Four Developments That Could Crush UNG

by on December 9, 2009 | Updated May 25, 2010 | ETFs Mentioned:

The United States Natural Gas Fund (UNG) has frustrated its fair share of investors so far this year, steadily declining throughout 2009 as money continues to flow in. Each decline in price has perhaps created new buying opportunities for investors, but those following a “buy low, sell high” strategy have seen few opportunities to unload their holdings at a higher price (see What’s Wrong With UNG? for a look at some of the reasons for UNG’s less than stellar performance this year).

Natural Gas ETFs Have Burned Investors In 2009After a four-day losing streak saw UNG lose more than 13% of its value (putting it down more than 60% on the year), the fund has bounced back in its last two sessions, adding more than 10% so far this week as cold weather in the eastern U.S. has stoked hopes that inventories will finally begin to decrease. But before jumping into a natural gas ETF, it’s worth considering a few trends that could weigh on UNG in coming weeks. Below are four news stories from this week that have the potential to reverse recent trends and send UNG lower (for more actionable ETF investment ideas, sign up for our free ETF newsletter).

1. Massive South China Sea Discovery

Calgary-based Husky Energy announced this week that it made its second major natural gas discovery in the South China Sea, a field that could ultimately yield more than 140 million cubic feet of natural gas per day. The new well was just 23 kilometers from the Liwan gas reservoir that the company discovered in 2006. Husky is planning to drill an appraisal well early next year in order to gauge the new well’s potential.

Production at the well likely wouldn’t begin until 2013 at the earliest, but expectations for a major increase in global supplies could weigh on natural gas prices long before then. The world’s proven natural gas reserves are believed to be in excess of 175 trillion cubic feet, so the additional South China Sea supply isn’t exactly a drop in the bucket.

2. Exxon’s LNG Project

Historically, major discoveries of natural gas in China have had little impact on prices here in the U.S. (UNG holds futures for delivery at the Henry Hub in Louisiana) due to the costs and logistical difficulties associated with storing and transporting the gas. But technological advancements are beginning to change that. Liquefication processes now allow natural gas to be converted to liquefied natural gas, which takes up less than 0.2% of the volume of natural gas in its gaseous state. Liquefied gas is considerably easier (and cheaper) to store and transfer than traditional natural gas.

Last month Murwab, a Qatari liquefied natural gas tanker, carried enough gas to the U.S. to heat nine million homes for a day, adding to inventories that are already at record levels. Tony Regan, a former executive for Royal Dutch Shell’s LNG business recently described the U.S. as “the sink for cargoes that can’t go anywhere else,” suggesting that increased LNG activity could translate into even bigger supplies to U.S.-based users of natural gas.

Exxon Mobil announced on Tuesday that it will move forward with a $15 billion liquefied natural gas project in Papua New Guinea. The project’s approval now hinges on securing sales agreements in Asia, which is expected to be completed sometime next year according to Exxon. The project has the ability to produce 6.6 million tons on LNG per year, and is one of the largest natural resource development projects in Papua New Guinea.

3. Rig Counts Still Way Down

As of late November, the domestic oil and gas rig count was down about 44% from its peak in September 2008 but 30% above the bottom experienced in June 2009. Looking only at U.S. natural gas rigs, the count stood at 748, up only about 10% from the June lows. “Clearly this tells us domestic natural gas rigs have been put back to work at a slower pace,” write the Wall Street Transcript.

Natural gas prices have been pushed lower in recent weeks on concerns of record levels of inventories. The fact that these inventories have been accumulating with a rig count far below capacity is a troubling indicator for long-term pricing power. With significant room to increase supplies by bringing rigs back on-line, a significant increase in demand will be needed to break through a price ceiling (see UNG’s technicals page for more information).

4. Inventories Still Rising

Despite falling temperatures, natural gas inventories in the U.S. continue to rise. The Energy Information Administration’s report for the week ended November 27 showed that inventories actually increased by 2 billion cubic feet over the previous week, the first time in several years that inventories have increased this late in the calendar year.

Drops in temperature this week have given some investors hope that stocks will begin to fall sharply in coming weeks, meaning that any result less than a material decline in inventories will disappoint. Moreover, if supplies from around the world continue to gravitate towards the U.S., the traditional winter drawdown could be not nearly as steep as in prior years (see charts of UNG).

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Disclosure: No positions at time of writing.