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How to invest in natural gas (part V)

2013.04.25 - Nat Gas vs Nat Gas ETF ChartEnlarge Graphcontinued from “How to invest in natural gas (part IV)”

To show how a wide bid-ask spread can be expensive for investors, let us take the example of NAGS. Assume that NAGS is currently trading with $12.00 as the bid price and $12.85 as the ask price (note that we use the average bid-ask spread in this example, but the spread can vary throughout the day depending on what orders exist). Also assume that the fair value is somewhere in the middle, take $12.40 for example. An investor who wants to buy shares of NAGS must pay $0.45 per share above fair value, and may not even get his entire order filled at $12.85 depending on how deep the order book is. In this case, an investor might have to pay nearly 4% more than fair value. In this way, a wider bid-ask spread can result in a large implicit cost to investors.

Additionally, as touched upon in the above example, investors may also want to consider depth. A fund can have a narrow bid-ask spread, but if there are few orders on each side, it can be difficult to fill large orders at attractive prices.

Another factor to consider in how easy and cheap it is to fill orders is volume. The 30-day average volume of UNG is ~5.7 million shares, for UNL is ~43,000 shares, and for NAGS is ~2,800 shares.

Lastly, another major factor is the expense ratio. The expense ratio represents a fee that the manager of the ETF charges for operating the fund. The expense ratio on the UNG is 0.98%, on the UNL is 0.75%, and on the NAGS is 1.50%.

If deciding to invest in a natural gas ETF, investors may want to consider the various aforementioned factors such as the cost of rolling in a contango environment, liquidity, and expense ratio.

Besides investing in natural gas ETFs, another way to get exposure to changes in US natural gas prices is to invest in upstream energy companies with a heavy skew towards domestic natural gas in their production ratios.

Continued to “How to invest in natural gas (part VI)”

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