What Is a Natural Gas ETF?

What Is a Natural Gas ETF?

Let me explain what a natural gas exchange-traded fund (ETF) really is. It's a pooled investment product that gives you exposure to natural gas prices. These funds are managed by professionals who invest on your behalf, and they usually focus on a basket of natural gas futures contracts instead of holding stocks in natural gas companies.

Key Takeaways

You need to know that natural gas ETFs are investment vehicles designed for exposure to natural gas prices. They operate as commodity pools holding natural gas futures contracts. These ETFs can use different strategies, like holding physical natural gas, investing in futures, or buying equities in natural gas-related companies. Remember, ETFs in general offer liquidity since they trade on stock exchanges, but watch out for management fees and expenses.

Understanding Natural Gas ETFs

Natural gas is a versatile commodity used for heating, cooking, fuel, electricity generation, and manufacturing plastics and chemicals. As an investor, you should understand how natural gas ETFs differ from other ETFs. Many ETFs own their assets directly, like gold ETFs with physical bullion or sector ETFs with company shares. But natural gas ETFs typically don't own physical gas; they invest indirectly through futures contracts traded on commodities exchanges. Your profitability depends on the direction of natural gas prices from exchange trading.

Keep in mind that natural gas prices fluctuate based on supply and demand.

Diversity of Natural Gas ETF Holdings

You have various strategies with natural gas ETFs to access the market. Most hold futures contracts, but there are other options. Some ETFs store physical natural gas in facilities, buying and holding it to track the spot price—this gives direct exposure but comes with high carrying costs.

Many prefer futures contracts instead, which are agreements to buy or sell at a set price later. These provide exposure to short-term price moves and are more liquid than physical holdings. Other ETFs invest in equities of natural gas companies, like producers, explorers, pipeline operators, and utilities, influenced by factors beyond just gas prices.

Finally, there are leveraged and inverse ETFs. Leveraged ones amplify daily returns, while inverse ones deliver opposite performance. These are complex and suited for short-term trading or hedging.

Natural Gas ETFs and Forward Contracts

Natural gas ETFs might use forward contracts for exposure. Unlike standardized futures, forwards are customized for the parties involved, offering flexibility in terms and settlement dates to match your investment horizon. They trade over-the-counter, so they're less liquid and regulated, introducing counterparty risk.

To handle that risk, ETFs often require collateral from the counterparty as security against default. They also roll over positions by closing old contracts and opening new ones as expiration nears.

Limitations of Natural Gas ETFs

Since these ETFs hold futures, they're exposed to contango risk. Each month, the manager buys new contracts to replace expiring ones, and new ones often cost more, adding expenses that drag on performance over time. That's why you shouldn't use natural gas ETFs for long-term investing—the contango costs can wipe out gains even if prices rise.

Instead, treat them as short-term trading tools where contango doesn't accumulate much. As of December 2023, there are two main natural gas ETFs trading in the U.S., excluding leveraged and inverse ones.

Example of a Natural Gas ETF

Take the United States Natural Gas Fund (UNG) as an example. It holds near-month natural gas futures contracts traded on the NYMEX and aims to reflect daily percentage changes in natural gas prices at Henry Hub, Louisiana. It's highly sensitive to price fluctuations, so you must monitor the market closely. Over 20 years, prices have swung from $22 in 2005 to under $2 in 2020.

UNG lets you access commodities without a futures account, offering intraday pricing and order types like market, limit, and stop. It provides transparency with updates on holdings, price, NAV, and TNA. As of September 2023, its management fee is 0.60%, total expense ratio 1.06%, and 1-month NAV was -4.08%.

What Is the Objective of Investing in a Natural Gas ETF?

Your goal in investing in a natural gas ETF is to gain exposure to the natural gas market. You might aim to profit from price movements, hedge against changes, or diversify your portfolio.

How Do Natural Gas ETFs Track the Price of Natural Gas?

These ETFs track prices mainly through futures contracts, which are agreements to buy or sell natural gas later. They mirror price movements and maintain exposure by rolling over expiring contracts.

Do Natural Gas ETFs Physically Hold Natural Gas?

Some do hold physical natural gas in storage to replicate the spot price.

The Bottom Line

In summary, natural gas ETFs give you access to the natural gas market through strategies like futures contracts. They allow profiting from or hedging against price moves, but come with risks like volatility and tracking errors, just like other ETFs.