Betting on Natural Gas, Part II: Investing Ideas

by: Shishir Nigam

Just as important as deciding to go long natural gas is how that view is translated into an investing strategy. The value chain of the natural gas industry, shown below (Source: Wikinvest), provides a good overview. There are numerous investment opportunities throughout the value chain that can be capitalized upon.

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Betting on the actual spot price:

1. Buying natural gas futures outright – If you have access to the futures market, are experienced enough to understand its intricacies and have enough capital, then take a dip in natural gas futures. The December futures are already trading at a 14% premium to the November futures, on the hopes of a cold winter pulling up demand. Inexperienced investors should probably stay away from the futures market.

2. Buying ETFs that hold natural gas futures – The biggest and most liquid one of these is the United States Natural Gas Fund (NYSEARCA:UNG). Many authors on Seeking Alpha have mentioned how UNG has been doomed by the contango in the natural gas market. UNG just finished selling its holdings of front-month contracts and rolled into December contracts this week. The premium on the December futures mentioned above means that UNG always sells low and buys high during rolls. For that reason, I would not recommend UNG. The Claymore Natural Gas ETF (NYSE:GAS) on the TSX holds futures of Alberta natural gas, unlike the UNG which holds NYMEX futures. As it turns out, the contango on NYMEX futures is steeper than that on Alberta natural gas, helping GAS reduce its rolling costs. If you’re really sure of your bets, consider HNU, a 2x long natural gas ETF trading on the TSX.

3. Buying natural gas royalty trusts – To avoid the costly contango issues, take a look at royalty trusts like Hugoton Royalty Trust (NYSE:HGT) which pay monthly dividends based on the basis of the price of natural gas. However, many of these trusts behave in sync with the general stock market, which takes away from a pure play in natural gas.

Betting on the producers and movers:

1. Buying the gas explorers, drillers – The most popular of these being Chesapeake Energy (NYSE:CHK). The stocks of the producers however are likely to be affected by the general market conditions as well, as opposed to just the natural gas price. Another well-established company is Devon Energy (NYSE:DVN) and like CHK, it is involved in both oil and gas markets. It is rare to find established companies which focus only on natural gas exploration. Internationally, Gazprom owns roughly 75% of Russia’s and Eastern Europe’s natural gas reserves.

2. Buying the gas movers – Gas that is produced needs to be moved to where it’s needed. Natural gas is transported mainly through pipelines and some major players in this industry are NiSource (NYSE:NI) - owner of the largest natural gas pipeline in the US, Northwest Natural Gas (NYSE:NWN), Nicor (GAS) and Piedmont Natural Gas (NYSE:PNY). All of them sport some very healthy dividend yields as well and have relatively solid balance sheets. A huge company involved in both producing and transporting gas is Encana (NYSE:ECA). ECA is has a very stable revenue base thanks to a large portion of its business being regulated and it provides one of the best avenues to benefit from increases in natural gas.

3. Buying a sector ETF – If you’re looking to invest in this sector but with diversification, look at a sector ETF like the First Trust ISE-Reverse Natural Gas Index fund (NYSEARCA:FCG) that replicates an index invested in natural gas exploration and production companies. It is one of the only ETFs that provides an opportunity to invest in a range of natural gas companies while having a reasonable expense ratio of 0.82%.

The best options for taking a long position towards natural gas, in my opinion, are either through getting direct exposure by investing in a commodity tracking ETF or investing in the gas movers which have the scale and size to provide a stable stream of dividend income while also standing to benefit from rising natural gas prices.

Disclosure: Long GAS on the TSE.