Jun 14, 2020
Written by:
Ella Vincent
Natural gas ETFs can be an effective investment option for traders. These exchange-traded funds can pay off for savvy investors-if they make the right choices. This TradingSim article will inform investors about natural gas ETF’s and how COVID-19 has impacted the industry as well. The TradingSim article will also help investors find the best natural gas ETF’s for them to improve their trading strategies.
Natural gas ETFs can possibly be more stable than individual stocks. When comparing stocks vs. ETFs, ETF’s may be able to provide less risk for investors. In natural gas ETFs, they invest in natural gas contracts or stocks to track the market price of the commodity.
Similar to emerging market ETFs, natural gas ETFs can be bought on the New York Mercantile Exchange or international exchanges outside the U.S.
There are many ways to trade natural gas ETFs. Some of the main points to trading are:
If investors want to take advantage of falling prices of natural gas ETFs, they can buy inverse natural gas ETFs. Shorting natural gas ETFs comes with risk. When investors buy inverse natural gas ETFs, they are making short-term investments.
Inverse natural gas ETFs use derivatives, financial instruments that get their value from other assets. The derivatives include futures contracts that are bought and sold at a certain date at a set price. After taking a short position, investors can earn more profits if natural gas prices plummet.
While there can be great profits if the prices continue to fall, investing in inverse ETFs is risky. Inverse natural gas ETFs also carry higher fees than other natural gas ETFs. One example of an inverse natural gas ETF is ProShares UltraShort Bloomberg Natural Gas (KOLD).
The decline in oil prices started in March when Russia and Saudi Arabia couldn’t agree to reduce their oil production. The nations were supposed to reduce production to increase demand and increase oil prices. Russia and Saudi Arabia flooded the markets with oil and there were deep repercussions. Oil prices dropped to their lowest levels since 1990. Prices plunged from $70 to $21 a barrel as a result.
After a month of plummeting oil prices, the impasse reached a breaking point. President Donald Trump, Russian President Vladimir Putin, and Saudi Prince Mohammed bin Salman all reached an agreement. The nations agreed to limit oil production by two million barrels a day.
Despite the agreement, Martijn Rats, oil expert at Morgan Stanley is pessimistic. He sees the agreement with OPEC ( Organization for Petroleum Exporting Countries) as ineffective against lower oil prices in the future.
“The OPEC+ agreement will not prevent sharp inventory builds in coming months, and near-term oil prices in the physical market will likely remain under pressure,” said Martijn Rats.
In order to end the oil war, Russia made the agreement not only to make peace with Saudi Arabia. The nation wanted to fend off any further economic downturns with the onset of coronavirus. Putin critic Vladimir Milov made an observation about the oil war. He noted that the Russian government came to an agreement with Saudi Arabia to end the oil war for a key reason. Putin didn’t want to dig into the nation’s oil reserves to boost Russia’s economy.
“They are afraid of future shocks, whether on oil markets or global recession, and don’t want to approach the next wave already having spent their reserves,” said Milov.
In addition to the Russia- Saudi gas war, coronavirus also impacted the industry. In the current bear market, the coronavirus negatively affected the natural gas industry. The COVID-19 outbreak led to worldwide shutdowns and a decreased demand for oil. The warmer weather in the spring also meant a diminished need for natural gas to heat homes as well.
Goldman Sachs analyst Samantha Dart noted that declining oil production in March may cause drop in natural gas prices in the future. If oil prices continue to decline, she believes that natural gas prices can struggle to rebound over the next year.
“As we move into 2021, this path of declining oil and gas production, if sustained, will likely result in an exceptionally tight summer 2021, which suggests current forward prices are not sustainable,” said Dart.
As a result of the oil and natural gas volatility, Shell (NYSE:RDS-B) is making drastic changes. One of the biggest oil companies in the world announced that it would reduce its dividend payout. The payout has been cut to customers by 66%. The company’s CEO Ben van Beurden, recently announced that the company’s dividend would be cut down to 16 cents.
“Considering the risks of a prolonged period of economic uncertainty, including the weaker demand for our products and lower and the less stable commodity prices, we do not consider that maintaining the current level of shareholder distributions is in the best interest of the company and its shareholders,” noted van Beurden.
Shell’s CEO also predicted that the oil war crisis will decrease demand for oil and natural gas.
“Two real big problems are facing the[oil and natural gas] industry. One is that, of course, everything has become much more challenging macro-wise, and we know it’s going to get worse before it gets better. The biggest challenge we find ourselves is this crisis of uncertainty that we have…It’s not just the oil price, that’s just one aspect. What will happen to demand?”
