Despite Dedicated ETFs, No Reliable Way to Play Natural Gas

I can't believe I just learned about Loren Steffy's economics blog.

Here's one post on the Baker-Hughes (BHI)/BJS merger and the price of natural gas. An analyst states that the deal makes sense if natural gas prices will return to at least $6.50 per thousand cubic feet by 2011.

I own some BJS shares. I wish there was a better way to play the price of natural gas than UNG and GAZ. Both rely on natural gas futures, not the price of natural gas itself. Thus, neither FCG nor ENY reliably track the price of natural gas because of contango.

Wall Street has invented numerous exotic products, including ways to profit from precious metals; indeed, gold and silver investors have several reliable options. But when it comes to creating a way to track the price of natural gas, suddenly, Wall Street is stumped.

Some people contend that a reliable tracking product must store the underlying physical commodity, and it is almost impossible to store sufficient amounts of natural gas. Yet, storage problems didn't stop Wall Street from having Gold and Silver ETFs. If Wall Street has products that hold gold and silver, why not natural gas?

Thousands of investors think the price of natural gas may double in two years. UNG, for example, trades tens of millions of shares daily. There must be many willing buyers who are interested in a better natural gas investment vehicle. What other investment opportunity might produce 80+% gains in less than three years? Despite thousands of investors willing to risk investing in a natural-gas-price tracking product, there is no reliable way to invest. It makes no sense whatsoever.

Comments

[BullnBear:]

Futures would be the way to go at this point as has been pointed out with a previous post.

I have a feeling that someone is working on an ETF or two to focus on this segment of the market but you probably won’t see a whole lot about this until the regulation debate has been straightened out.

Sep 13 05:08 PM

[Rick Husband:]

A couple of points: First, the contango has been collapsing. Despite rig rate reductions, YTD EIA production data through June shows that we are still tracking, even slightly above, last year. In the Barnett and Haynesville plays, there are still a few hundred wells shut in waiting on pipeline. Pipelines are issuing more OFO's and we will soon test storage capacity, going into winter with a record number. As the surplus mounts, the expectation of a near term recovery in gas prices will fade. Second, once the contango collapses, UNG should be less distorted by the rolling loss. Supposedly there will be a new 12 month strip product, similar to UNL for oil, which rolls the front and back month to reduce the magnitude of the now rolling adjustment, thereby permitting the ETF in theory to more closely track natural gas. In conclusion, this glut has a longer tail on it than most think right now. Once reality sets in, UNG will be flat, like the commoity for awhile. Rick

Sep 14 07:22 AM

[ewr:]

consider FCG

Sep 14 08:29 AM

[Eric van de...:]

What do you want this better natural gas investment vehicle to do?

Sep 14 08:54 AM

[Henri DeToi:]

I think no one has a clue except those who control it.

Sep 14 09:05 AM

[MexCom:]

Take a look at my previous comments on UNG.
My best pick for Nat. gas is DOM. I am looking for income not a gamble on price alone. DOM is a great income play on future price increases.

Sep 14 09:10 AM

[AndrewBaker:]

Natural gas is underpriced right now, and the upside potential is far greater than the downside. The fundamentals of natural gas are such that it is a fuel that will increasingly be used, supply can be relied upon, and price compared to alternatives is far less. I'm happy to invest in ETF that buy futures in a commodity where the longer term price is almost certainly up.

Sep 14 09:18 AM

[Heythere:]

"I own some BJS shares. I wish there was a better way to play the price of natural gas than UNG and GAZ. Both rely on natural gas futures, not the price of natural gas itself. Thus, neither FCG nor ENY reliably track the price of natural gas because of contango."

FCG does not track the price of natural gas because it is not a pure play on natural gas. Many of the companies that it holds are not solely dedicated to the natural gas business. In addition, you also are exposed to a layer of corporate risk, which further enhances the tracking error of a stock ETF to an underlying commodity.

UNG and GAZ are the only two funds impacted by the effect of contango/backwardation, not FCG and ENY.

