U.S. Commodity Funds, the issuer behind ultra-popular commodity ETPs such as UNG and USO, has launched the United States 12 Month Natural Gas Fund under the ticker UNL. The investment objective on UNL is to reflect the changes in percentage terms of the spot price of natural gas delivered at Henry Hub, Louisiana, as measured by the changes in average of the prices of 12 NYMEX natural gas futures contracts, consisting of the near month contract to expire and the contracts for the following 11 months. UNL will “roll” near month futures contracts when they are within two weeks of expiration.
UNL is very similar in some ways to the United States Natural Gas Fund (UNG), but very different in others. UNG has become one of the most popular exchange-traded commodity products this year as investors have sought out ways to gain exposure to natural gas prices. Due to the physical properties of natural gas, storage by an ETF issuer is nearly impossible (and would be prohibitively expensive). So in order to gain exposure to natural gas, UNG invests in near month futures contracts, rolling its holdings to the second month futures contracts as expiration nears.
While this futures-based strategy generally performs well, there are some potential pitfalls. When the markets are in contango, meaning longer-dated futures contracts are more expensive than short-dated futures contracts, value can be eroded quickly as the fund rolls contracts forward to the next month (this chart shows just how material this “roll yield” can be).
Because UNG invests primarily in front-month futures contracts (but not exclusively – the fund has begun using swaps on occasion), it rolls a significant portion of its holdings over every month. And due to the sheer size of UNG – it has seen cash inflows of almost $5 billion this year and has a market capitalization of about $3.5 billion – it must buy an enormous volume of futures contracts each month. This concentration of holdings has drawn the attention of regulators concerned about distortion of prices by such a large market participant.
UNL vs. UNG (and USO vs. USL)
Because UNL invests in 12 separate futures contracts, it will roll a much smaller portion of its portfolio forward every month (approximately 1/12th), which could result in performance that tracks spot prices much more closely. The relationship between UNG and UNL is similar to two other products from U.S. Commodity Funds: the United States Oil Fund (USO) and the United States 12 Month Oil Fund (USL). USO invests in (and rolls) near month futures contracts on light, sweet crude oil traded on NYMEX, while USL holds 12 crude oil futures contracts, rolling only a portion of its holdings each month. So far this year, USL has outperformed USO by a wide margin and more closely tracked the spot prices of West Texas Intermediate (WTI) crude oil (although it still trails spot prices by quite a bit):
But as shown above, the 12 month strategy doesn’t solve all the problems that come with futures-based investing in commodities. It should also be noted that the approaches taken by UNG and USO won’t always underperform spot prices – in many cases it can outperform a hypothetical investment in the physical commodity.
Natural Gas Investing
Natural gas has become one of the hottest investment trends this year, as hopes that its efficiency, abundance, and clean-burning properties will make it the “fuel of the future.” Legendary financier and takeover artist T. Boone Pickens has been actively promoting natural gas as a major component of the “Pickens Plan,” his initiative to reduce American dependence on foreign oil. Natural gas funds have seen inflows of more than $5 billion through October as interest has surged. Interest in “indirect” natural gas ETFs, such as FCG, has surged as well (for a look at all the ETF plays on natural gas, see this feature).
But for all the hype surrounding natural the future of natural gas, current fundamentals present a grim picture. Huge discoveries in recent years and major technological advancements in the drilling, storage, and transportation of gas have led to increased supply. At the same time, reductions in operations in the manufacturing sector have led to weaker demand for the gas, resulting in inventories that are currently near capacity and don’t show any signs of shrinking in the near future.
Verdict On UNL
Despite some potential shortcomings, UNG has long been the best way for many investors to gain exposure to natural gas prices (as evidenced by its tremendous popularity). Now UNL offers a new option, one that we expect will be fully embraced by those who are bullish on either short-term or long-term prospects for gas prices. It will take time to tell how UNL performs relative to UNG and spot natural gas prices, but we applaud the continued innovation in the space and look forward to analyzing the performance of natural gas options.
Explore UNL on ETFdb:
Disclosure: No positions at time of writing.