What Is a Natural Gas ETF?

A natural gas exchange-traded fund (ETF) invests in natural gas futures contracts—or other investment products—in an effort to closely track the market price of natural gas. Natural gas ETFs are organized as commodity pools, which issue interests in limited partnerships as opposed to shares. These funds may also invest in heating oil, crude oil, and gasoline futures.

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An Introduction To Exchange-Traded Funds (ETFs)

Understanding Natural Gas ETFs

Investors in natural gas exchange-traded funds do not own the physical asset, gas. Rather, they own a set of futures contracts that track a commodity index, which fluctuates based on the underlying value of the commodity. ETFs that do not track commodities are generally comprised of multiple securities—like equities—that share a similar investment profile; the performance of these stocks drives the performance of the ETF. Unlike equity and other ETFs, natural gas ETFs reflect the price of a commodity instead of the performance of a group of stocks; this makes natural gas ETFs vulnerable to the price swings of natural gas, itself.

Know the Downside Risk Potential

Besides being susceptible to the underlying commodity's price volatility, these ETFs are riskier than others because they're comprised of derivatives, like futures and swaps, which are speculative. Of course, all investments come with a degree of risk; but by their very nature, derivatives are among the riskier investments, and this is especially true for futures-based commodity ETFs.

Futures Are Inherently Risky

Because they rely on futures, natural gas ETFs are susceptible to contango—a situation where the futures price of a commodity is higher than the spot price. Each month as the old contracts expire, futures roll into new contracts. The new contracts tend to have slightly higher prices than the old ones; so each roll costs the ETF a little bit more. Over time, these price hikes can add up to create a big drag on the fund's performance.

Because they're based on commodities and futures contracts, natural gas ETFs come with certain risks.

Dependent on the Weather

Weather also may affect the performance of natural gas ETFs. If the weather is warmer than usual, then natural gas prices can take a dive. In the U.S., natural gas is currently at its lowest price since May 2016 and likely would not turn around significantly until there is a forecast of bad weather, which can boost demand for the commodity. Recent warmer-than-usual autumns on the East Coast also have influenced demand for gas: East Coasters aren't using nearly as much gas to heat their homes, driving prices down further. Thus, the natural gas markets are extremely bearish because of oversupply.

Generally Not For Beginners

Natural gas ETFs did well when they first opened on the American Stock Exchange (AMEX); in recent years, however, they've had a bumpy ride. Because of their heightened risk factor, natural gas ETFs are not for all investors. Nonetheless, adding exposure to natural gas may make sense as part of a well-diversified investment strategy; having a more liquid way to access natural gas as both a speculative and hedging play can be a useful tool for both retail and institutional investors. For the individual investor, you may find a number of natural gas ETFs that you can use simply and safely.

Key Takeaways

  • Natural gas exchange-traded funds (ETFs) invest in natural gas futures and track the market price of natural gas.
  • These ETFs can experience performance volatility based on the underlying commodity's price swings.
  • Because natural gas ETFs come with some inherent risks, they're generally best for sophisticated investors.

Example of a Natural Gas ETF

One example of a widely traded natural gas ETF is the United States Natural Gas Fund, issued by the U.S. Commodity Fund. This fund is composed of natural gas futures contracts and swaps and trades on the New York Mercantile Exchange (NYMEX) as UNG. The NYMEX is tied to the Henry Hub spot price, which is the main United States benchmark for natural gas. The United States Natural Gas Fund is very sensitive to fluctuations in natural gas prices, so investors need to watch market prices closely to try to yield a profit. 

Top-7 2019 Natural Gas ETFs

For investors interested in natural gas ETFs, there are many funds to choose from. The table below lists, by assets, seven of the top natural gas ETFs for 2019.

Top-7 Nat Gas ETFs 2019
Carla Tardi / Investopedia.

Note: Data is as of the market close November 15, 2019. UGAZ, UNG, DGAZ, BOIL, KOLD, UNL, GAZ.