a 19% premium over its NAV [(11.13-9.35)/9.35)], vs. 14% a week ago.

Over the next three weeks, the price of the October futures contract (which is what UNG holds) will get within a few cents of the spot price – on August 21st, the September contract was just $0.02 above the spot price. I’ll assume 3 cents for mid-September.

So, if the spot price moves from $2.50 to $3.00 (i.e. over the next 3 weeks), the October futures price remains unchanged, and UNG’s NAV also will remain unchanged.

On the other hand, if the October futures contract drops to 3 cents above the current spot price (i.e. to $2.53), UNG’s NAV will drop from $9.35 to $7.81. If UNG gets out of its regulatory box with the CFTC (possible, but unlikely to happen over the next 3 weeks), UNG’s market price will align with its NAV.

Over the long-term, a natural gas price of $2.50 is not sustainable. However, over the short term, next 2 months, it is a different story. In the DOE’s weekly storage report (Thursday, 10:30AM), the amount of natural gas in storage (3,258 Bcf) is way above the 5-year historical range for this time of year.

The record amount in storage was on Nov. 2, 2007, at 3,545 Bcf. Friday’s Bloomberg article (Natural Gas to Fall as Weak Demand Bolsters Supply):

Supplies may reach 3.9 trillion cubic feet, which would be near U.S. storage capacity, according to Energy Department data.

Because it is cooler in September and October, these are months when significant amounts of gas are put in storage.

Also, here are a few quotes from DOE's Natural Gas Weekly Update.

At 3,258 Bcf, working gas stocks are about 7 weeks ahead of the normal fill rate, exceeding the 5-year average (2004-2008) level of 3,242 Bcf for October 9.

[...]

Warmer-than-normal temperatures in most of the Census Divisions in the lower 48 States during the week ended August 20, 2009, likely contributed to the below-normal level of injections into storage. Based on the National Weather Service’s degree-day data, temperatures in the lower 48 States during the week were, on average, more than 2 degrees warmer than normal and 3 degrees warmer than last year’s levels.

So, given the supply/demand and storage situation, it is difficult to make a bullish case for the natural gas spot price over the next two months.

Perhaps the only thing that could change the equation would be a major hurricane in the Gulf, and we are just now entering prime hurricane season. Currently, there are no near term threats (National Hurricane Center).

A more likely situation is a piling into UNG stock to reach an ungodly premium to NAV (i.e. similar to what happened to AIG, FNM, and FRE over the last week).

Disclosure: I am short straddles on UNG (September and October). But I am short ~4X more calls than Puts. In other words, I am hoping that UNG stays below ~$12/shr, and below $11/shr would be somewhat better. But below $8, not good.

Comments

[whidbey:]

NG is the victim of the recession and questionable policy at the DOE. Our positions were seasonal, but not recession related and that was an error. And, we never thought that solar or wind would be supported over NG, something that was reliable, cost less and ......, but markets and governments can remain irrational longer than you have life to hope. (or words to that effect).

We have poor energy policy and when it changes we will have an NG market.

Aug 31 05:43 PM

[H. T. Love:]

What flabbergasted me wasn't the wind & solar, but the "clean coal". At least wind & solar can really be called "clean" and provide some benefit, even if the lead time and amortization period would be long. But BHO get pumping "clean coal" all the time and seldom mentioned NG.

Oh well, at least we know where a lot of his campaign contributions came from and who has the most(?) effective lobbiests.

HardToLove


On Aug 31 05:43 PM whidbey wrote:

> NG is the victim of the recession and questionable policy at the
> DOE. Our positions were seasonal, but not recession related and
> that was an error. And, we never thought that solar or wind would
> be supported over NG, something that was reliable, cost less and
> ......, but markets and governments can remain irrational longer
> than you have life to hope. (or words to that effect).
>
> We have poor energy policy and when it changes we will have an NG
> market.

Aug 31 05:58 PM

[Vladimir Se...:]

Fred, thank you very much. Finally something informative about UNG in a sea of average. All of those who are whining about gambling being bad: Usually, I'd agree. Gambling adds to volatility and doesn't help stability. But at the moment natural gas is so cheap that I'd look for ways to encourage gambling in it to help with demand.

