Natural Gas ETFs Heat Up as Market Moves into Backwardation

ETF Trends

Natural gas exchange traded funds are firing up as increased electricity usage to combat the scorching heatwave across the U.S. has pushed the natural gas futures market into backwardation.

The United States Natural Gas Fund (UNG) rose 10.8% over the last week and jumped 40.4% over the past three months.

On July 9, natural gas futures moved into a backwardated market for the first time in 10 months, reports Naureen S. Malik for Bloomberg.

Natural gas is in its third week of backwardation, with investors netting 4.6% annualized from rolling front-month natural gas, reports Sumit Roy for IndexUniverse.

Backwardation occurs in a market when futures contracts with a later expiration date are cheaper than the front month futures contracts set to expire.

Investors typically roll futures contracts, or sell a contract that is about to mature to avoid physical delivery of the actual commodity and buy the next month’s future contract to remain exposed to the commodity. Natural gas ETFs hold a basket of futures contracts and stand to profit when they roll higher priced contracts that are about to mature for cheaper later dated contracts.

Nearby futures contracts have gained 12% over the last five trading sessions, their largest five-day jump in a month, reports Joe Silha for Reuters.

Front month August prices were rising above the next month’s contracts as Americans let their air conditioners run to keep cool during the heat. According to the National Climactic Data Center, the first six months of 2012 were the warmest start of any year since 1895. [Natural Gas ETF May Heat Up with Weather]

“We have enough heat and enough current power utility demand for natural gas to boost the cash and the nearby futures to a premium,” Tim Evans, an energy analyst at Citi Futures Perspective, said in the Bloomberg article. Backwardation “doesn’t mean that we are running out of gas or that there’s real physical tightness as we still have a record inventory for the date.”

The Energy Information Administration reports total gas inventories for the week ended July 13 was at 3.163 trillion cubic feet, or 77% full and a level not typically seen until mid-September. Additionally, there is still 500 billion cubic feet more gas in the inventory year-over-year.

Natural gas ETFs that hold a basket of futures contracts with varying expiry dates have not captured the front month backwardation. For instance, the United States 12 Month Natural Gas Fund (UNL) rose 3.6% and Teucrium Natural Gas ETF (NAGS) was 4.6% higher over the past week.

UNG, on the other hand, rolls the near-month contract on a monthly basis, which helped it capitalize on the backwardated market. It should be noted that potential investors should keep an eye out for contango moving back into the futures market.

“When the prices of those back-month contracts exceed the price of the front-month contract (known as a state of “contango”), the fund loses money each time it rolls its position,” according to Morningstar analyst Abraham Bailin. “In contangoed markets, a fund like UNG can suffer heavy losses even as natural gas prices rise.”

United States Natural Gas Fund

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Max Chen contributed to this article.

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