Will UNG Be the First Big ETF to Go Bust?

madhedgefundtrader's picture

The poster boy for everything that can go wrong with an ETF is undoubtedly the United States Natural Gas Fund (UNG). If you had studiously done all of your homework in September and concluded that natural gas was severely oversold and about to go up 40%, you would have been dead right. If you then went out and bought the UNG you would have then lost 40%. You would think at first glance that this is a chart for an inverse gas ETF that would only profit from falling gas prices. However,  such an instrument doesn’t exist.

This dreadful state of affairs was brought about by the intricacies of contango, where far month contracts in the futures markets are trading at premiums to the front month. As each month expired, the managers of UNG bought fantastically rich forward contracts, and then rode them all the way down to spot, as they were mandated to do by their prospectus. They then repeated this exercise every month.
If the contango continues indefinitely, the UNG will eventually approach zero. Moral of the story: don’t just punch in a symbol and hit enter. Read the damn prospectus first.

Since we are discussing CH4, I have to tell you that the outlook does not look great. We are just coming out of one of the worst winters in history, and NG only managed a rally from the $2.40/MCF low to six bucks and change. Gas in storage is about to rise again, and gas producers, like Chesapeake Energy (CHK), XTO Energy (XTO),  and Devon Energy (DVN), are racing to out-produce each other in the hope of offsetting falling prices with increased volumes. The price collapse is prompting a Darwinian consolidation of the entire industry. The spot price for NG has already backed off to $4.08. It’s sad to see such a great molecule fall on such hard times. Pitiful, really.

This is all happening thanks to the new miracle fracting technology, which has suddenly and unexpectedly been used to discover a 100 year supply of natural gas. The Marcellus shale in Pennsylvania, Ohio, New York, and West Virginia could power the entire East Coast for decades. The Haynesville shale in Louisiana, Texas, and Arkansas could knock oil out of the box for power generation in the South. Huge fields in North Dakota are yet to be fully developed. All this makes the construction of a gas pipeline from Alaska pointless, once a pet project of former governor Sarah Palin.

It seems that now only need poke a straw in their backyard to obtain a lifetime supply of clean burning energy. Gas majors are now jockeying to exploit untapped shale fields in Europe, with Poland leading the charge in deploying fracting technology. They must be sweating bullets in Qatar, which just invested $50 billion in facilities intended to export NG to the US and Europe. Looks like they’ll have to flare it instead.

The problem is that ETF’s have become a great money spinner for Wall Street, replacing earlier income generators, like CDO’s, that died in the crash. By the beginning of this year, some 836 ETF’s had been created worth $782 billion, generating massive management fees and trading commissions for the industry. The big question is, when one of these marquee ETF’s goes under, will it sour investors on the entire asset class? UNG has already cratered from $65 in July, 2008 to $7.68 today, a plunge of 88%, costing investors billions. Imagine how a leveraged ETF would have fared. Will this be the ETF that kills the goose that laid the golden egg?

To see the data, charts and photos that back up this story, as well as other iconoclastic and out of consensus analysis, you can always visit me at www.madhedgefundtrader.com , where the conventional wisdom is mercilessly flailed and tortured daily, or listen to me on Hedge Fund Radio at http://www.madhedgefundtrader.biz/ .

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-1Delta's picture

UNG only owns 23% of 2 front month contracts (could be an issue eh); thus, if contango stays high and NG continues to decline- the UNG fund could easily go bust. Please for all who thing Natty is Gasoline- find another webpage to share your ignorance....

fivethousandoverlibor's picture

All sources of media continue to fail when attempting to describe the rot that governs UNG.  This explanation is no different.  While it isn't incorrect, it goes 2 of the required 200 feet to fully understand what is wrong with UNG and every other ETF that employs long-only, prompt-only consumable-commodity futures strategies.

UNG carries prompt gas, perpetually, through time.  Carry and carry and carrying away.  While none of its activities are in the physical arena, the profit/loss profile of their strategy is identical to holding physical length for 30 days and then contracting to carry it for another 30 days.  Rinse and repeat. 

The contango spread between the prompt and second contract, often referred to as the "front switch", is the implied cost to carry gas for the 30 days between the two months.  This spread has been in contango 80% of the 5,000 or so trading days since NYMEX NG debuted in April 1990. 

So UNG (and any other long-only, prompt-only consumable-commodity futures fund) has two exposures.


Long Natural Gas


Short Natural Gas Storage

It’s the short natural gas storage that many in the beginning completely missed and that many now inaccurately describe with terms like “UNG bought fantastically rich forward contracts, and then rode them all the way down to spot”. 

