Consider Natural Gas ETF for New Energy Investments

Quite predictably, crude oil has been on a roll in recent weeks as the summer driving season has driven seasonally strong performance. With oil trading around $75 per barrel, fresh money investments into the energy sector might not be ideal at these prices. Don’t get me wrong, I am still bullish on oil in general, but investors should not jump on the energy bandwagon with new money when we are in the middle of peak oil season.

For new money right now I would suggest investors take a look at natural gas. In fact, in mid April a new ETF was formed to track natural gas prices. Even while oil has soared from the low 60’s to the mid 70’s, natural gas has collapsed from more than $8 to below $6. Another non-existent hurricane season has contributed to the drop, but natural gas prices will remain volatile in the future, and given the weakness lately, it appears to be an attractive entry point.

The natural gas ETF trades under the symbol UNG and has plummeted from above $54 to $38 in the last couple of months, as you can see from the chart below. After a 30 percent drop, I think it looks attractive for investors looking to add some energy exposure but are wary of buying crude oil stocks at current prices. You can also play this via unhedged natural gas producers, but since this ETF is new, I figured I would point it out as another potential investment vehicle in the space.

Full Disclosure: No position in UNG at the time of writing

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7 Thoughts on “Consider Natural Gas ETF for New Energy Investments

  1. sagacious on July 24, 2007 at 10:08 AM said:

    This is probably not a bad place to be given that natural gas is currently trading at a 30-40% Btu discount to oil.

  2. Rubens on July 25, 2007 at 11:52 AM said:

    To say that gas is trading at a X% Btu discount to oil is like saying that bananas are trading at a Y% calorie discount to oranges. Oil is used to make cars and airplanes run, make plastics, asphalt, some petrochemicals etc. Gas is used to fuel power plants, make fertilizers, other petrochemicals, etc. In most cases they are not interchangeable so most companies cannot switch between oil and gas and “arbitrage” away the Btu price discount.

    I would point out that both USO (oil ETF) and UNG (nat gas ETF) are poorly designed, in that they invest in the next month future, then roll to the following month as the the contract matures. The problem with that? Both gas and oil forward curves are have been in contango for quite some time now; prices for future months are higher than for the near months. The ETF loses money as it rolls the futures position every month. I think buying UNG is fine for a short term speculation but is a bad bet for the longer term.

    This article provides a good graphical illustration of what happened to USO. Below, a user (jbianco) gives a good explanation of why.

  3. Chad Brand on July 25, 2007 at 12:21 PM said:

    I think there has historically been a 5 or 6 times relation between nat gas and crude oil prices, so I’m not sure the BTU comparison is an incorrect way of looking at it. I don’t use those calculations, but many people do, I believe.

    The ETF’s are not perfect, but it will do the trick if NG rallies in coming months. I don’t doubt there are more perfect ways of playing it, but it’s enough for me from a simplicity point of view.

    Thanks for the link.

  4. Rubens on July 25, 2007 at 12:30 PM said:

    You are right on the historical relationship.

    How about a paired trade long UNG and short USO? That way you offset your negative carry on UNG with positive carry in USO.

  5. sagacious on July 25, 2007 at 12:32 PM said:

    Tell Aubrey McClendon, CEO of Chesapeake Energy, that the Btu discount not relevant. Citing the argument you give in his 2006 annual letter he says that, “Although 91% of Chesapeake’s production is natural gas, and oil and natural gas are not exact substitutes, oil still plays a very important role in how natural gas is priced. Natural gas prices have recently traded at a 20-40% discount to the price of oil on an energy equivalent (BTU) basis. Historically, the significant BTU discount of natural gas prices to oil prices has existed because natural gas is not as freely tradable around the world as oil and also natural gas is not influenced by geopolitical tensions in the same way oil is. Over time, however, we believe that natural gas prices will trade more closely to BTU parity with oil, given our view that natural gas demand will increase more quickly than oil demand in the years ahead.”

    Mason Hawkins (of Southeastern), an investor with a phenomenal long-term track record, seems also to believe it’s relevant, citing the Btu discount as a reason for investing in natural gas companies during their annual presentation to shareholders.

    By the way, the forward curve for light, sweet crude as of today is in backwardation.

  6. Anonymous on February 19, 2008 at 2:15 PM said:

    I’m wondering if there is something that does for COAL (ETF, ETN, etc) what USO, OIL, etc, or even an analogue or the more exotic UCR, does for oil?

    I think that would be a good investment if it tracked the price of coal (of course there are different types of coal, I realize that..but an investment tracking the price of coal should be possible to create.

    You’d get to make money on the new demand while actually being green at the same time at least in the sense that you’d profit from coal having higher prices..

    Any information of leads would be appreciated.

  7. Chad Brand on February 19, 2008 at 2:52 PM said:

    The only coal ETF right now is KOL, but it tracks coal stocks, not the price of coal specifically.

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