Natural Gas ETF

What Is a Natural Gas ETF?

A natural gas exchange-traded fund (ETF) is a type of pooled investment product that provides investors with exposure to natural gas prices. These funds are often overseen by a professional manager, who invests on behalf of the investors, and tend to invest in a basket of natural gas futures contracts rather than hold stocks of natural gas companies.

Understanding Natural Gas ETFs

Natural gas is a commodity that serves many purposes. It is used as a source of energy for heating, cooking, fuel, and electricity generation as well as to manufacture plastics and other organic chemicals.

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 industry-sector ETFs that own the shares of companies operating in their industry.

Natural gas ETFs, however, do not usually own any physical natural gas. Instead, they own natural gas indirectly by purchasing natural gas futures contracts that trade on a commodities exchange. The profitability of a natural gas ETF is, therefore, dependent on the overall price direction of natural gas, based on the trading that takes place on the commodities exchange.

Limitations of Natural Gas ETFs

Because natural gas ETFs hold futures contracts, they are exposed to a special type of risk called contango. Each month, the manager of the natural gas ETF has to purchase new futures contracts to replace the old contracts that expire. The new contracts tend to have slightly higher prices than the old ones, meaning that each time contracts are replaced, extra costs are incurred by the fund manager. Over time, these small costs can add up to create a large 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. Because of contango risk, an investor could incur significant costs from the ongoing roll-over of futures contracts, meaning that even if natural gas prices do rise over their investment period, they might not rise enough to make the overall investment profitable.

Most investors seeking exposure, therefore, use natural gas ETFs mainly as a short-term trading vehicle, so that the costs of contango do not accumulate enough to have a meaningful impact.

Example of a Natural Gas ETF

One example of a widely traded natural gas ETF is the United States Natural Gas Fund. This fund is primarily composed of natural gas futures contracts that are set to expire within the next month and trades on the New York Mercantile Exchange (NYMEX) as UNG. Its goal is to reflect the daily changes in percentage terms of the price of natural gas delivered at the Henry Hub, Louisiana, a natural gas pipeline that serves as the official delivery location for futures contracts on the NYMEX. 

The United States Natural Gas Fund is very sensitive to fluctuations in natural gas prices, so investors need to watch market prices closely to try to yield a profit. Over the past 20 years, natural gas prices have ranged between a high of $20, reached in the Fall of 2005, to just under $1.7, reached in September of 2020.