Natural gas prices rallied this week but an exchange traded note designed to track futures contracts actually ended the week with a steep loss.
Why are the exchange traded products diverging? The answer has to do with the premium to indicative value that has built up in GAZ. As we reported Monday, the natural gas ETN was trading at a premium of more than 100% to indicative value, setting investors up for potential losses unrelated to the movement of the commodity’s price. [GAZ Premium]
GAZ is trading at a premium because its share price is being determined by demand for the ETN, in addition to movement in natural gas futures. Barclays, the issuer for GAZ, suspended the creation of new shares in August 2009. At the time, the bank said the suspension was “temporary.”
On Friday afternoon, GAZ was trading at a premium of about 84% to indicative value
The ETN moved in the opposite direction of natural gas prices this week as some of its premium was unwound.
UNG, the ETF, has done a better job tracking natural gas futures this week.
The commodity’s rebound from a multiyear low has triggered speculation the brutal bear market for natural gas is nearing an end.
UNG has rallied about 20% from its recent low. [Natural Gas ETF Recovers]
Natural gas, unlike other energy commodities, is at a 20-year low because the commodity is hard to ship out to developing markets that need it, writes Kenneth D. Worth for Seeking Alpha. Consequently, prices rely on supply and demand dynamics within North America.
Over the past four years, natural gas prices have plunged from $14 per million British thermal units to under $2.
Worth predicts that with prices at their current levels, new hydraulic fracturing techniques, or “fracking,” in shale beds may become increasingly unsustainable. Prices may have to come back to $8 to $10 before fracking operations become profitable again.
Now, with natural gas prices at what appears to be a bottom, the only direction left is up, Worth notes.
UNG has been on a 97% losing streak over the past four years as contango ate away at the ETF. If the natural gas outlook is more positive, we might return to a favorable backwardated market, where the fund would roll to cheaper front-month contracts at a profit.
United States Natural Gas Fund
For more information on natural gas, visit our natural gas category.
Max Chen contributed to this article.