Even if contango narrows, you still have to deal with the fact that UNG closed at a 16% premium. Since the fund will now start issuing new shares at the end of the month, the market price will converge with the NAV. If natural gas falls, you will experience an additional loss of 16%. If natural gas appreciates, then you may either stay flat, and not experience the potential appreciation, or you may actually lose money. *all of these impacts are assuming that you enter positions now*

Sep 14 09:46 AM

[Henri DeToi:]

That's my opinion as well. The industry is going to change to natural gas, electric power companies, cars, trucks, buses and people will swap their heating furnaces for natural gas; and as always this will jack back the price. It seems like a no brainer. A guess as always, but an educated guess.

Sep 14 09:46 AM

[Maxe Paul:]

Why do people think that investing should be easy?

Why do people expect that trading NG should be less risky?

Why do people think that their should be an ETF for everything?

Why do i constantly hear people on here say its too hard and risky to buy NG futures?

If investing was easy and there was no risk we would all be billionaires, get with the program, you cannot take away risk and make investing easy AND make money, it doesn't work like that.

Sep 14 10:00 AM

[jayminho:]

there is a way to play etfs, SHORT THEM ALL..

Sep 14 10:01 AM

[drspankey:]

Have you looked at SJT?

Sep 14 10:25 AM

[Ozarker:]

Have you all considered the old Dart Board method of commoditie trading? Coin flipping also works well.

Sep 14 10:31 AM

[arbormed:]

Why not take the attractive yields offered by the likes of SJT, HGT, and DMLP and wait?

Sep 14 10:52 AM

[mbkelly75:]

This is my take also and the way I have done it in my portfolio. Re-investing the dividends has worked out well for me in these markets. I am getting more shares cheaper and when the price of NatGas goes back up eventually, I will come out looking pretty good. I also (knowing my cost/share) lowered my cost/basis considerably by buying more at the lower stock prices.


On Sep 14 10:52 AM arbormed wrote:

> Why not take the attractive yields offered by the likes of SJT, HGT,
> and DMLP and wait?

Sep 14 11:12 AM

[joeevan:]

Yes, arbormed...and I like the MLPs...e.g., AHD, APL, BBEP, XTEX...as well.


On Sep 14 10:52 AM arbormed wrote:

> Why not take the attractive yields offered by the likes of SJT, HGT,
> and DMLP and wait?

Sep 14 11:42 AM

[bricki:]

I am a huge long-term bull on NG at these levels. I think it is a generational opportunity. NG is not only a key energy source, but it drives chemical and fertilizer production as well, plus it is suitable for a variety of other applications. Plus it is domestic, making it free of international security issues.

The problem with UNG and GAZ is they are impacted by regulatory overhead, and they leak badly because of contango. You might view them as a way of capturing losses but not so much gains.

Producers and other forms of commodity funds have to be the way to go.

On Sep 14 09:46 AM Henri DeToi wrote:

> That's my opinion as well. The industry is going to change to natural
> gas, electric power companies, cars, trucks, buses and people will
> swap their heating furnaces for natural gas; and as always this will
> jack back the price. It seems like a no brainer. A guess as always,
> but an educated guess.

Sep 14 12:07 PM

[Bob Wallace...:]

Check out CLNE - good company with solid business model for developing "bricks and mortar" Natural Gas vehicle fueling stations across the country and are entering into long term design, build operate (DBO) contracts with both private and public sector clients for CNG fueling of transit buses, utility vehicles, city fleets, and refuse collection vehicles and is very aggressive in marketing their products and services.

Sep 14 12:08 PM

[axelrod608:]

Ultimately price is a function of supply and demand. The latest generation of discovery techniques combined with the latest generation of technology in drilling have created a situation where potential supply is, essentially, unlimited, The ONLY constraint on supply is producers shutting down or slowing down or just not drilling anymore.

NG prices WILL fluctuate, but for the next decade or more, they will not rise much more than they are currently. Like the contestants at a chili eating contest, there's simply too much gas.

Sep 14 12:30 PM

[Fred Linn:]

Natural gas is clean, flexible and efficient. It causes comparatively little environmental damage to extract and distribute. It is completely compatible with biomethane and can be mixed with biomethane in any proportion with no loss of performance(it is exactly the same methane chemically). Mixing methane made from biological sources with natural gas reduces the greenhouse effect(heat capture ability) of the resulting emissions with anything over a 6% biomethane mixture, if mixed with methane that would have ordinarily escaped into the atmosphere anyway(for example, sewage treatment---we need to treat sewage anyway). Natural gas does not pollute the air, and is already used in environments where air contamination is critical, for example, powering forklifts in enclosed warehouses.