Aug 31 06:37 PM

[User 480107:]

I bought Jan 11 call leaps on UNG today. I promise by the time Jan 11 comes around....Ill make an absolute shitload of money. buy low sell high

Aug 31 09:22 PM

[realold:]

My understanding is that there is no such thing as clean coal. So, backing it is meaningless and probably got him some coal state votes. As with all of his energy policy, it is more theoetical than real world.


On Aug 31 05:58 PM H. T. Love wrote:

> What flabbergasted me wasn't the wind & solar, but the "clean
> coal". At least wind & solar can really be called "clean" and
> provide some benefit, even if the lead time and amortization period
> would be long. But BHO get pumping "clean coal" all the time and
> seldom mentioned NG.
>
> Oh well, at least we know where a lot of his campaign contributions
> came from and who has the most(?) effective lobbiests.
>
> HardToLove

Sep 01 12:03 AM

[learnmoney:]

When there is blood on the street then buy.............natural gas is not going to go away in fact the US government is going to look at how this clean fuel can help us all.

Sep 01 05:37 AM

[Maxe Paul:]

If you invest money based on what any fool at CNBC tells you, then you are an idiot and deserve everything you get (lose).

Why anyone would invest in an ETF of the worst performing commodity ATM just amazes me. 99% of stocks and commodities are rising, so why pick NG?

Why you feel you need to tell us all on SA about this, god only knows.

I realy hope he (Altucher's) went all in.


On Aug 31 12:25 PM Ken Fischer wrote:

> I'm thinking back to a month or two ago ... I was watching CNBC and
> James Altucher came on (he is one of Jim Cramer's cohorts at the
> Street.com) and he said I'm selling everything I own ... EVERYTHING,
> and I'm taking all the proceeds and buying UNG. He showed this graph
> with a long slide to its then price around $14. He pointed out the
> relation between the price of oil and the price of Nat Gas and implied
> that if there was ever a sure bet it was UNG. The rationale appeared
> impeccable to me and I now own UNG at an avg price of $14.28 so,
> of course, I am loosing my ass. Beside the questions of supply and
> demand and storage the other thing I worry about is the whole world
> of levered ETFs (the world's next BIG BUBBLE). I think some kind
> of blow up is coming in 6 to 12 months. Anyway, for Altucher's sake
> I hope he did not literally go "all in" to UNG.

Sep 01 08:35 AM

[Ken Fischer:]

I was hoping for some helpful insight re UNG, such as I received from H.T. Love, as opposed to the completely unhelpful and mean-spirited response I got from you. If you happen to see my name on a blog comment in the future just scroll past it and then you won't have to concern yourself why I decided to comment. And BTW, FU and the horse you rode in on.


On Sep 01 08:35 AM Maxe Paul wrote:

> If you invest money based on what any fool at CNBC tells you, then
> you are an idiot and deserve everything you get (lose).
>
> Why anyone would invest in an ETF of the worst performing commodity
> ATM just amazes me. 99% of stocks and commodities are rising, so
> why pick NG?
>
> Why you feel you need to tell us all on SA about this, god only knows.
>
>
> I realy hope he (Altucher's) went all in.

Sep 01 01:10 PM

[pockyclips ...:]

I still have trouble with the concept of calling UNG a closed fund, with recent SEC approval to issue additional shares. $1 B worth is the number that sticks in my mind.


On Aug 31 01:07 PM H. T. Love wrote:

> I suggest you start selling out of the money calls

Sep 01 03:00 PM

[H. T. Love:]

I agree. For now, it acts like one. But they can't make as much money if they aren't creating and redeeming baskets. That leads me to believe that they will work their way around to where they can issue with a clear conscience.

So I am playing it as if the premium will go to 0% sometime in the future. Since I bought in as a trade before the cessation of issuance, if I closed my short calls yesterday (Sep. 1) I would've garnered 8.33% (including friction) and reduced my cost basis by $1.13 (friction included) in 5 weeks. But I'll close them during the roll period (9/14 - 9/17) and that would put me at 9.44% and basis down $1.37 if price remains unchanged and implied volatility remains the same.

UNG NAV:NG has dropped from 3.45:1 to 3.084:1, based on day-end closing values 9/1. Premium has begun to drop off slightly, down to 18.05%. Figuring the NG drops an other $0.10 by the time roll comes around and premium drops to around 15%, UNG should be around $9.60 and my calls should get closed out around $.08. This will leave me at 10% gain and effective basis down $1.43.