UNG doesn’t have to buy “fantastically rich” forward contracts, Hyland can buy them cheap too and still have the very same problem.  In fact, the largest singular monthly problem that UNG ever suffered was taking their OCT gas 30 days forward into NOV last year, and “paying” $1.00 per MMBtu to do it.  On $3.20 gas (OCT avg price on their roll back in Sep), that’s a 31% carry cost – for 30 days.  They bought that OCT at around $3.75 a month earlier – a price near 7-yr lows at the time.  Fantastically rich is not a prerequisite for the pain of the Hyland Party Trick. 

Storage costs for UNG will always accumulate faster than the gas that UNG carries can appreciate over time. Why? Because natural gas prices oscillate about a marginal cost to produce and that marginal cost to produce does not advance ad infinitum. Things, like technology, interrupt advancing costs. Storage costs, on the other hand, will steadily accumulate throughout time with little interruption. As stated previously, the front-switch in NG has been in contango 80% of the days over the past 20 years.  This worsens to 87% and 94% for the past 10 and 5 years, respectively.  This renders UNG worthless and is expressly why no entity/fund/person in the futures market has ever deployed a perma-long, perma-prompt strategy prior to the advent of these ETFs.

Now, UNG never explicitly “pays” these “storage costs”, they simply lose gas each roll – they pay for the storage by taking less gas with them every 30 days.  But the exposure IS short storage, as that is what UNG is, a vehicle that carries gas for 30 day clips that will continue until the fund eventually “spends” all of its capital on NG storage. 


oldtimer23's picture

I have studied this a bit and concluded that the real problem is the roll.

In contango prices of natural gas are higher down the road, so yes UNG buys less and lessas it rolls, however, if constant, the value of the fund would be the same.An extreme example is if the spot contract was $5 and the second contract $10.  UNG may have $10 invested as it initially holds 2 contracts, but ends up with one after the roll.  The value is the same.  The problem is they are too large and everyone front runs the roll.  The price then drops back to $5 in this extreme example.  The only hope is the % of open interest steadily declines as well and the future roll will become less sensitive to the ETF.  This product is horrible.

House Atreides's picture

Thanks for your input here - this stuff is new to me, I read a lot but it helps when people explain in more detail.

Learning, always learning.

dcb's picture

I called I path about their gaz etn. it has a two month forward roll over and the foll over dates at between the 5th and 9th. I don' have UNG with me.


does anyone know a way around this issue to play natural gas.

AR15AU's picture

Thanks for this analysis... much appreciated.

Warren Laurde's picture

@MHFT: please note that like Thorny, I am around fracs all the time and have never heard of "fracting." It is called fracturing or fracking. You can read about it in my next post..."My lunch with Putin" :-)

dcb's picture

As usualy I consider your commentary a buy signal. it is falling below trend as we speak, when I joined in before at this "point" I made about 30% in   very short time. To me I see a small market the big boys are shorting like crazy to drive people out, and will then buy again. Kind of like when they drove oil down so much (what was the low again?).  LNG going to be a waste with the new supply.

Of course the fact that it is cheap and fairly low carbon intensive, and the fact that we have a nice supply not controled by the middle east does of course weigh on long term final demand, esp with peak oil, and the very high costs of drilling deep water. If we had Nat gas cars what would we be filling up with $ wise. We going to build lots of coal power stations to make up for demand, or if you are going to build one are you going to pick nat gas so you don't have to spend so much on pollution controls. Also don't for get the subsidies our bankrupt giovernment has to dole out to the coal industry. Of course that will go on forever.


So in a converse way the cheaper it gets, the better it gets?

House Atreides's picture

" I consider your commentary a buy signal.".


Agreed. If Time magazine comes out with a front cover about the end of natural gas I'm remortaging the house and going all in.

dcb's picture

up 0.79% from yesterdays close (GAZ) and this am open. Why is it that youy are always able to ID the end of a trend, but can't say when to short it or buy in.

Grand Supercycle's picture


Equities are ignoring the rallying dollar.

EURO has resumed it's downtrend.

Wait til the USD rally really gets going ...


Cookie's picture

Just another way to facillitate wealth distribution away from the middle class.

Anal rape, no less.

MrPalladium's picture

Looking at the MYMEX futures for NG, you will see that NG for April, 2011 costs $1.13 more than the $4.11 for the nearby April 2010 contract, or 27%.