VW is producing vehicles that have factory installed CNG(compressed natural gas) bi-fuel engines. Gas/CNG vehicles are already on sale. Diesel/CNG is being introduced this year. The new clean diesel engines use USLD(ultra low sulphur diesel) and are powerful for their size. They are also efficient and get about 30% greater mileage than gasoline. A problem with diesel has always been starting and running in cold weather. Petroleum and biodiesel both tend to gel and get hard to work with at low temperatures. A diesel/CNG engine avoids these cold weather problems entirely----simply start and run the engine on CNG until it is warm, then switch to diesel if necessary. I think consumers will be pleased with bi-fuel savings and no loss of any power or other amenities with bi-fuel engines. There may be a whole new market for natural gas opening up in transportation.

Natural gas burns 4 hydrogen atoms for every carbon atom burned. It provides more energy with less CO2 produced than coal. In order to convert a coal burning plant to natural gas--the only thing that needs to be changed is the furnace. Coal grates are removed, and gas burners are installed----just like on a kitchen stove. Sort of like converting a charcoal BBQ grill to use gas---only bigger. Nothing else needs to change, buildings, boilers, turbines, generators, condensers, controls---everything else remains the same. Flue scrubbers and other elaborate pollution controls are not needed. Almost all contaminants are removed from NG before it is used. Since it is a gas, NG can be handled by pipeline---no trains, trucks front loaders, hoppers, conveyers are needed. It is a lot less work to move around, store and use.

Natural gas use should expand greatly in the future.

Sep 14 12:31 PM

[Fred Linn:]

BTW----natural gas can also be used with diesel engines to generate electricity directly---or power large ships or railroad locomotives. Existing diesels can also be retrofitted to burn both diesel fuel and natural gas.

Sep 14 12:38 PM

[Mistrofan:]

GAS and HNU in Canada/TSX are wonderfull plays on Natural gas.

Sep 14 01:09 PM

[receipt:]

HZBBF (Horizons BetaPro NYMEX Natural Gas Bull Plus ETF is a wonderful way to go long at 2x.

Sep 14 01:17 PM

[WPSPIKER:]

I have been investing in other areas where Nat Gas is used, transported or sold to end users, not so much the producers as others have said the producers are going to fast be in a corner, limiting production down to keep supply at the area it already is, east coast reserves are nearly full. I would look at pipeline holding/transportation companies they are paid based on how much they send down the line, their costs for transmitting are down and getting lower the major costs are NEW pipelines and maintenance. Two good names are (NI) Ni Holdings and (DUK) Duke Energy both have a diversified company structure and hold areas that are very profitable now with lower energy cost to THEM yet they are able to continue to charge the higher retail costs to the ave consumer. look for their profits to get better much faster as supply contracts run out. while larger producers like (CHK) Chesapeake have sold future gas prices these are starting to run out and Nat Gas with the GLUT we have the chances of locking in good profit margin contracts are over. most producers only have a 8~24 month futures contracts and anyone that will buying Nat Gas at volume will be shopping for best rates if not already doing so...

Mark m

Sep 14 01:27 PM

[bobbybutte:]

My buddy is playing gas through COP and he is up almost 15% over the past 2 months while nat gas prices are down

Sep 14 03:04 PM

[hp99:]

if you look at the futures curve gas is already trading $6.50 in 2011, the curve already is pricing a recovery in price.

Sep 14 06:12 PM

[naturallight:]

>>>Yet, storage problems didn't stop Wall Street from having
>>>Gold and Silver ETFs. If Wall Street has products that hold
>>>gold and silver, why not natural gas?

I’m sorry if this sounds mean, but shouldn’t the Seeking Alpha contributors at least attempt some analysis?

Natural gas ETF’s have well over $4bn in AUM now. How much storage space would that require? How much storage space is available, and how much is currently being used? What is the current cost of storage, and would it be more expensive than the losses from the steep contango?

The answers to all of these questions are easily available through the Google.

