What it means
Investors cannot easily buy and store physical natural gas, so these funds buy futures contracts (agreements to buy gas at a set price on a future date). The fund's share price then moves broadly with the prices of those contracts.
A few funds instead hold shares in gas producers, which behave differently because company profits, debt and management also matter. Futures contracts expire, so a futures-based fund must keep selling the contract that is about to expire and buying the next one.
This is called rolling. If later contracts cost more than the near one, a market condition called contango, each roll locks in a small loss even when the spot price (today's price for immediate delivery) has not moved.
The reverse condition, backwardation, occurs when later contracts are cheaper than near ones. Rolling then produces a small gain.
For gas, the shape of the futures curve is strongly seasonal because winter heating demand lifts prices for the cold months. For a finance or business reader, these funds matter in two ways.
Treasurers and founders of gas-exposed businesses sometimes see them as a quick way to gain or offset price exposure. Analysts also watch fund flows as a rough sign of how speculators feel about the market.
The main nuance is holding period. Because of roll costs, daily price tracking can be good while long-term results diverge sharply from the gas price, so many of these products are designed for short-term trading, not for buy-and-hold investing.
Costs and structure also deserve a look before buying. Management fees are usually modest, but they are paid on top of roll costs and the bid-offer spread (the gap between buying and selling prices) when you trade.
A small investor should compare the fund's published holdings and its recent tracking record against the gas price, not only its stated objective.
In practice
Real-world examples.
Example
A small business owner with a heating-fuel distribution firm buys shares in a gas ETF to partly offset the risk that rising gas prices will squeeze her margins before she can raise customer prices.
Example
A retail trader buys a gas ETF in October expecting a cold winter. The spot price does rise, but the fund lags because it spent weeks rolling into more expensive contracts.
Example
A corporate treasurer at a fertiliser manufacturer, where gas is the main input cost, reviews an ETF as a hedge but decides that its tracking error and roll costs make a direct futures hedge or a supplier contract more suitable.
Formula
Calculation
Roll cost per contract = (Next-month price - Front-month price) x Contract size
A standard exchange gas futures contract covers 10,000 million British thermal units (MMBtu, the unit gas is priced in).
Worked example: a fund holds 100 contracts. The front-month contract trades at $3.00 per MMBtu and the next month at $3.12.
Price gap = $3.12 - $3.00 = $0.12 per MMBtu
Roll cost per contract = $0.12 x 10,000 = $1,200
Total for 100 contracts = $1,200 x 100 = $120,000
If the spot price stays at $3.00, the $3.12 contract is expected to drift down towards $3.00 as it nears expiry, so the fund absorbs the $120,000 loss. Relative to the value of the front contracts, which is $3.00 x 10,000 x 100 = $3,000,000, that is a 4% drag from one roll.Case study
Seen in the real world.
Brightfield Packaging is an illustrative, fictional manufacturer that spends heavily on gas for its ovens. Its finance manager wanted a cheap way to protect against a price spike and bought $200,000 of a futures-based gas ETF in autumn.
Over the next six months the spot price rose modestly, but the ETF finished almost flat because the futures curve stayed in contango and each monthly roll cost the fund a few per cent. The company's gas bill rose while the hedge barely helped.
In this fictional story the manager concluded that an ETF is a trading instrument, not a precise hedge. The following year Brightfield negotiated a fixed-price supply contract instead.
Watch out
Common mistakes.
- Assuming a gas ETF will track the spot price over months or years, when roll costs can cause large long-term divergence.
- Treating a gas ETF as a safe long-term holding because gas is a basic commodity, ignoring the sharp seasonal swings.
- Using the fund as a precise business hedge, when its contract maturities will rarely match the company's actual purchase dates.
Questions
People also ask.
Does a natural gas ETF own physical gas?
Usually not, because most hold futures contracts, and a few hold shares of gas producers instead.
Why can the fund lose money when gas prices rise?
Contango roll costs, fees and the timing of contract changes can outweigh a modest rise in the spot price.
Are leveraged gas ETFs different?
Yes, they aim to deliver a multiple of the daily move, and compounding makes their long-term results hard to predict, so they suit only short-term trading.
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