In all the furor about potential inflation and the pricing pressure on energy, one amazing anomaly stands out — natural gas. In my view, it is an almost perfect fuel and energy source, yet it is getting cheaper and cheaper compared to oil. What’s up?
And, on top of that trend, there is the flameout in the biggest natural gas ETF — United States Natural Gas (UNG), which lost almost 60% last year and is now down big time so far in 2010 (see Natural gas ETF flames out and Fueling a losing bet). To get a sense of how bad it has been for UNG, look at this MarktWatch chart comparing it to the United States Oil ETF (USO):
Source: MarketWatch
The reddish orange line is USO and the blue line is UNG. As you can see, the past three years have seen a significant outperformance from USO compared to UNG.
There are several reasons why this ETF (UNG) has had such a lousy run compared to USO. Due to some internal issues, UNG did not issue new shares for quite a while last year. What with strong investor demand, that caused the existing shares to get priced upward until they sold at a premium to the fund's net asset value. When that shortage ended, the share price fell.
Another factor is that investors are increasingly pricing oil up higher and higher compared to an energy equivalent amount of natural gas.
This chart from Bespoke tracks changes in the oil to natural gas price ratio. In commodity investing, certain ratios between related commodities have some value, for example the gold / silver ratio or the oil / natural gas ratio. The ratio denotes the difference in price between roughly equivalent (in terms of energy) amounts of the two commodities. When the line is going up, it means oil is becoming more expensive compared to natural gas.
Source: Bespoke Investment Group
Though oil and natural gas are both energy forms, there are some differences that can account for the persistence of a substantial price difference, but this extreme difference is hard to figure out. It has happened before on occasion, but a ratio this large is rare.
A hellish year for UNG
It has been a hellish year for natural gas investors and, in particular, for UNG investors. By all accounts, natural gas would appear to be very cheap relative to oil. Also, UNG seems way overdue for a comeback. I’m tempted to buy a little, but, so far, have not done so. If there are any fans of UNG out there, I’d like to hear from you.
Update: My colleague Chris Eagles-Smith reminded me that Exxon is also of the mind that natural gas may be cheap as it just completed its purchase (for over $28 billion) of XTO Energy.
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Kurt Brouwer is a fee-only financial advisor with three decades of experience. He is the chairman and co-founder of Brouwer & Janachowski, LLC. Kurt has written books, articles and hundreds of blog posts on mutual funds, ETFs and other investment topics. E-mail: kurt.brouwer *at* gmail.com.
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