After the roll, if the current contango Oct-Nov remains at $1.059 and the UNG:NG ratio remains at 3.084 (impossible?), UNG NAV should be around $6.35. Since I expect the seasonal price rise to be muted and/or delayed, I expect the premium to continue to drop as folks become discouraged and bail out. Figuring a 10% premium, UNG should be around $6.95 after roll completes. On the other hand, folks may see the price as a great entry point (again) and pile in, driving the premium up.

Contango, even without any current catalysts, drops off substantially as we look at the contracts out through April, dropping to $0.007 Mar-Apr, when injection season begins again. Sometime prior to that I expect some catalyst to eliminate the contango, even if only briefly. At this point the roll will begin to benefit UNG NAV and my best guess, based on price/consumption/prod... charts seems to be January '10. However, if producers continue to add rigs (+7 last week), this may not happen. Also keep in mind that NOAA is predicting slightly higher winter temps for this winter for 50% of the U.S. So drawdown will certainly be muted, compared to "normal" seasons. With current storage so high, price increases will remain muted.

I think I'll add some puts to my position, creating a synthetic short position. This should almost double my yield.

HardToLove


On Sep 01 03:00 PM pockyclips 2020 wrote:

> I still have trouble with the concept of calling UNG a closed fund,
> with recent SEC approval to issue additional shares. $1 B worth
> is the number that sticks in my mind.

Sep 02 07:51 AM

[HTA:]

NAV is now 8.43. Premium is down to 12%. The simplest way to benefit from this situation is to replicate the fund's long position in the futures market while shorting UNG itself. If your broker won't let you short it then either get another broker or create a synthetic short by buying a put and selling a call. Unfortunately, the synthetic short will cost you about one-third of the potential profit in the trade, at this point. When I put this trade on last week the premium was 18% and the the synthetic short had a cost of only about 10% of the premium.
HTA

Sep 02 05:43 PM

[Windsun33:]

Not true.

Every time I see a recommendation on CNBC, I go the opposite way. Done quite well since Jan :D


On Sep 01 08:35 AM Maxe Paul wrote:

> If you invest money based on what any fool at CNBC tells you, then
> you are an idiot and deserve everything you get (lose).

Sep 02 11:20 PM

[Anthony Alfidi:]

The slient point about commodity ETFs is that they hold futures contracts and not the physical good, so their volatility is nothing like that of the underlying commodity. Proceed with caution.

Sep 03 07:28 AM

[Windsun33:]

I see that UNG has hit another all time low today, down to 8.99. Looks like people are dumping it - 30 min after market opens and already over 7 million shares traded.

That might at least make it lose some of that 20% premium to NAV.

Sep 03 09:56 AM

[Maxe Paul:]

Looks like your gunna lose a shitload before you make it given todays action in NG!


On Aug 31 09:22 PM User 480107 wrote:

> I bought Jan 11 call leaps on UNG today. I promise by the time Jan
> 11 comes around....Ill make an absolute shitload of money. buy low
> sell high

Sep 03 11:54 AM

[Maxe Paul:]

Heres some free advice,
1) Sell your position.
2) Don't listen to CNBC for advice
3) Certainly dont listen to Cramer or any "cohort" of his
4) Buy something that goes up, which is anything other than NG.

Hope this helps.


On Sep 01 01:10 PM Ken Fischer wrote:

> I was hoping for some helpful insight re UNG, such as I received
> from H.T. Love, as opposed to the completely unhelpful and mean-spirited
> response I got from you. If you happen to see my name on a blog comment
> in the future just scroll past it and then you won't have to concern
> yourself why I decided to comment. And BTW, FU and the horse you
> rode in on.

Sep 03 12:03 PM

[Maxe Paul:]

OK, that's some free advice, you wont like it of course, but that's the facts.

NOW, you want some insight. OK, so you are "losing your ass" on this? Obviously you have a far too large position on this trade/investment, if it makes you feel this uncomfortable, you need to close it down, or at a minimum, bring it to 2% of your trading account, my guess is you are WAY OVER this limit.

Once you have done that, you need study up on why traders NEVER go all in on a trade, in fact i doubt the CNBC dude you mention, Altucher, would have done this. The fact he "suggested" that he did go all in etc, is quite frankly a disgrace, and just one of many reasons seasoned traders disregard what talking heads on CNBC say they are doing or recommend.

NOW after this horrible experience of a trade, every time you make a trade you should remember this trade as a reminder to never make this mistake again.

