ETF/ETN Conundrum: Size Limits, Roll Dates, Future Trading (UNG, USO)

We have noted how CFTC inquiries and reviews into whether or not the size of certain speculative instruments in commodities markets, including ETF and ETN instruments, is likely to be regulated in the future.  This would potentially affect the United States Natural Gas (NYSE: UNG) and the United States Oil (NYSE: USO) immediately.  While the market has been able to front run the USO during the major price swings, the “UNG” has been accused by many as being a manipulator of the commodity prices of natural gas.

United States Natural Gas (NYSE: UNG) was listed on the site as being $4.47 billion and holds a mix of August Natural Gas Futures, September Natural Gas Futures, and cleared swaps.  Its seeks to track the price movement of natural gas using NYMEX and ICE trading in the front month.  This one has 347,400,000 units outstanding and it has an average daily volume of 35,100,700 units.  At $13.35 today, it is very close to the bottom of its $11.91 to $49.79 range over the last year.

One of our affiliates has just highlighted the long-side and short-side trading opportunities for the price of natural gas via the “UNG” ETN.  This audio/video not only shows how the price has behaved, but shows some trends of what to expect from here.  What is interesting in this analysis over considering coming changes, is that it strictly takes the technical issues into account.

United States Oil (NYSE: USO) was listed on the site as being $2.013 billion and currently holds a mix of September Crude futures on NYMEX and ICE.  This one has 64,000,000 units outstanding and has an average daily volume of about 13.7 million units.  Around $35.00, this compares to a 52-week range of $22.74 to $106.98.

There is a twofold issue here in regulating these instruments.  The first is of course how they can affect the price of the underlying commodity.  By our count, the UNG is more of a leading instrument on the price of natural gas.  And in the USO, oil traders have been able to tool that fund by essentially figuring out the order flow and applying the trades around the roll dates.  The second issue we have is that because these hold contracts rather than buy and sell physical product, these can act just like leveraged ETF products and could drift infinitely toward zero if prices became static or if the commodity prices drift lower and lower through time.

With the non-approval to list more shares for the United States Natural Gas (NYSE: UNG) over the last couple of weeks, it would be very interesting to see how this one is affected.  For a quick one-sentence prediction, our take is that both of these are ultimately likely to resemble closed-end funds.  Whether they have to change methods of strategies and holdings is one thing, but the second prediction is that these two are likely to be forced into being smaller closed-end funds than they are today.

If these issues become more concrete in energy ETF and ETN products, the same could be expected to occur in other commodity ETF and ETN products like metals and more.

JON C. OGG
JULY 21, 2009