Friday, August 28, 2009

TIME Explains Gas Prices and UNG

TIME Magazine has taken a crack at explaining what's going on with natural gas prices.  The article explains the big picture fairly well and focuses on the U.S. Natural Gas Fund, an exchange traded fund (ticker: UNG) that is being blamed, at least in part, for keeping gas prices down.

UNG is a way for individual investors to buy exposure to natural gas prices.  Sounds like a great idea.  To accomplish this goal, the fund has to buy natural gas or a related financial instrument to be able to track the price of natural gas.  In this case, the fund buys futures and swap contracts on natural gas in the near month. But because of a recent flood of investors seeking to take advantage of the expected increase in gas prices, the fund has gotten too big to work properly.  (It might also run afoul of certain trading restrictions that are being considered by the government, although that is not addressed in the article).

UNG has been under pressure all summer.  The fund applied to the government to be able to issue new shares because it had used its allotment with the flood of new investors, but after receiving permission it decided to hold off on issuing new shares until it can work out other mechanical problems.  As a result of its problems, the fund no longer accurately tracks natural gas and trades at a 16.5% premium to its net asset value.  It also still owns half of the action in the gas futures market, and because its month-end trades where it has to roll into the next batch of contracts are no secret, independent traders swarm like roaches to make their own arbitrage trades to take advantage of UNG (I call them "roaches" with some admiration).

The article doesn't cover all of the woes of the fund, but it does give a pretty good overview of the jam in which the fund finds itself.  Much has been said about the UNG situation over the past few months, but I thought the TIME article was one of the few that was not burdened by excessive finance-speak.

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