With all of the focus on the price of oil over the last few months the gyrations in the price of the other product from fracking, natural gas, have often been overlooked. It has, however, been a wild ride. The increased supply in the commodity combined with the inability to export and a warm start to the winter season caused U.S. natural gas to collapse even more spectacularly than oil, but it seems we may finally have found a bottom. If that is the case it is worth looking at how traders can play that story.
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From a high of 6.49 in February of 2014, natural gas futures lost close to 75 percent, dropping to 1.68 in December of last year, and then bounced to start this year around 2.50. Despite colder weather, however, over supply has remained the focus of the market, and gas futures have dropped back to below $2 this week.
At these levels, many may be tempted to initiate a long term trade that involves some kind of a bet on higher natural gas prices in the future. In many ways, though, that is not as easy as it sounds. Playing futures is one option, but the leverage involved makes that difficult to do in a trading account for any length of time. The margin requirement would seriously dent your available liquidity for other trades and the need to roll over contracts makes it less than ideal for the longer term. To some extent that can be mitigated by using the EMini Natural Gas contract (QG) that requires less margin, but the rollover factor still applies.
Natural gas is, like oil, in contango right now, meaning that contracts dated further out are more expensive, which makes leveraged ETFs such as UGAZ that constantly roll over contracts more suitable for short term trading. That said, though, I still like to use UGAZ for trades expected to last a few days or even a week or two. It still offers leverage, but ties up less of your account than a futures trade. A non-leveraged fund, such as UNG is better suited to long term trades, but even there contango and management fees eat away at returns as time goes by.
Under normal circumstances the best way to bet on a long term recovery in the price of a commodity is to buy stock in one or more producers. These, however, are not normal circumstances. The kind of boom and bust pricing that we have seen over the last few years has left many firms facing crippling debt service payments amid sustained low prices. When one of the biggest U.S. producers of natural gas, Chesapeake Energy (CHK) feels the need to issue a statement denying that they are filing for bankruptcy, as they did this week, then you know there is a problem. That introduces a risk of total loss to a stock trade, something that traders avoid like the plague. From a stock perspective, the big producers of natural gas who are equipped to withstand this kind of market are also not an ideal way to play long term appreciation in the commodity price. The large firms all have significant oil exposure too and are more likely to react to fluctuations in that market than to what happens to gas.
There is, then, no perfect way for retail traders to play a longer term view that natural gas prices will recover. The best approach would be a combination of things. A small EMini futures position and a broad based ETF of natural gas producers such as the First Trust ISE Revere Natural Gas Fund (UNG) is probably the best answer, giving direct and indirect exposure to prices, while spreading the risk amongst the producers.