Over the last four years, investors in natural gas have been suffering big losses. The fundamental parameters of natural gas - demand, supply and reserves - have dramatically changed during those years, mainly due to the development of cost-effective shale gas extraction technologies. However, there have already been periods when investing in natural gas was very profitable, and perhaps it will be that way again in the future. In this article, I will compare the different ways to invest in natural gas:
- Natural Gas futures contracts
- Natural Gas ETFs and ETN
- Shares of Natural Gas companies
Click to enlarge
Data: TradeStation Group, Inc. Chart: Arie Goren
Data: TradeStation Group, Inc., U.S. Bureau of Labor Statistics Chart: Arie Goren
First, let us compare the historical return of the different investment instruments.
The table below presents the historical price appreciation and the Compound Annual Growth Rate (CAGR) between February 26, 1993 and September 14, 2012, for the following investment instruments: natural gas continuous leading future contract; natural gas continuous futures contract adjusted for rollover of the expiring contract; and the stock of Chesapeake Energy Corporation (CHK), which considers also the dividend distribution.
Chesapeake is an energy company which is mainly active in natural gas. The calculation does not take into account natural gas ETFs and ETN which did not yet exist in 1993. The adjusted-for-dividends stock prices were extracted from Yahoo Finance, and the data for the continuous contracts were taken from TradeStation Group, Inc.:
During the period calculated, investing in natural gas futures contract has not been profitable; nonetheless, holding on to the shares of Chesapeake Energy has given a very nice return 1,973% or 16.8% annually. The appreciation of the unadjusted futures contract was 58.6% or 2.39% annually; but because long-term investors in futures contracts should roll over expiring contracts, and because of very strong contango conditions during this period, the return was very negative: -84.3% or -9.04% annually, without taking into account trade commissions (a comprehensive explanation about the influence of contango and backwardation on long-term investment in commodities can be found in my article here).
In order to include the natural gas ETF, United States Natural Gas (UNG), which was launched on April 2007, and iPath DJ-UBS Natural Gas TR Sub-Idx ETN (GAZ), an identical study was performed on a much shorter period, from October 31, 2007 to September 14, 2012.
The stock of Encana Corporation (ECA) was also included in this study, even though it could not form a part of the first study, since stock prices from Yahoo Finance for this company are only available since September 2002. Encana Corporation is an energy company which is mainly active in natural gas. The results are shown in the table below:
During that short period, all means of investment in natural gas (going long) turned out to be very painful. The return of the adjusted continuous futures contract was very negative: -82.6%. The return of natural gas companies was also negative. The return of Chesapeake Energy was -44.9%, and the return of Encana Corporation was -27.4%.
The return of the natural gas ETF and ETN has been even worse, and the whole investment fund was almost lost due to the decline in the natural gas price, strong contango conditions, and the funds' expenses.
In light of the results of the past years, using the term "the best way to invest in natural gas" is a little difficult, but one must remember that investing in Chesapeake Energy has been very profitable on the long run, and the loss resulting from investing in Encana Corporation during the last five years has been the smallest. In conclusion, I think that for investors who believe that the current low prices of natural gas would not remain such for much longer, the best way to invest in natural gas is through the stocks of one of these two companies.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.