He also predicted that “will come down massively…The reduction in demand that has been predicted just for April is going to be 29 million barrels of oil a day. We don’t know what that may bring. So there’s a lot of challenges coming from that,” said van Beurden.
Because of the coronavirus crisis, Shell’s Q1 2020 profits fell to $2.9 billion from $5.3 billion in Q1 2019.
As a result of the decrease in oil and natural gas refinement, van Beurden noted that Shell’s future guidance was uncertain.
“The margins in downstream refining margins, who knows where that will go, who knows actually where the viability of our assets will go in many cases? We have seen people having to shut-in simply because they do not have the logistics inbound or outbound…It is that level of uncertainty that you cannot model scenarios,” said van Beurden.
Shell’s chief financial officer, Jessica Uhl, noted that Shell’s cash margins may continue to be impacted by COVID-19.
“We are looking at a major demand destruction that we don’t even know will come back. So the oil price may come back, but if the volumes are significantly lower, we still have a major dislocation, ” said Uhl.
As oil and natural gas companies reel from the COVID-19 pandemic fallout, the business model of natural gas ETF’s may have to change. Artem Abramov is head of global oil research at Rystad Energy. He believes that the current low prices of oil and natural gas will hurt the industry.
The current price environment is more or less a complete disaster for the majority of shale[oil and natural gas] companies,” said Abramov. “At $30 a barrel, many companies would be able to adapt gradually. But at $20 a barrel, many players – especially those with poor balance sheets – will struggle financially.”
Abramov also noted that investors may be unwilling to bail out troubled oil and natural gas companies.
“Even before the oil price crash, the business models began to change. Investors historically provided a lot of capital to the industry to finance the capital growth. Last year, they began asking these companies to come up with more disciplined and balanced capital programs and focus more on profitability,” said Abramov.
In response to diminished demand for natural gas in the spring, many natural gas companies are cutting dividends to save money. Jeffrey Germain, director at Brandes Investment Partners, noted that dividends must be cut to reduce debt.
“Long term, it is appropriate to cut the dividend. We are not in favor of raising debt to support the dividend,” said Germain.
Jonathan Waghorn is a co-manager of the Guinness Global Energy Fund. He noted that oil and natural gas companies have to reduce dividends if they don’t spend enough capital expenditure.
“The measures taken by Shell seem to be sufficient but, over time, if Shell (for instance) does not spend enough capital expenditure then production will start to fall and the underlying cash flow will not be sufficient to sustain the dividend long term,” said Waghorn.
Because of the decreased oil and natural gas demand, BP announced it would slash 10,000 jobs. The oil behemoth’s CEO, Bernard Looney, wrote about the job cuts in a company email.
“We will now begin a process that will see close to 10,000 people leaving BP – most by the end of this year,” said Looney.
“To me, the broader economic picture and our own financial position just reaffirm the need to reinvent BP. While the external environment is driving us to move faster – and perhaps go deeper at this stage than we originally intended – the direction of travel remains the same,” added Looney.
After BP’s Q1 2020 revenue dropped by 67%, Looney noted that the corporation will focus on more renewable energy and less on oil production.
“It was always part of the plan to make BP a leaner, faster-moving and lower-carbon company,” said Looney.
In addition to BP vowing to move to renewable energy, cleaner energy sources could hurt natural gas as well. A study from the International Energy Association noted that demand for natural gas could fall by 5%.
According to researchers, lower-cost renewable energy could also impact natural gas ETFs.
“This trend is affecting demand for electricity from coal and natural gas, which are finding themselves increasingly squeezed between low overall power demand and increasing output from renewables. As a result, the combined share of gas and coal in the global power mix is set to drop by 3 percentage points in 2020 to a level not seen since 2001,” noted the researchers.
Tudor, Pickering, Holt & Co. analysts also noted that decreased natural gas exports to Europe and increased renewable energy could hamper natural gas prices in the future.
“We see natural gas pricing skewed to the downside in the near term, as LNG feed gas losses and production increases are expected to weigh on the commodity,” said the analysts.
BMO Capital Markets analysts noted that another COVID-19 outbreak could further hurt natural gas prices.
“The possibility of another Covid-19 outbreak remains a risk to the demand outlook, along with the likelihood of slower economic growth due to job losses and rising debt levels. Government stimulus packages have so far cushioned the economic blow; however, they can’t last forever,” said the analysts.