This contango tells you two things:

First, above average storage figures are meaningless, given the 27% profit one can make buying at spot and storing for one year.

Second, producers are unwilling to hedge forward production at current spot prices.

In short, one faces the same 27% per annum melt whether one invests in UNG or the distant futures. The problem is in the contango, and not in the ETF. I notice that UNG is not an "HTB" stock, thus one can go long the futures and short UNG if one really believes that UNG will underperform the futures. Or, if one really believes the "oceans of cheap gas" story, one can simply short the 2011 contracts in a naked directional bet.

Best of luck!!

37FullHedge's picture

Something I must get around to looking into is the short side of ng, This is possibly where the money is, I dont know but lets say a short etf leases a long future contract and agrees to buy ng at a future date near spot price, I assume/guess this would be the case the contango will be very nice for the short side traders.

I will look into this area and I may trade short side if the contango helps the trade but I dont think I will ever go long ng, Its too much high risk for me unless backwardation creaps in.

Ragnarok's picture

I am amazed how we burned off all that record storage this brutal winter (NE and South, mild in the West). Just more evidence for all those global warming alarmists.


Global warming causes global cooling!

OR it could just be el nino/la nina, the 60 year cycle, solar activity also known throughout time as "Weather".



House Atreides's picture

"also known throughout time as "Weather"."


Thorny Xi's picture

Living in the area where shale gas fracking was refined into an art, I can assure you there's no "100 year supply" of gas because of this technology. When shale is fractured and sand injected to allow gas flow, it flows like crazy - for a few months. Decline in production over the first year averages 80%. 30 or more the second year. Gas still trapped in shale remains trapped in shale. Add to this the documented problems with groundwater pollution in this are due do fracking, now finally seeing EPA investigation after the Bush administration gave Halliburton an exemption from clean water rules and the fact that shale gas must cost $7 per MMCF to be profitable, and the present gas hype is ... just hype.

Dirtt's picture

Conclusive evidence that natural gas has hit a bottom. UNG? Whatever.


But the market itself has hit a bottom if this is his theme of the day.

Racer's picture

No doubt prices for consumers will continue to be pushed higher

Tense INDIAN's picture

can someone tell me why GAS prices have gone DOWN?????

House Atreides's picture

"can someone tell me why GAS prices have gone DOWN?????"

Hmmm. Not a simple answer. But here goes :

1. Over supply -  new sources of gas (so called game changer of shale gas. Don't know enough about this to separate fact from hype) 

2. Fear of oversupply.

3. Fear of capacity limits being breached for storage and dumping of gas onto the market at rock bottom prices (not so much right now but back in Sept it was a real fear. Right now storage is below same point last year but above 5 year average.

4. Lack of demand partic. from industrial use - recession etc.

5. Huge short positions probably by the larger investment banks (speculating here, not sure but I assume GS etc).

6. Exaggerated price movements via market manipulation ? and leveraged etfs both inverse and long.

6. Milder summer last year reducing domestic demand (colder winter helped drawdown on record storage)

7. UNG problem is a combination of the above but also the mechanism by which they roll over their contracts. Gas been in contango (where commodities for future delivery are priced higher then nearer month delivery) for most of the last 12 months, severely so for a lot of that time. To avoid taking physical delivery of gas UNG has so sell their contracts to the market and then replace with the next months contracts. If near month price is at $4.00 and future month is at $5.00 then you are not going to be able exchange for the same volume of contracts - in addition  UNG publishes rollover periods which was a red flag to the shortsters..... Basic trend was down over most of 2009 punctuated by these huge shortcovering rallies.

Probably another due soon but really hard to time - lucrative if the force is with you..... slow digestion in the stomach of the sarlacc if you get it wrong... Buying UNG as a trade, sure, buy and hold.. no fuckin' way.


Hope this explains some of the reasons for gas price dropping.


P.S. "You would think at first glance that this is a chart for an inverse gas ETF that would only profit from falling gas prices. However,  such an instrument doesn’t exist. "

Yeah. they conceal those on things called stock markets.


InsanePonziClown's picture

lot's of them have already died, ung will not be the first

ung, is almost 50-50 controlled by GS and fidelity, reading the prospectus does have some benefits, i imagine these guys break even on there shares and print coin taking the other side of those options, just a guess

the problem with alot of these etf's is what they are verses what they purport, as always buyer beware


Mr Lennon Hendrix's picture

You have the best name on the site...congratulations.

john_connor's picture

Interesting that my nat gas heating bill has gone up in spite of natural gas prices plummeting over the past couple years.