Should You Gas Up Your Portfolio

There are four (4) primary ways to invest in the natural gas space.  We will review all four methods and discuss the pro’s and con’s of each in an effort to provide you with a clear picture of your options in the event you decide to make such an investment.

Companies that operate in the natural gas space

When investing directly into companies within the natural gas space, you get a little more than you might bargain for if your looking to simply predict that the price of natural gas will rise, therefore the companies will rise in value by association.

Some of the companies to take note of are:

Devon Energy (DVN)

Chesapeake Energy (CHK)

Cimarex Energy (XEC)

Cabot Oil & Gas Corporation (COG)

EOG Resources (EOG)

EnCana Corporation (ECA)

These companies range between exploration, refining, transportation and pipeline providers.  Investing in these stocks will provide good liquidity and exposure to the the commodity.  On the other hand, they come with their own risks like buying any other stock.

The investor is subject to headline news directly related to the company, which may be positive or negative.  Another risk factor is being subjected to an adverse movement in the stock market due to forces unrelated to the commodity.

However, if the market is good and the price of natural gas rises at the same time, you may get a twofer.

Exchange Traded Funds & Exchange Traded Notes

Exchange traded products have been a catalyst that has enabled widespread investment opportunities within almost all commodities.  Natural gas is no exception.  Most of these investment and trading vehicles are misunderstood by the individual investor who is under the impression they are “less expensive” mutual funds.

While some ETFs double as mutual funds and provide wonderful investment exposure to many sectors of the market at a low cost, ETNs are another animal altogether.

For the most part, commodities are traded as futures contracts originally designed with agriculture and farmers in mind to allow them to purchase or sell their crops at a specified price rather than be subjected to the large seasonal price swings.  This practice enables them to run a more efficient predicable business.

In order to create a product that the individual investor could purchase easily through a traditional brokerage account, you must package those futures contracts into another investment – which makes it a derivative.

Two main risks associated with these Investments.

1.  Slippage

When the Exchange traded note is holding futures contracts that are approaching the predetermined expiration date, they must role those contracts to an outer month.  There are both expenses and fees associated to this process, which eat into your return.  So as time goes forward, the price of a commodity may rise, but your investment may not go up in proportion.

Case in point is the United States Oil Fund (USO).  As a test, look at how the price of oil has risen from early 2009 through 2012, and you’ll see that USO has significantly lagged the commodity.

2.  Issuer Risk

Another elusive fact about exchange traded notes is that your exposure is more than just the price of the security or commodity.  Enter one more dynamic.  Remember when Lehman Brothers went bankrupt?  Of course you do…..  Well, certain structured products similar to exchange traded notes were not able to be redeemed by investors, they lost their money.

These securities are subject to the viability of the issuer, or the brokerage firm creating the note.  It’s basically a direct obligation of the issuer, just like a bond.

Here is a list of the most popular natural gas exchange traded products.  I would encourage anyone thinking about using one of these vehicles to conduct your own due diligence.

United States Natural Gas Fund LP (UNG)

United States 12 Month Natural Gas Fund (UNL)

E-TRACS Natural Gas Futures Contango ETN (GASZ)

DJ-UBS Natural Gas Subindex Total Return ETN (GAZ)

Natural Gas Fund (NAGS)

Seasonal Natural Gas ETN (DCNG)

These are typically best suited for trading either intra day or limiting a hold time to no more than a few trading sessions.

Master Limited Partnerships (MLPs)

Many of the characteristics of MLPs are the same or similar to stocks, however there are some distinct differences that commands their own category.

The main differences are tax treatment and corporate structure that provides the high yields akin to real estate investment trusts or REITs.

These company’s are structured as partnerships as the name would suggest, and as a result they distribute both profits and principal back to the limited partners or investors on a regular basis.  At first, most people think the income is normal qualified dividends as is the case with most stocks, but these are more complex.

Without getting too technical, they make regular distributions, issue a tax form K-1 at the end of the year (which never comes with your other tax forms).  They should not be held in an Individual Retirement Account (IRA) because you don’t get the full tax benefit and may be unpleasantly surprised when the tax man comes knocking.

Some of the most popular MLPs in the natural gas space can be found in the short list below.  Keep in mind there are many of these to chose from, some of which have had wonderful performance for many years at a time.

Kinder Morgan Energy Partners LP (KMP)

Boardwalk Pipeline Partners, LP (BWP)

Enbridge Energy Partners LP (EEP)

Energy Transfer Partners LP (ETP)

Natural Resource Partners LP (NRP)

Buckeye Partners LP (BPL)

Futures Contracts

Not meant for the casual investor.  These trading vehicles were originally designed to hedge price movement of the underlying commodity and are complex in nature and allows the trader to fully leverage their capital beyond what traditional margin accounts allow.

The largest exchange for trading commodity futures contracts is the CME Group.

Other exchanges to make note of are:

London Metal Exchange (LME)

Intercontinental Exchange Inc. (ICE)

Multi Commodity Exchange (MCX)

There were previously additional exchanges, however the CME Group has merged or purchased several others which may give the appearance of limited competition.

Conclusion

Due to the volatility in many commodities including natural gas, there remains plenty of trading and investment opportunities to chose from.  Individual investors need to be cautious and recognize the risks associated.

The good news is we provide a simple systematic approach toward investing and trading that benefits our members.

At My Strategic Forecast, we let our subscribers know immediately when a potential profit opportunity presents itself.  We send trade alerts letting you know what to do, at what price to do it, and what our expectations are for the trade.  If you would like to try our service, we invite you to sign up for a 2-week free membership and take us for a test drive.  No risk, no contracts, no strings attached.

 

 

About the Author

Trading and investing in markets is second nature to some, but a mystery to others. The goal is to provide a forum where everyday people aspiring to be part time or full time traders will learn how view markets differently and profit beyond their wildest dreams.

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