US Natural Gas ETF Discloses Strategy Changes & Risks (UNG)

The United States Natural Gas (NYSE: UNG) is disclosing some current and future changes to its investment vehicle strategy in its attempt to manage its size and to track the price moves of natural gas.  While the aim and goal of the ETF is to still trade around the price moves of natural gas, the managers are adopting additional investments so that the fund can more easily attempt to track the price moves of natural gas.  As the fund became such a large portion of the natural gas futures market, it is deemed one of the key targets from the CFTC over all the limits in size and dominance over speculation in the energy commodities markets.  While this was easy to expect, this can create higher risks and many ETF investors in this vehicle may have a hard time grasping what the fund they are investing in is really doing on a day to day basis.

As it may issue more new shares again, it is looking elsewhere outside of merely trading natural gas futures contracts.  An SEC filing this morning disclosed that it has invested “primarily in futures contracts for natural gas, crude oil, heating oil, gasoline, and other petroleum-based fuels.”    The ETF expects these to remain the primary vehicles, but listed how other trading vehicles may be used:

• cash-settled options on Futures Contracts,
• forward contracts for natural gas,
• cleared swap contracts,
• and over-the-counter transactions that are based on the price of natural gas, crude oil and other petroleum-based fuels, Futures Contracts and indices.

This is to comply with accountability levels and position limits. Because of new rules and restrictions on positions, the fund noted that the accountability levels and position limits applicable to the Futures Contracts it invests in are anticipated to change.

UNG’s management said that it has determined that UNG may need “to invest a larger portion, or potentially all, of its investments in Other Natural Gas-Related Investments in order to continue to meet its investment objective and comply with these regulatory changes.” The UNG has already entered into cleared natural gas swap contracts and into natural gas-based over-the-counter swap agreements to mitigate some risks.  This does create larger risk and could subject the UNG to payment of fees that exceed the amounts it currently pays in connection with its direct investments in futures Contracts. In short, there is an increased tracking error risk.

We were one of the first who cover ETF and ETN vehicles that noted how many of these similar exchange traded products could ultimately begin trading as if they were closed-end funds or smaller trusts that can trade at premiums or discounts to their net asset values.  Based upon what we have seen so far, we only expect more and more issues like this to arise in this time of higher regulation.

JON C. OGG
OCTOBER 13, 2009