Sep 14 08:34 PM

[JBSecurities:]

Just an idea, if any one wants an accurate tracking of Natural gas, check out the Canadian HNU, which trades at a 2.72% premium and has an average trade volume of 63 million shares per day. Just a thought if you want to get clear exposure to NG without paying the premium that UNG add. I think the Canadian listing is better than the HZBBF mentioned earlier just due to liquidity as the US one trades about 592K per day.

Sep 14 08:59 PM

[daniel3582:]

The only way to play natural gas through UNG is to call the bottom to the month, and buy then. Case in point:

Oil is currently trading at $70/barrel. USO is at $35/share. Compare that to January of this year: $40 barrel. The only way you would have participated in the doubling of oil price is if you had bought in at the exact bottom when USO briefly dropped to $22/ share in March.

Those who bought USO at the beginning of the recovery period... November, December, January... they have gotten completely shafted, and they were only a few months early. Imagine what will happen to you if you start accumulating natural gas by buying UNG, and we don't move off of the bottom for another three months? Six months? A year?

Conclusion: if you don't possess the skill to time a market to the month or the week, then go to Vegas. At least you get free drinks while you lose your money.

Sep 14 10:51 PM

[Jonathan Swift:]

Mr. Rafat wrote:

"Some people contend that a reliable tracking product must store the underlying physical commodity, and it is almost impossible to store sufficient amounts of natural gas. Yet, storage problems didn't stop Wall Street from having Gold and Silver ETFs. If Wall Street has products that hold gold and silver, why not natural gas?"

How much storage space do you suppose is necessary to store say $1000 of natural gas compared to the same value of gold (1 ounce)? Any concept of the differences in the expenses of storage coming through?

Sep 14 11:02 PM

[Mark Anthony:]

The natural gas storage capacity of the WHOLE NATION, is roughly 4000 BCF (billion cubic feet). Each thousand cubic feet of natural gas is worth $3.50 as I speak now. So the value of all natural gas stored in all facilities is no more than $14B. Even if natural gas price doubles from here, there can be no more than $14B profit made in the whole sector of natural gas commodity, and that is a theoretical absolute top limit of possible profit.

The majority of profit that natural gas longs can make, will come from the shorts who bet big on the wrong direction, not from the appreciation of the commodity itself. Therefore expect extreme volatility and extreme price swing on both sides. I am expecting an explosive rally up, as natural gas is deeply over sold yet many shorts actually believed natural gas price can go below ZERO.

Sep 14 11:44 PM

[Joe Duggins:]

While many investors are now well aware of the commodity exchange traded Funds (ETFs) as they have been around for some time now, there is an ETF on the market that is creating quite a furore. The natural gas EFT has done very well after being traded for a little over a year. The Victoria Bay Asset management company introduced this EFT in April of 2007 which has risen by more than 40% in the first year of operation. Victoria Bay, who also manages a host of other energy ETFs, plan to introduce other ETFs soon.

The natural gas ETFs trade in futures commodities by tracking the movement of prices on natural gas and make future contracts investments. The natural gas ETFs are quite lively, based on predictions as they are. This works out quite well though for those who also hold crude oil ETFs, as the prices tend to go in the opposite direction with oil thus offsetting the oil ETFs if in one has both commodities in their energy portfolio.

The Investment Company Act of 1940 does not cover natural gas ETFs as they are securities. A good number of investors are not, therefore, comfortable with them, however others are quite happy to dive in and enjoy the absence of these government annoyances.

Because of their volatility, the natural gas ETFs exchange traded funds have some analysts treating them as very high risk and warning investors away from them. Due to the lack of liquidity in the gas futures, there is a fear that if some companies pull out their contracts, there would be no way of recovery.

Some experts on the other hand see a bright future for the gas ETFs which are expected to grow, albeit slowly. The wild weather fluctuations we are experiencing are the reason. This has increased the use of gas for heating during the harsh winters and running air-conditioners in the extremely hot summers to the extent that the gas is used up as soon as it is pumped. The experts also recommend buying yearly contracts to benefit from both seasonal effects.

Congress is looking at an energy bill aimed at reducing the generation of greenhouse gases. Many countries around the world are also looking at ways of combating global warming. Natural gas produces less greenhouse gases that other fuels and should soon be in greater demand. For the ones still studying natural gas ETF's, this new commodity could be your best choice.
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Sep 15 03:02 PM