Despite the COVID-19 impact, natural gas analyst Samantha Dart believes that the decline in gas production and consumption will impact the U.S. gas markets until next year.
“Specifically, we expect that the cut in associated gas production, although very significant, will show in U.S. gas markets late enough this year,” said Dart.
Dart and other Goldman Sachs analysts predict that the recession will further depress natural gas prices.
“However, as we enter the 2020/21 winter, we expect production declines to be visible enough that gas prices will rally sharply in our view to help summer 2021 reach comfortable inventory levels,” said Dart and the other analysts.
Similar to Goldman Sach’s pessimistic prediction, other financial experts are also bearish on natural gas after the Saudi and Russian oil overproduction. Andy Weissman is the CEO of EBW AnalysticsGroup. Weissman believes that the government shutdown led to a reduction of natural gas in many offices and businesses. He doesn’t have faith that the natural gas prices will increase.
“U.S. electricity demand is beginning to rapidly decline due to coronavirus-related containment measures,” wrote Weismann in a note to clients.
Moody’s analysts are also pessimistic about the future of natural gas ETFs.
“Wholesale markets like [regional transmission organization] PJM have already observed meaningful reductions in peak and around-the-clock demand. Lower demand is translating into weaker power pricing, negatively impacting revenues for gas- and coal-fired resources and denting the independent generation sector’s credit outlook,” noted Moody’s analysts.
“Our medium-term price bands reflect our fundamental assessments of the prices necessary for producers to reinvest in and replace their hydrocarbon assets, which deplete as they are produced,” the Moody’s analysts said. “But we do expect that realized oil prices will average below our fundamental price range in 2020, and possibly 2021,” added the Moody’s analysts.
Despite the decline in natural gas prices and demand, Shell’s CEO, Ben van Beurden is still optimistic that natural gas use can rise.
“We still very much believe that with the current supply-demand outlook, this is a fundamentally strong sector that will grow at a rate that is close to 4% per year,” said van Beurden.
Shell’s CEO also noted that the company will make investments to get production and profits back to pre-pandemic levels.
“We will obviously flex our investment program to be aligned with where we believe the sector will go, but the profitability of the business and the outlook of this business is going to be as good as what you saw before the pandemic,” said van Beurden.
After COVID-19, some financial experts say natural gas is already down to a low price. So, any further downturn won’t hurt natural gas ETFs any further. Patrick Morris, executive vice president and director of Unicorn REH, thinks that natural gas can withstand the downturn.
“Natural gas at $1.70 to $1.85 is very depressed and were it not for all of the residual gas from fracking, significantly below replacement cost,” he says. “Since the industry is already pretty well rung-out, this new downturn might not be as painful,” said Morris.
The International Energy Agency also believed that natural gas won’t be as hurt as oil by the COVID-19 fallout.
“The decline is less than the anticipated fall in oil demand, reflecting the fact that natural gas is less exposed to the collapse in demand for transportation fuels,” said the International Energy Agency.
When investing in natural gas ETFs, investors can choose these options. The following are five of the best natural gas ETFs.
In the United States Natural Gas Fund (NYSEARCA:UNG), investors can trade the largest natural gas ETF. It invests in futures contracts for natural gas. The United States Natural Gas Fund also follows the movement of natural gas prices. The fund provides access to the futures market without the risk of actually investing in the high-risk market of futures. Investors who are buying assets at a pre-determined rate face a lot of risk. The natural gas ETF helps mitigate that risk.
As of early June, the ETF has assets of $374.1 million in the fund. The United States Natural Gas Fund tracks the New York Mercantile Exchange (NYMEX). The NYMEX contract is the Henry Hub Natural Gas Futures. The Henry Hub is the primary benchmark of natural gas.
Even though UNG’s year-to-date returns are down -35.35%, investors that want to trade in natural gas ETFs should choose this fund. Bullish investors can hold on the fund until natural gas prices rebound. Bearish investors can short this fund for short-term profits.
In addition to the UNG, another natural gas ETF is the Alerian Energy Infrastructure ETF(NYSEARCA:ENFR).
While upstream natural gas production is volatile, middlestream production has heled steady. The Alerian Energy Infrastructure ETF predicted growth for its middlestream holdings in a note earlier this year.
“Some of the largest US and Canadian midstream companies are guiding to robust annual dividend growth in 2020,” said Alerian.
“After growing its dividend by 25% in 2019, Kinder Morgan (NYSE:KMI) is planning another 25% increase in 2020, which would bring its dividend up to $1.25 per share on an annualized basis. The outsized dividend growth marks a recovery from KMI’s 2015 dividend cut,” added Alerian.
