Definition of natural gas ETF

What is a natural gas ETF?

A natural gas exchange-traded fund (ETF) is a type of joint investment product that allows investors to easily invest in natural gas futures contracts.

Natural gas ETFs are often organized as commodity pools, in which a professional manager invests the funds on behalf of investors. Rather than owning natural gas directly, investors in a natural gas ETF own a small portion of a large portfolio of natural gas futures contracts.

A natural gas ETF can also invest in and track the stocks of companies related to natural gas.

Key takeaways

  • Natural gas ETFs are investment vehicles that allow exposure to natural gas prices.
  • They are structured as sets of commodities that hold natural gas futures contracts.
  • Natural gas prices have recently hit some of their lowest prices in decades, making this a difficult period for investors in natural gas ETFs.

How Natural Gas ETFs Work

It is important for investors to understand the difference between natural gas ETFs and other popular types of ETFs. Many ETFs own their underlying assets directly, such as gold ETFs that own physical bullion or industrial sector ETFs that own the shares of companies operating in their industry. However, natural gas ETFs typically do not own physical natural gas. Instead, they own natural gas indirectly by purchasing natural gas futures contracts that are traded on a commodity exchange.

Therefore, the profitability of a natural gas ETF depends on the general direction of the natural gas price, based on the trading that takes place on the commodity exchange. Also, since natural gas ETFs have futures contracts, they are exposed to a special type of risk called contango. What this refers to is the fact that each month the natural gas ETF manager has to buy new futures contracts to replace old contracts that expire. New contracts tend to be priced slightly higher than old ones, which means that each time the contracts are replaced, the fund manager incurs additional costs. Over time, these small costs can add up to create a huge drag on the fund’s overall performance.

For this reason, investors will generally avoid relying on natural gas ETFs as a type of long-term investment vehicle. Due to the risk of contango, an investor could incur significant costs from continually renewing futures contracts, which means that even if natural gas prices increase during their investment period, they may not increase enough to that the overall investment is profitable. Most investors seeking exposure therefore use natural gas ETFs primarily as a short-term business vehicle, so contango costs do not add up enough to have a significant impact.

Real world example of a natural gas ETF

An example of a widely traded natural gas ETF is the United States Natural Gas Fund, issued by the United States Commodity Fund. This fund is comprised of natural gas futures contracts and swaps and is listed on the New York Mercantile Exchange (NYMEX) as UNG. The NYMEX is tied to the Henry Hub spot price, which is the main US benchmark for natural gas.

The United States Natural Gas Fund is very sensitive to fluctuations in natural gas prices, so investors should keep a close eye on market prices to try to make a profit. Over the past 20 years, natural gas prices have ranged from a high of nearly $ 20, reached in the fall of 2005, to just under $ 1.7, reached in September 2020.

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Mark Holland

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