It's up to you if you learn from this or not, but i hope you do.
One day you will look back at this as a valuable learning experience, that we have all gone through.


On Aug 31 12:25 PM Ken Fischer wrote:

> I'm thinking back to a month or two ago ... I was watching CNBC and
> James Altucher came on (he is one of Jim Cramer's cohorts at the
> Street.com) and he said I'm selling everything I own ... EVERYTHING,
> and I'm taking all the proceeds and buying UNG. He showed this graph
> with a long slide to its then price around $14. He pointed out the
> relation between the price of oil and the price of Nat Gas and implied
> that if there was ever a sure bet it was UNG. The rationale appeared
> impeccable to me and I now own UNG at an avg price of $14.28 so,
> of course, I am loosing my ass. Beside the questions of supply and
> demand and storage the other thing I worry about is the whole world
> of levered ETFs (the world's next BIG BUBBLE). I think some kind
> of blow up is coming in 6 to 12 months. Anyway, for Altucher's sake
> I hope he did not literally go "all in" to UNG.

Sep 03 12:28 PM

[Slava15:]

Going to the horse races and casinos is additive to GDP


On Aug 31 12:43 PM John Bowman wrote:

> Totally true! I have a relative (investment advisor) who follows
> dozens of charts all day long. He is in and then out of a market
> within hours or days. Tell me that the money that he is investing
> is contributing to the nation's GDP.
>
> Same thing as going to the horse races or the casinos.

Sep 03 05:16 PM

[Mook:]

I have to say it borders on comical listening to all the back and forth on this topic from people who don't trade natural gas physical or futures.

So just a few tidbits for you:
1)Today cash (aka spot) natural gas traded round 65 cents below the Ocotober futures. Indications for tomorrows trading for the weekend are much worse with cash indicated to be around $1.80.

2)There are several "unexpected" cargos of LNG showing up this month just when we don't need them.

3)The likely case is the futures contracts will trade down to cash versus cash up to futures over the next 1-2 months. Meaning this is going to get really UGLY.

and drum roll for the biggie....

4)I'm short UNG through fidelity. They called today to inform me they were raising the carrying cost on the shares because they had become EXTREMELY had to find to short. I was paying a 2%/yr of NAV per year for the borrowed short shares. Today they raised it to 10%!!!!!!!!!!!! Think about it. They want me out so the smart money (ie institutional customers) can short more shares.

Enjoy.!

Sep 03 09:22 PM

[Vladimir Se...:]

Shorting UNG while replicating it via futures seems to be a "sure thing" and it will be. But every time there is a "sure thing" in this market (or any market) you have to be extra careful. Just like shorting GM, FNM, FRE, AIG and many other worthless stocks. Market can stay irrational longer than most of us can pay "hard to borrow" fees and/or meet margin calls. So if you are trading against UNG premium, you are doing the right thing, you just have to be careful and not discount markets ability to stay irrational longer than anyone would expect.
The fact that UNG is hard to borrow isn't good for (short term) shorts. It means a short squeeze is much more likely.
It IS good for the long term shorts, because the best opportunity to double down on your short is during a short squeeze. I'm not short UNG yet, but if there is a short squeeze and premium goes to say 30% I think I'll just have to be.

On Sep 03 09:22 PM Mook wrote:

> I have to say it borders on comical listening to all the back and
> forth on this topic from people who don't trade natural gas physical
> or futures.
>
> So just a few tidbits for you:
> 1)Today cash (aka spot) natural gas traded round 65 cents below the
> Ocotober futures. Indications for tomorrows trading for the weekend
> are much worse with cash indicated to be around $1.80.
>
> 2)There are several "unexpected" cargos of LNG showing up this month
> just when we don't need them.
>
> 3)The likely case is the futures contracts will trade down to cash
> versus cash up to futures over the next 1-2 months. Meaning this
> is going to get really UGLY.
>
> and drum roll for the biggie....
>
> 4)I'm short UNG through fidelity. They called today to inform me
> they were raising the carrying cost on the shares because they had
> become EXTREMELY had to find to short. I was paying a 2%/yr of NAV
> per year for the borrowed short shares. Today they raised it to
> 10%!!!!!!!!!!!! Think about it. They want me out so the smart money
> (ie institutional customers) can short more shares.
>
> Enjoy.!

Sep 06 01:43 PM