“Additionally, with midstream companies approaching a free cash flow inflection point, particularly in 2021, it’s possible that excess cash flow will drive further dividend growth,” according to Alerian.
Paul Baiocchi is a senior Investment strategy advisor at ALPS Advisors and monitors natural gas ETFs. He thinks that midstream natural gas ETFs can be a good investment for savvy traders.
“Midstream provides critical energy infrastructure while offering defensive energy exposure and attractive income,” Baiocchi said. “Company-level improvements leave midstream well positioned to withstand the current energy downturn, particularly the larger names,” said Baiocchi.
Kinder Morgan (NYSE:KMI) is a key holding in the Alerian Energy Infrastructure ETF. The natural gas company had a negative earnings report because of COVID-19 and the oil wars. The company’s Q1 2020 earnings were $1.848 billion, a decline of 5% year-over-year. David Michels is the chief financial officer of Kinder Morgan. He spoke about the disappointing results in the company’s revenue report.
“Revenues were down $323 million, driven in part by lower natural gas prices versus Q1 of 2019. The lower natural gas prices also drove a decline in the associated cost of sales of $285 million,” said Michels.
Michels also noted that the natural gas industry faces upheaval as production slows down.
“Natural Gas segment is projected to be down 4% from planned for the full year, driven by lower gathering and processing activity levels. Products is expected to be down about 17%, driven by lower refined product volumes, lower crude pipeline volumes and unfavorable price impacts,” added Michels.
Kinder Morgan’s CEO, Kim Dang, acknowledged that the coronavirus caused a decline in natural gas demand.
“Sharp declines in both commodity prices and refined product demand in the wake of the COVID-19 pandemic clearly affected our business and will continue to do so in the near term. Largely due to the non-cash impairments noted above, we generated first-quarter earnings per common share loss of $0.14, compared to earnings of $0.24 in the first quarter of 2019,” said Dang.
Despite a drop in Q1 2020 earnings per share, there was some good news. Dang noted that its discounted cash flow( DCF) was still positive.
“Adjusted earnings per share in the first quarter of 2020 were down 5 percent compared to the first quarter of 2019. At $0.55 per common share, DCF per share was down $0.05 from the first quarter of 2019, yet we achieved $664 million of excess DCF above our declared dividend,” said Dang.
Dang also noted that while there was a decline in Kinder Morgan’s revenue, there was an increase in natural gas transportation volumes.
“At the same time, we saw strong financial contributions from the Natural Gas Pipelines group in the first quarter that were offset by the impact of the sale of the U.S. portion of the Cochin pipeline in the fourth quarter of 2019. Volumes on our gas pipelines were up 8 percent year over year and strength in transportation volumes has continued into April,” said Dang.
Kinder Morgan is part of the Alerian Energy Infrastructure ETF that investors could buy if they want to buy a stock before it rises again.
The VanEck Vectors Unconventional Oil & Gas ETF(NYSE:FRAK) is a newer natural gas ETF with $9 million in assets. It seeks to replicate the Market Vectors Unconditional Oil and Gas Index.
Noble Energy(NYSE:NBL) is a holding in the VanEck Vectors Unconventional Oil ETF. The oil and gas exploration company had a Q1 2020 earnings report with mixed results.
Noble Energy posted Q1 2020 revenue of $1.02 million, a 3% decline from Q1 2019. A plunge in oil and gas sales during the nationwide quarantine hurt the company’s profits.
David L. Stover, Noble Energy’s CEO, noted that because of the coronavirus fallout, the company was lowering its capital expenditure.
“First, in response to the current commodity environment, we’ve lowered our 2020 capital plan by more than 50% versus original guidance, a decrease of $900 million,” said Stover.
Noble Energy’s chief financial officer, Kenneth Fisher, noted that even though spending was down, the company still had liquidity and available cash.
“Noble Energy ended first quarter with $4.4 billion in financial liquidity, including $1.4 billion in cash and $3 billion of available borrowing capacity on our revolving credit facility,” said Fisher.
Fisher also spoke about how Noble was still optimistic about its future.
“We are confident on our financial position, with robust liquidity and a well-managed maturity profile, solid hedge protection and the cash flow contribution of our long-term international gas assets,” said Fisher.
Despite the worse-than-expected Q1 2020 earnings report, there is some good news for Noble Energy. Hedge fund Diamond Hill Capital bought the plunging stock at a discount. The company explained why it bought Noble Energy stock.
