Natural Gas ETF

One way to participate in the natural gas market is through a Master Limited Partnership or MLP. They are not taxed as heavily as corporations so this allows them to pass more of their income to investors on a regular basis, most often as a monthly distribution. This provides income to the investor and allows them to earn a competitive return while waiting for Natural Gas prices to rise. This has been a good strategy during the past two years of low natural gas prices. By creating a Natural Gas MLP ETF, it allows investors to diversify among several MLPs and thereby eliminate some of the company specific risk.

One that is currently available is actually structured in the form of an ETN (Exchange Traded Note) and is called the UBS E-TRACS Alerian Natural Gas MLP Index (MLPG). This ETN is an equal-weighted composite of the 15 largest natural gas infrastructure Master Limited Partnerships by market capitalization.

The Top 10 holdings of the fund are currently:

Copano Energy LLC-Units CPNO 7.00%
Spectra Energy Partners LP SEP 6.87%
Targa Resources Partners LP NGLS 6.80%
Duncan Energy Partners LP DEP 6.80%
Boardwalk Pipeline Partners BWP 6.74%
TC Pipelines LP TCLP 6.74%
ONEOK Partners LP OKS 6.71%
Energy Transfer Partners LP ETP 6.70%
Enterprise Products Partners EPD 6.62%
Regency Energy Partners LP RGNC 6.54%

Source: Alerian

Currently the only problem with this ETF is that the trading volume is extremely thin so be sure to check the liquidity before you consider investing.

If you are looking for a leveraged Natural Gas ETF there is one available from Direxion and trades under the ticker symbol FCGL.  The name of the fund is the Direxion Daily Natural Gas Related Bull 2x Shares. The goal of this etf is to provide 200% of the daily moves in the ISE Revere Natural Gas Index™ before fees and expenses. The companies selected for the index earn a substantial portion of their profits from the exploration and production of natural gas. It is not a pure play on the price of natural gas.

Currently here is the mix of companies that make up the index:

Oil & Gas Exploration & Production 72.1%
Integrated Oil & Gas 24.3%
Gas Utilities 3.5%

On the day of this writing there was a “roughly” equal dollar weighting of the following 30 companies:

APA, COG, CHK, XEC, CRK, COP, DVN, EOG, XCO, ECA, XOM, FST, HES, MUR, NFX, HK, PQ, STR, KWK, RRC, RDS/A, SM, SD, SWN, STO, SGY, SU, TLM, TOT, UPL

It appears the 2x leverage is achieved by using financial derivatives.

This ETF began trading on July 14, 2010 and after several days of heavy trading the volume completely dried up. It only has an average trading volume of about 3,000 shares per day at this time. Since Leveraged ETFs are designed for short term trading, that’s not much liquidity so be careful if you think about trading this one.

The price performance has been quite spectacular over the limited time it’s been trading as you can see by the chart below.

There have been few ETF products that have come under more scrutiny than the Natural Gas ETF – UNG.  This etf was an instant hit with investors just as USO was with oil investors, however UNG has been plagued with not only moderate to severe cantango but also a never ending bear market in natural gas.

Look at the performance of UNG since inception:

This dismal performance is partially caused by having to roll futures forward on a regular basis.  When the contracts are rolled forward in the fall from September – January the fund often has to buy at sharply higher prices – this is called contago.   This makes it impossible for UNG to capture the improvements in the cash market because they are already reflected in the way futures contracts are priced.  For this reason futures based ETFs such as UNG work well when prices are moving fast, but are horrible in sideways markets.  As you can see the price of natural gas has really gone nowhere ever since the 2008 crash in prices.

Despite this miserable performance UNG has remained an incredibly popular ETF trading millions of shares per day.  There is another alternative to UNG but it has failed to gain much attention, it trades under the ticker symbol UNL.

UNL – United States 12 Month Natural Gas Fund LP

This fund is from the same ETF sponsor as UNG but spreads out the futures purchases over the next year. This is an effort to reduce the volatility caused by contango as they are only rolling 1/12th of the holdings each month. As you can see by the chart below this has a slight positive effect in the sideways market of the past couple years.

It’s still my though that you are better off in the Natural Gas MLPs instead of the futures based ETFs because you capture the monthly dividend while you wait. The only time this wouldn’t be true is during a raging bull market (like 2006-2007) because futures prices strongly outperform in that type of environment.