What it means
Natural gas is a heating and power fuel with a price that can move sharply with weather, storage levels and supply. Most investors do not want to store physical gas, so they use funds.
UNG is a commodity pool that invests mainly in near-month futures contracts for natural gas, and its shares trade on a stock exchange like a share. Futures are agreements to buy gas at a set price on a future date.
Because they expire, the fund must regularly sell the contract that is about to expire and buy a later one, a step called rolling. Each roll has a cost or benefit depending on the shape of the futures curve.
When later contracts are more expensive than the current one, the market is in contango. The fund sells low and buys higher, so the roll costs money, and that cost can eat into returns even if the spot price of gas is unchanged.
When later contracts are cheaper, called backwardation, rolling adds to returns. This is why holding UNG is not the same as owning gas.
Over long periods, funds that roll futures in contango can lose value while the spot price goes sideways. Investors who treat it as a long-term holding are often surprised, and the fund's materials warn that it is designed mainly for short-term use.
It also carries management fees, trading costs and the tax treatment of a commodity pool, which can differ from ordinary funds. Anyone considering it should read the fund's prospectus and consult a qualified adviser, as this entry is general education and not advice.
Businesses with gas exposure, such as utilities and manufacturers, usually hedge with futures or contracts directly. They sometimes watch UNG as a visible indicator of market sentiment.
In practice
Real-world examples.
Example
A trader expects a cold winter and buys UNG shares for $20,000 to profit from rising gas prices. Prices do rise, but the fund's return lags the spot price because of the cost of rolling futures.
Example
An investor holds UNG for two years as a long-term inflation hedge. Spot natural gas ends roughly where it started, but the fund's value falls significantly because of repeated roll costs in contango.
Example
A utility's treasurer follows UNG's price as a quick sentiment gauge but uses futures contracts and physical supply agreements to lock in actual fuel costs.
Formula
Calculation
Roll cost percentage = (Next-month futures price - Near-month futures price) / Near-month futures price
Suppose near-month natural gas futures trade at $3.00 per unit and the next month trades at $3.15.
Roll cost = ($3.15 - $3.00) / $3.00 = $0.15 / $3.00 = 5%
If the fund holds $10,000,000 of near-month contracts, rolling them into the next month costs about $10,000,000 x 5% = $500,000, assuming the curve does not change.
If this contango persisted for 12 monthly rolls at 5% each, the cost compounds to about 1.05 multiplied by itself 12 times, which is roughly 1.80. The fund would then be worth about 1 / 1.80 = 0.56 of its starting value against a flat spot price, a loss of around 44% before fees. The exact result depends on how the curve moves each month.Case study
Seen in the real world.
Meadowlark Capital is an illustrative, fictional investment club whose members bought a natural gas fund after reading that gas prices were at a low. They put $50,000 into the fund and planned to hold for several years.
Over the following 18 months, the spot price recovered modestly, but the futures curve remained in contango, and the club's holding fell by about 30%. A member who had checked the fund's documents noticed that roll costs and fees explained most of the loss.
The club moved to a shorter holding approach and set a stop-loss rule. The illustrative story shows why a futures-based fund should be understood before it is used, and why it is not a substitute for owning the physical commodity.
Watch out
Common mistakes.
- Assuming UNG will always track the spot price of natural gas.
- Holding a futures-based commodity fund for years without understanding contango and roll costs.
- Treating UNG as a stable income or inflation hedge, when it can be highly volatile.
Questions
People also ask.
What does UNG stand for?
It is the ticker of the United States Natural Gas Fund, an exchange-traded fund that holds natural gas futures.
Why can UNG lose money when gas prices are flat?
Because rolling futures in contango means selling cheaper expiring contracts and buying more expensive later ones, a steady drag on returns.
Is UNG suitable for long-term investing?
Most commentary, including the fund's own warnings, treats it as a short-term trading tool, and any decision should be made with professional advice.
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