“We purchased oil and gas exploration and production company Noble Energy, Inc. at an attractive discount to our estimate of intrinsic value as equity values for oil-producing companies declined rapidly in the quarter,” noted Diamond Hill.
If investors want cheap oil and gas stocks, the Fidelity Select Natural Gas Portfolio ETF may be a good choice.
The First Trust Natural Gas ETF has $99 million in assets. The year-to-date performance is down 37%.
In the First Trust Natural Gas ETF, Southwestern Energy is a key holding. During the Q1 2020 earnings report, CEO Bill Pay noted that its natural gas production has increased. That’s in contrast to a decline in other natural gas companies.
“Wells in the rich area of West Virginia produced a high rate of natural gas. By way of example in this area, we recently set a company record for an initial production rate of 170 million cubic feet per day equivalent from a four-well pad placed to sales in the quarter. The swift action to pivot our capital toward natural gas was done in a short period of time and without additional cost to the company,” said Pay.
Pay also noted that the natural gas company’s capital investment is expected to increase.
“As for capital, our capital guidance released in February included a 20% reduction in capital compared to last year. At this time, full-year capital investment is expected to be around $860 million,” said Pay.
Even though Southwestern’s Q1 2020 earnings were below expectations at $592 million, there was still good news for the stock. Southwestern stock rose 26% through 2020 because of its natural gas production. The First Trust Natural Gas ETF could be an option for investors.
The Energy Select Sector SPDR Fund (NYSEARCA:XLE) is an ETF with natural gas holdings. The fund has $8.3 million in assets. The natural gas ETF had a poor year-to-date performance of -45.90%.
ConocoPhillips( NYSE:COP) is a holding in the Energy Select Sector SPDR Fund. In its last earnings report, the oil and natural gas company reported losses in the billions.
“ConocoPhillips today reported a first-quarter 2020 loss of $1.7 billion, or ($1.60) per share, compared with first-quarter 2019 earnings of $1.8 billion, or $1.60 per share,” reported ConocoPhillips in its press release.
Despite the losses, ConocoPhillips reported that it had adequate working capital.
“For the quarter, cash provided by operating activities was $2.1 billion. Excluding a $0.5 billion change in operating working capital, ConocoPhillips generated CFO of $1.6 billion,” said ConocoPhillips.
“You saw in today’s press release that we ended the quarter with total liquidity of nearly $14 billion, including the $6 billion available under our revolver,” added ConocoPhillips.
The oil and gas company also noted that it would suspend future guidance because of its COVID-19 caused losses.
“Given ongoing uncertainty, continued market volatility, and production curtailments over the coming months, the company recently announced that its original 2020 guidance items should not be relied upon and that further guidance has been temporarily suspended,” said ConocoPhillips.
The iShares U.S. & Gas Exploration ETF(NYSEARCA:IEO) tracks equities in the oil and gas sector. It has $187 million in assets. Its year-to date performance is -59. 65%.
Diamondback Energy(NYSE:FANG) is a holding in the iShares U.S. & Gas Exploration ETF. The corporation had a disappointing Q1 2020 report. In the report, the company had an adjusted net income of $230 million, a 25% decrease.
Despite the diminishing returns, Diamondback CEO Travis Stice noted the strength of the company.
“Diamondback is prepared to preserve our strength through this cycle and protect our stockholders’ investment. Our industry, through the free market, has responded as quickly as ever to this unprecedented global demand shock without the need for regulatory intervention.
Stice also noted that Diamondback is cutting oil and natural gas production because of its $272 million net loss.
“Diamondback is choosing to curtail production in May because of economics, which should be the baseline for decisions on whether or not to produce barrels. The addition of regulatory uncertainty to operators in the state of Texas is a distraction to managing the social and economic crisis we are all currently facing,” said Stice.
Diamondback Energy is a stock that suffered large losses, but may be able to withstand the current economic volatility.
The coronavirus had a terrible effect on the natural gas industry. The pandemic shut down production and lower demand. However, natural gas ETFs often have reliable dividends for patient investors. Natural gas ETFs can also rebound from this brutal year if the economy recovers. An increase in natural gas prices and demand could also lift natural gas ETFs. TradingSim charts and analysis can help traders find the best natural gas ETFs to invest in to diversify their portfolios.
Tags: best natural gas etfs
Commodity Futures
Natural gas is a flammable gas comprising of methane and other hydrocarbons. It is a naturally occurring gas found underground and is extracted the same as other fossil fuels such as oil. Natural gas...
