How to invest in natural gas – Several tips!

Introduction

Natural gas is the third most-used energy source globally after oil and coal, and its consumption is expected to surpass coal by 2030. Domestic consumers use it in homes for cooking and heating purposes, whereas it is used in industries for the generation of electricity, production of chemicals and fertilizers, and as a fuel to power big industrial machines.   

Natural gas for cooking

The United States, Russia, Qatar, Iran, China, Canada, and Norway are among the world’s largest producers and exporters of natural gas. Natural gas is exported through pipelines in gaseous form. However, for exporting natural gas to longer distances where pipeline construction is not feasible or practical, it is converted into Liquid form (Liquified Natural Gas or LNG) by cooling it to around minus 160°C and transported through tankers in refrigerated cryogenic tanks. The liquified natural gas is then regasified or reconverted into gaseous form when it reaches its destination.

Participants in the natural gas market

The common participants in the natural gas market include producers, suppliers, traders, suppliers, speculators, distribution and transmission companies, and pipeline companies. All of the market participants play their roles due to which the market functions. 

Natural gas trading hubs

The natural gas trading hubs are located in those areas where there are gas pipelines networks, storage facilities, liquified natural gas terminals and infrastructure. The hubs act as pricing points for the natural gas available in the network and as a benchmark for the financial derivative contracts, such as futures contracts and options. 

Henry Hub, located in the U.S state of Louisiana, is the world’s largest natural gas trading hub. The Henry Hub Natural Gas Futures on the CME Globex exchange are delivered at the Henry Hub, and the prices at the hub serve as a benchmark for pricing other U.S natural gas futures and the LNG (Liquified Natural Gas). It has a vast network of pipelines that expands into Mexico and Canada.

Britain’s National Balancing Point (NBP) and the Dutch Title Transfer Facility (TTF) are the two main natural gas hubs in Europe. The futures contracts for physical delivery through the transfer of rights in respect of Natural Gas at the NBP and TTF Virtual Trading Point are available on the Intercontinental Exchange (ICE). Futures contracts for physical delivery of natural gas at the two hubs are also listed on the CME Globex exchange. 

How To Invest in Natural Gas?

Here is how you as a retail investor can invest in natural gas:

Natural Gas Futures Contracts

Natural gas futures contracts allow you to buy or sell natural gas at a predetermined price on a specified future date. The contracts are standardized and are traded on a futures exchange. The natural gas futures contracts typically have the following specifications:

Name of Futures Contract Contract Unit Price Quotation Exchange Settlement Method
Henry Hub Natural Gas 10,000 MMBtu U.S. dollars and cents per MMBtu CME Globex Deliverable
Dutch TTF Natural Gas 672-745 MWh Euro and cents per MWh CME Globex Deliverable
UK NBP Natural Gas  1,000 therms x number of days in the contract month British pence per therm CME Globex Deliverable
UK NBP Natural Gas  1,000 therms of natural gas per day Sterling and pence per therm Intercontinental Exchange (ICE) Deliverable
Dutch TTF Gas 1 MW Euros and Euro cents per MWh Intercontinental Exchange (ICE) Deliverable

Futures contracts are leveraged financial instruments, which means that you don’t need to have the full amount in your account to buy or sell a futures contract. You only have to meet the initial margin requirement to initiate the contract, which is usually a fraction of the contract’s total value. 

Although the future contracts we mentioned above involve the physical delivery of natural gas, you can choose not to take delivery or deliver the product physically to the buyer if you close your open positions before the expiry. Retail traders and speculators mostly are not interested in taking the physical delivery of natural gas, so the logical way to trade the futures is to close the open positions before contract expiry. 

Natural Gas Options on Futures

Natural gas options are contracts that give you an option but not an obligation to buy or sell natural gas at a predetermined price on or before a specific date, the contract expiration date. In  futures contracts, you have the obligation to either buy or sell the physical commodity or financial instrument on the contract expiration date if you keep your position open. In contrast, with natural gas options on futures, you only have to buy or sell the futures contract on the option expiration date if you do exercise the option. 

Option contracts have two types: Call Options and Put Options. A Put Option gives the purchaser of the contract an option, but not the obligation, to sell the underlying asset at a predetermined price on or before the contract expiration date. In contrast, a Call Option allows the option buyer to purchase the underlying asset or security at a specified price (strike price) on or before the option expiration date. Buying an option contract also involves a fee called premium. 

Option contracts are commonly used by corporations to hedge against unfavorable price movements in the underlying asset. For example, a company selling natural gas can buy a Put option which would give it an option, but not an obligation, to sell natural gas at the specified strike price. If natural gas prices increase, the company loses only the premium or fee paid to buy the Put option. But if natural gas prices decrease, the company could choose to exercise the option and benefit from rising prices. 

