Why Natural Gas ETFs Are Soaring

November 20, 2018

Talk about a divergence. Just as crude oil has been making headlines for its eye-popping moves on the downside, another energy commodity has been in the news for its equally astonishing moves to the upside.

Prices for natural gas, the heating and cooling fuel, leapt 11% in just a single session on Monday, adding to a rally that’s sent prices nearly doubling from this year’s lows. ETFs tied to natural gas have been surging in tandem, awakening from a five-year slumber that’s caused nothing but pain and frustration for investors.

As of Nov. 19, the $693 million United States Natural Gas Fund (UNG), which tracks natural gas futures, was up 64.1% year-to-date, after having been in the red for the year as recently as September.

UGAZ Spiking, DGAZ Not

The leveraged VelocityShares 3X Long Natural Gas ETN (UGAZ), which is nearly as popular as its unleveraged competitor, with $604 million in assets, is now up 157% year-to-date, following a 60% surge in the past two trading sessions alone. UGAZ was down 25% on Sept. 14, before the rally began.

Meanwhile, anyone unfortunate enough to bet on falling natural gas prices via the $520 million VelocityShares 3X Inverse Natural Gas ETN (DGAZ) is in a world of hurt, because the product dropped by more than half in the past two days. The ETN is down 91% year-to-date.

These leveraged and inverse products are trading tools and not intended to be buy-and-hold investments.

 

Year-To-Date Returns

 

Highest Since 2014

Natural gas prices moving to just shy of $5/mmbtu puts it in territory not seen since 2014, when record-low temperatures enveloped the U.S. as a southward shift in the “polar vortex” unleashed frigid Arctic air into the country. During that winter, natural gas prices also doubled, peaking at $6.50, and inventories of the fuel tumbled to an 11-year low.

This year, a similar situation is playing out, as colder-than-normal temperatures push into much of the country, raising worries about the adequacy of storage levels.

Adding to jitters, natural gas inventories are peaking at their lowest point in 15 years heading into the winter withdrawal season. Back in the 2013/2014 winter, storage levels peaked at 3,834 billion cubic feet—close to the five-year average. This time, they are peaking at 3,247 bcf, 15.3% below those levels.
 

Inventories Peaking At Low Levels …

 

If a frigid winter leads to withdrawals from inventories equivalent to those during the 2013/2014 season, inventory levels would drop 3,010 bcf by April, to a critically low 237 bcf.

That probably won’t happen. The winter would have to be brutally cold (a possibility), but in that case, prices would likely rise high enough to impact demand negatively. That’s the bullish scenario that natural gas traders are envisioning and trying to get ahead of.

LNG Exports Increase

Along with cold weather and inventory levels, other factors may also be driving natural gas prices up. As analysts at Barclays point out, U.S. exports of liquefied natural gas (LNG) reached a record 4.7 bcf/d this month as new export terminals came online.

While expected, the sudden increase in exports added upside fuel to an already-nervous market. Technical levels were broken, causing shorts to frantically cover, dislodging natural gas futures prices from the fundamentals, the analysts said.

Even traders seem to agree that current prices aren’t necessarily reflective of the long-term outlook for the commodity. Prices for natural gas futures contracts dated May 2019—a month when winter will solidly be in the rearview mirror—only reached $2.80 at the same time front-month prices neared $5.

Equities of natural gas producers paint a similar picture. They actually declined as natural gas prices spiked. The $122 million First Trust Natural Gas ETF (FCG) is down 15.6% year-to-date.

What futures and equities suggest is that even as supply may be tight this winter, looking further out, natural gas remains abundant.

Soaring Production

That’s because production of natural gas in the U.S. continues to rise robustly.

In 2018, dry natural gas production is on track to surge more than 11% to a record 83.2 bcf/d, according to the Energy Information Administration. Growth could be similar or higher next year, especially if prices increase.

“Despite low storage levels, strong growth in U.S. natural gas production [will] put downward pressure on prices in 2019,” the EIA said.

Analysts at Barclays agree that “a downward correction [in prices] is likely, unless Mother Nature continues to play into the bulls’ hands.”

Investors in natural gas ETFs will have to weigh the strong natural gas production outlook against the potential for a near-term, winter-related price spike.

(See: ETF Of The Week: NatGas Volume On Fire)

Email Sumit Roy at [email protected] or follow him on Twitter sumitroy2

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