NatGas Shortage Fuels ETFs

Huge price spikes for the resource in Europe ahead of winter are driving short returns.

An eye-popping spike in natural gas prices in Europe earlier this week has partially lifted oil producer ETFs and could be a foreshadowing of persistently higher prices for the commodity over the coming winter.

Why The Spike?

A combination of forces drove natural gas prices to new heights around the world this week. Contracts for November delivery in the U.K. jumped from $135.51 per 1,000 therms per day at the start of the month to a high of $293.91 on Monday, while prices at a Dutch gas hub that acts as a benchmark for much of Europe soared from $52 to $116 in the same time period.

Futures for December delivery deflated late Wednesday after Russian President Vladimir Putin pledged to shore up Europe’s supplies of gas through Ukraine, with contracts falling 8.3% and 6.3%, respectively, in the U.K. and the Dutch hub.

The roots of the shortage are traceable back to last winter.

Troy Vincent, a market analyst for commodities analytics firm DTN, said Russia’s production of natural gas was disrupted by COVID-19’s larger supply chain effects. That, combined with a particularly cold winter, left a relatively smaller amount of gas left in reserves across Europe.

“Even though [Russia is] working pretty hard to get production levels back up to the pace that would allow for both domestic inventories in Russia to be refilled, as well as to send more across Europe, that's just not being seen yet,” he said.

Natural gas is the primary backup in western Europe for power generation in the case that solar and wind generation can’t keep up with demand, as that part of the world is broadly phasing out coal and nuclear sources.

Shortages aren’t limited to Europe, either. The U.S. has almost 14% less natural gas in working storage compared to this point last year, and about 5% less than the five-year average, according to Thursday estimates from the U.S. Energy Information Administration.

Capital Discipline

The shortages aren’t as dire in the U.S. as they are abroad, but drilling and production haven’t been able to ramp up in line with demand over the year.

There’s a greater demand for capital discipline among investors across the hydrocarbon industry after the onset of the pandemic kneecapped oil prices and put over-leveraged firms in peril. Vincent also said the supermajor drillers are less willing to put additional capital toward new drilling projects because of the pressure from ESG investors.

That, combined with record-high exports of liquified natural gas abroad, has brought down the available supply of gas in the U.S., but natural gas prices are still around the same prices before shale drilling and fracking became widespread, Vincent said.

Natural Gas Futures ETFs

The top four commodity exchange-traded products over the past month and three months that follow natural gas:

Table courtesy of FactSet

The iPath Series B Bloomberg Natural Gas Subindex Total Return ETN (GAZ) is also streaking away in year-to-date performance from its broad-energy cousin, the iPath Series B Bloomberg Energy Subindex Total Return ETN (JJE).

The ProShares Ultra Bloomberg Natural Gas (BOIL) is also an option for investors willing to take on a leveraged exposure, with the critical caveat that investors need to check on the return of any leveraged or inverse holding daily.

Explorers & Oil’s Exposure

Investors can also get partial exposure to gas through natural gas explorers. The First Trust Natural Gas ETF (FCG) shares considerable overlap with oil producer ETFs like the SPDR S&P Oil & Gas Exploration & Production ETF (XOP) since oil and natural gas are often extracted in tandem.

However, FCG is outperforming XOP to the tune of more than 27% year-to-date thanks to the additional exposure to natural gas-heavy drillers.

Winter Is Coming

Vincent says while governments and exchanges are trying to tamp down volatility, the winter weather outlook will be the main driver of prices for natural gas and other carbon fuel sources. He also notes that oil stands to benefit if natural gas soars, as kerosene can act as a substitute in keeping buildings warm.

“If the weather is extremely cold and it pushes natural gas prices up even higher, we're going to see natural-gas-to-oil switching,” he said.

Contact Dan Mika at [email protected], and follow him on Twitter