Natural Gas Mutual Funds

You can get exposure to natural gas by investing in energy mutual funds. While there might not be a purely natural gas mutual fund, there are plenty of them that hold stocks of energy companies that deal in natural gas. You can consider investing in the following popular equity energy mutual funds:

1- Fidelity Advisor Energy Fund (FANAX)

2- Hennessy BP Energy Transition Fund (HNRGX)

3- Invesco Energy Fund (IENAX)

4- Delaware Ivy Energy Fund (IEYAX)

5- Fidelity Select Energy Portfolio (FSENX)

6- Cavanal Hill World Energy Fund (AAWEX)

7- Vanguard Energy Fund (VGENX)

8- Rydex Energy Services Fund (RYESX)

The main advantage of investing in mutual funds over ETFs and other investment vehicles is that most of these funds are actively managed, and the fund managers continuously update their holdings based on the market dynamics to earn above-market returns. Although actively managed funds are costlier than passively managed funds or some ETFs, you need to evaluate the fund’s previous returns to determine whether the premium management fee is worth your investment? 

There are plenty of other energy equity mutual funds with varying degrees of allocations to energy companies. You can use a mutual fund screener to select a mutual fund that has a low expense ratio, higher allocation to natural gas companies, and a higher historical alpha.  

Natural Gas CFDs

Natural gas CFDs or Contracts For Differences are derivatives contracts that allow you to invest in natural gas without taking physical delivery of natural gas. CFD contracts track and move according to the prices of the underlying asset. 

The CFDs are cash-settled, which means that the difference between the opening and closing prices of the contract is paid in cash and physical delivery of the underlying asset is not required. For example, if you bought a natural CFD worth $100,000 and its market price declines by $1,000, the difference of $1,000 has to be settled in cash at the end of each trading day. In other words, your account balance would be reduced by $1,000, the decline in the market value of the contract. 

Like futures contracts, CFDs also involve leverage, which makes them highly risky. Leverage is a double-edged sword with a potential to magnify your profits as well as losses. It is necessary that you implement risk mitigation strategies, such as putting stop loss, optimal contract size, and other tactics to reduce your downside risk. 

Stocks of Natural Gas Companies

Natural gas processing plant
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There are hundreds of companies that deal in natural gas, so you can get exposure to natural gas if you buy their stocks. You might not find a company that deals only in natural gas, but you can find plenty of energy companies that are involved in exploration and production of crude oil, natural gas, and other energy products. 

Famous oil and gas companies are mostly cash-rich and are known for providing their shareholders with consistent, healthy, and growing dividends. Also, their stocks usually correlate with the prices of oil and natural gas prices. Investors who want to take long term positions in natural gas, oil, or other energy products can consider investing in stocks of oil and gas companies. 

Here is a list of the top 10 natural gas companies whose stocks you can buy:

1- Exxon Mobil (NYSE: XOM)

2- Devon Energy (NYSE: DVN)

3- Chesapeake Energy (NASDAQ: CHK)

4- Anadarko Petroleum (NYSE: APC)

5- ConocoPhillips (NYSE: COP)

6- BP (NYSE: BP)

7- Ovintiv Inc. (NYSE: OVV)

8- Chevron Corporation (NYSE: CVX)

9- Southwestern Energy Co. (NYSE: SWN)

10- The Williams Companies (NYSE: WMB)

You can use a stock screener to find many other oil and natural gas companies that suit your investment style and strategy. Alternatively, you can read financial newspapers, financial reports, and analysts’ recommendations to find the best stocks for investment. 

Natural Gas ETFs

An Exchange-Traded Fund (ETF) is a financial security that trades on a stock exchange like a stock and holds a collection of securities, such as stocks, bonds, commodities, currencies, and other financial assets. Similarly, natural gas ETFs comprise natural gas stocks and natural gas futures contracts, depending on the type of ETF. When you buy a natural gas ETF, you get exposure to the underlying asset, natural gas. 

Here are some of the popular natural gas ETFs available on the market:

1- United States Natural Gas Fund LP (UNG)

2- United States 12 Month Natural Gas Fund LP (UNL

3- ProShares UltraShort Bloomberg Natural Gas (KOLD)

4- iPath Series B Bloomberg Natural Gas Subindex Total Return ETN (GAZ)

5- ProShares Ultra Bloomberg Natural Gas (BOIL)

You can use an ETF screener tool to find natural gas or energy ETFs. The tool allows you to screen various ETFs based on your defined criteria, such as asset class, issuer, returns, holdings, and others. 

