UNG: The Wrong Way To Play Natural Gas

| About: The United (UNG)

For investors who are bullish on the future of natural gas, There are few worse bets than The United States Natural Gas ETF (NYSEARCA:UNG). UNG is currently a bad bet because of the contango in the natural gas futures market.

UNG's mission statement:

The investment objective of UNG is for the changes in percentage terms of the units' net asset value to reflect the changes in percentage terms of the price of natural gas delivered at the Henry Hub, Louisiana, as measured by the changes in the price of the futures contract on natural gas traded on the New York Mercantile Exchange that is the near month contract to expire, except when the near month contract is within two weeks of expiration, in which case it will be measured by the futures contract that is the next month contract to expire, less UNG's expenses.

This means that UNG is forced to continuously sell the front month and buy the forward month. This is a problem because of the contango in the natural gas market. Below are the prices for Henry Hub Natural Gas futures over the next year.

  • Jan 2012- $ 3.12
  • Feb 2012- $ 3.17
  • Mar 2012- $ 3.20
  • Aprl 2012- $ 3.26
  • May 2012- $ 3.31
  • Jun 2012- $ 3.35
  • Jul 2012- $ 3.41
  • Aug 2012- $ 3.44
  • Sep 2012- $ 3.45
  • Oct 2012- $ 3.47
  • Nov 2012- $ 3.88
  • Dec 2012- $ 4.03

As you can see, prices for natural gas are higher in each month that is "further out" on the futures curve. This means that UNG loses the difference between each month. So, if natural gas prices remain flat and end December 2012 at 4.03 UNG will lose the enormous 89cent spread between Jan and Dec natural gas.

The natural gas stocks are a much better way to play natural gas itself than UNG. Companies that hold natural gas underground will receive higher prices going forward. These stocks include Chesapeake Energy (NYSE:CHK), Southwestern Energy (NYSE:SWN), Anadarco (NYSE:APC), Sandridge (NYSE:SD), and other smaller natural gas companies. Major integrated oil companies such as Exxon Mobil (NYSE:XOM), and Conoco Phillips (NYSE:COP) also have major natural gas holdings. These should benefit from any upside in natural gas. The (NYSEARCA:FCG) is another way to play it, this ETF owns a group of natural gas stocks. Investors looking for more risk could consider Cheniere (NYSEMKT:LNG), Cheniere is hoping to export natural gas from America to foreign nations where gas prices are much higher.

Conclusion: Investors who believe in natural gas should be buying the natural gas companies, not UNG.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.