After dropping to a decade low, natural gas prices are on the rebound as bottom fishers have jumped at the oversold commodity. While natural gas commodity exchange-traded funds strengthened on the recovery, these types of funds still track the futures market, which is not the only way to gain exposure to natural gas. Investors, though, may consider the equity-based ETF as an alternative to the rising natural gas prices and expanding industry.
Natural gas futures dipped below $2 per British thermal unit in late April, the first time in over a decade, but prices have since rallied to $2.70 as there were signs that record production was finally slowing while demand was picking up.
On the supply side, large oil producers pump out natural gas, a byproduct from their core crude oil production; however, in light of record low natural gas prices, some producers began turning off the crude nozzle. Additionally, distribution companies are expanding their networks and pushing the industry, along with the government, to treat natural gas as a solution to clean, lost-cost energy. For instance, energy tycoon T. Boone Pickens is convinced that natural gas is the country's solution to end our dependence on foreign energy.
Meanwhile, on the demand side, warmer weather forecasts and electric utilities switching from coal to the cheaper gas in generating power has helped boost consumption of natural gas. Furthermore, with natural gas as cheap as it is now, there are talks of converting natural gas to energy in combustion engines and trucks.
It should still be noted that storage and production is still at or near all-time highs. Production, primarily from increased extraction through new fracturing, or "fracking," techniques in shale beds, is at near-record highs.
Comparing Equities- And Futures-Based ETFs
To capture the growth in the natural gas industry and recovering natural gas prices, investors may consider a natural-gas equity ETF option, First Trust ISE-Revere Natural Gas Index Fund (FCG).
FCG tries to follow an equal-weighted index of 30 natural gas producers and explorers. Top names include Exco Resources, Comstock Resources, EnCana Corp., Cabot Oil & Gas Exploration and Questar Corp. The fund has an expense ratio of 0.60%.
While natural gas prices are rallying off their lows, the market is still mired by a large supply overhang. Consequently, natural gas prices may not skyrocket any higher, but rather, remain more tempered. In contrast, producers are still expanding into the shale business, and many companies are also exposed to crude oil.
In comparison, most commodity ETFs deal with futures contracts traded on the commodities exchange. Typically, the futures contracts are settled or swapped for cash before the date of maturity to prevent the fund from taking actual physical delivery. In the case of futures-based ETFs, the funds will swap or roll the contracts so that they do not take delivery. Consequently, futures-based ETFs will come with a time component that could affect the ETF. Specifically, when the ETF rolls its holdings or buys a later-dated contract, the future-dated contracts may cost more than the contracts that are about to mature. In this case, the futures contracts are said to be in "contango," the opposite is called "backwardation." If the underlying commodity's futures contracts are in contango, the ETF could lose money when the managers roll contracts, or purchase pricier later-dated contracts.
For instance, the largest natural gas ETF, U.S. Natural Gas Fund (UNG) with $1.1 billion in assets, has been trapped in the constant state of contango in the futures market. Consequently, over the years, it has experienced a steep loss, even to that of the natural gas spot prices.