Investing in natural gas can give you the benefit of diversification because when you buy a natural gas ETF, you invest in a basket of natural gas stocks or natural gas futures or both. If you want to invest in natural gas for the long term, investing in a natural gas ETF is perhaps the best option. It is a cost-effective way of investing in a wide range of stocks as investing in different stocks individually is costly and time-taking. Although ETFs do not give you direct exposure to natural gas, they are comparatively less risky compared to the natural gas futures contracts.

What Moves the Prices of Natural Gas?

To invest in natural gas successfully, you need to understand the factors that drive the prices of natural gas. The following factors usually influence natural gas prices:

1- Natural gas production or supply

Natural gas is difficult to extract from underground resources, and it requires a large infrastructure and pipeline network to increase natural gas supplies. But when the production increases by a higher degree than the demand, the prices usually fall. The reverse is also true: When natural gas production falls due to any reason, the prices rise. 

2- Changes in demand

During winters the demand for natural gas rises as more households use it for heating their homes. In contrast, during summers, the demand for natural gas declines. If the natural gas supply is unable to match the demand and results in a supply shortfall, the prices of natural gas rise in such a situation. However, when the weather gets hotter, there is a supply glut, which results in a decline in prices. 

3- Economic growth

During times of economic growth, the consumption of natural growth rises due to the high demand for natural gas from the industrial and commercial sectors. So, high economic growth can potentially increase natural gas prices. On the contrary, natural gas prices usually decline when the industrial output decreases due to a slowdown in economic growth. 

4- Storage facilities

Underground natural gas storage facilities enable producers or gas companies to store the excess supply of gas to stabilize prices during times of low demand. Also, during times of high demand, the shortfall in supplies could be met from these underground storages, which again helps in stabilizing the prices. High-capacity storage facilities can lessen the impact of supply and demand shocks, whereas low-capacity storage facilities can struggle to moderate the impact of supply and demand shocks. 

5- Substitute fuels

Coal, petroleum, and electricity serve as substitute fuels for natural gas. When the natural gas prices increase, the owners of industrial or manufacturing units shift to other energy fuels to power their machines for production and manufacturing purposes. Other things equal, higher natural gas prices are not sustainable because of the fair number of substitutes available on the market. However, if the prices of substitutes are higher than natural gas, the demand for natural gas rises as it, too, can serve as a substitute for coal, petroleum, and electricity. 

Risks & Rewards for Investing In Natural Gas

Like any other investment, investing in natural gas has its own risks and rewards. Let’s discuss them briefly:

Advantages

  • Investing in natural gas can diversify your portfolio as you get exposure to one of the most-used commodities of the energy market. 
  • The demand for natural gas is expected to rise and its consumption is expected to surpass coal by 2030. The increased demand could push the prices of natural gas higher in the future and benefit the investors.
  • Stocks of big oil and gas companies can provide investors with healthy dividends.
  • Natural gas CFDs and futures contracts are leveraged products, which means that you can open large contracts of natural gas by having just a fraction of the contract value in your account. 
  • You don’t need to take or deliver physical natural gas, and still invest in natural gas futures or other derivative financial instruments. 
  • Natural gas provides a hedge against inflation and a weak dollar. A weak dollar gives rise to inflation, which, in turn, could increase natural gas prices due to its limited supply. So, natural gas prices could overcome inflationary pressures. 

Risks

  • Natural gas future contracts are leveraged products, and a small price movement against you can inflict significant losses on you.
  • If you don’t close your position before the expiration of a future contract, you’ll have to take or deliver the physical commodity, depending on whether you were long or short on the contract.
  • Lower costs of clean and greener fuels can lower the demand for natural gas as economies could substitute green and renewable fuels for natural gas.

Conclusion

Financial markets have made great progress over the years. Now, even retail investors can invest in different kinds of assets electronically without on the go or from their homes with just a few taps on their smartphones. You can invest directly in natural gas by buying commodity futures contracts if you hold the contract until the expiry of the contract. 

The other methods of investing in natural gas indirectly are options on natural gas futures, options, natural gas ETFs, natural gas mutual funds, natural gas CFDs, and stocks of natural gas or energy companies. 

Like any other investments, investing in natural gas involves investment risk, particularly the leveraged natural gas futures contracts and CFDs. Each investment vehicle comes with its own risks and advantages, which you need to evaluate before making an investment decision. 

Futures contracts and options are mostly used by large corporations that deal in the physical natural gas and energy market. They use it mostly for hedging purposes to smooth out their cash flows and reduce the impact of volatility in natural gas prices. Speculators and traders mostly trade CFDs and futures, but they close the futures contracts before expiry to avoid taking or delivering the physical underlying product.