A natural gas exchange-traded fund (ETF) is a type of pooled investment product that provides investors with exposure to natural gas prices. These funds are often overseen by a professional manager, who invests on behalf of the investors, and typically invest in a basket of natural gas futures contracts rather than holding stocks of natural gas companies.
Key Takeaways
- Natural gas ETFs offer exposure to natural gas prices.
- Structured as commodity pools, they hold natural gas futures contracts.
- Strategies can include holding physical natural gas, investing in futures contracts, or equities of companies in the natural gas sector.
- ETFs provide liquidity by trading on stock exchanges but come with management fees and associated expenses.
Understanding Natural Gas ETFs
Natural gas is a multifaceted commodity, used for heating, cooking, fuel, electricity generation, and manufacturing plastics and other organic chemicals.
It’s crucial for investors to distinguish natural gas ETFs from other popular ETFs. While many ETFs own their underlying assets directly, such as gold ETFs holding physical gold or sectoral ETFs holding shares of companies in specific industries, natural gas ETFs usually don’t own physical natural gas. Instead, they own natural gas indirectly by purchasing natural gas futures contracts trading on commodities exchanges. The profitability of a natural gas ETF is dependent on the overall price direction of natural gas on these exchanges, which rise and fall according to supply and demand fluctuations.
Diversity of Natural Gas ETF Holdings
Physical Natural Gas ETFs
Some ETFs hold physical natural gas in storage facilities. These funds purchase and store actual natural gas, typically in the form of futures contracts, aiming to closely track the spot price of the commodity. However, these ETFs carry significant storage costs.
Futures-Based ETFs
Many natural gas ETFs use futures contracts to track the commodity’s price. These funds invest in natural gas futures—agreements to buy or sell at a predetermined price on a specified future date. Futures-based ETFs can provide exposure to short-term price movements and offer good liquidity.
Equity-Based Natural Gas ETFs
Certain ETFs invest in equities of companies involved in the natural gas sector, such as producers, exploration firms, pipeline operators, and utilities. These funds offer exposure to the broader industry, impacted by factors beyond just natural gas prices.
Leveraged and Inverse Natural Gas ETFs
Leveraged ETFs aim to amplify the returns of the underlying asset on a daily basis. Conversely, inverse ETFs seek returns opposite to the underlying asset’s performance. These complex ETFs are generally used for short-term trading or hedging strategies.
Natural Gas ETFs and Forward Contracts
Forward contracts provide another way for ETFs to gain exposure to the natural gas market. Unlike standardized futures contracts, forward contracts are custom-tailored to the needs of the parties involved. Offering more flexibility in terms of settlement dates and terms, forward contracts are typically traded in OTC markets and pose higher counterparty risks. Collateral is often required to manage this risk.
Limitations of Natural Gas ETFs
Natural gas ETFs holding futures contracts face a unique risk known as contango, where new futures contracts have higher prices than expiring contracts. This continuous roll-over incurs extra costs, creating a drag on fund performance. Hence, natural gas ETFs are generally better suited for short-term trading rather than long-term investment.
Example of a Natural Gas ETF
One prominent natural gas ETF is the United States Natural Gas Fund (UNG). This fund trades on the New York Mercantile Exchange (NYMEX) as UNG and is composed of natural gas futures contracts expiring within the next month. The goal is to reflect the daily percentage changes in natural gas prices delivered at the Henry Hub, Louisiana. Features of UNG include intraday pricing, the ability to place market, limit, and stop orders, along with portfolio transparency updates. As of Sept. 2023, its management fee is 0.60% and the expense ratio is 1.06%.
What Is the Objective of Investing in a Natural Gas ETF?
The primary objective is to gain exposure to the natural gas market. Investors aim to profit from price movements, hedge against price changes, or diversify investment portfolios.
How Do Natural Gas ETFs Track the Price of Natural Gas?
Natural gas ETFs typically invest in futures contracts, which are financial agreements specifying the purchase or sale of natural gas at a future date, closely mirroring price movements. These ETFs roll over expiring contracts to maintain exposure to the commodity.
Do Natural Gas ETFs Physically Hold Natural Gas?
Some may directly hold physical natural gas in storage facilities, aiming to replicate the spot price of the commodity.
The Bottom Line
Natural gas ETFs provide exposure to the natural gas market through various investment strategies, although most invest via futures contracts. While convenient for accessing the energy commodity market, natural gas ETFs come with risks like price volatility and tracking errors. They offer opportunities to profit or hedge against natural gas price movements, but investors must be cautious of associated risks.
Related Terms: exchange-traded fund, commotidies trading, futures contracts, inverse ETFs, leveraged ETFs.
References
- CME Group Education. “Fundamental Analysis - Futures Supply and Demand”.
- U.S. Securities and Exchange Commission. “Updated Investor Bulletin: Leveraged and Inverse ETFs”.
- CME Group Education. “Futures Contracts Compared to Forwards”.
- CME Group Education. “What is Contango and Backwardation”.
- VettaFi. “Non Leveraged Natural Gas ETF List”.
- U.S. Commodity Fund. “UNG: United States Natural Gas Fund”.
- Macrotrends. “Natural Gas Prices - Historical Charts”.
