The North American energy boom has been about natural gas nearly as much as oil. The same explosion in oil drilling has happened in the natural gas segment, sending wholesale NG prices down by half over the past two years:
However, companies are getting better at producing it more cheaply, demand is growing, and production volumes are beginning to fall in line with actual demand. This could lead to an eventual recovery and that will boost the bottom line of the companies involved and lead to market-crushing returns.
That is, if you invest in the right companies.
Another option? Natural gas ETFs. Instead of picking a single company, you are invested in a bucket of the best companies in the segment held in one fund. You may not get the same returns at the very best-performing companies, but you'll also avoid losing a boatload if you pick the wrong company.
Here's a closer look at three natural gas ETFs, each with a different approach. One of them may be right for you.
Natural gas producer-targeted index fund
The First Trust ISE Revere Natural Gas ETF (NYSEMKT:FCG) tracks the The ISE-REVERE Natural Gas Index, which is an index of 30 companies primarily involved in the exploration and production of natural gas. These companies are almost all American independent producers, such as Chesapeake Energy and Devon Energy. This segment has been one of the hardest hit in the downturn of natural gas and oil prices, so this ETF could be a great investment in the eventual recovery in natural gas prices.
There's tremendous upside for natural gas producers, making this a great ETF for a rebound in natural gas prices or just lower-cost operations. But it also carries the risk of a prolonged downturn in gas prices hurting profits for an extended period of time. That would lead to poor returns for the fund as well as potential losses.
Infrastructure for income investors
If you're looking to get regular paychecks, the Alerian Energy Infrastructure ETF (NYSEMKT:ENFR) may be worth a look. This fund is made up of 36 different companies, including midstream operators such as Kinder Morgan, as well as utilities like Dominion Resources. In other words, they are the glue that connects the entire natural gas, oil, and power infrastructure together.
Since these are largely demand-based and not commodity price-based operations, the drop in oil and natural gas prices affects them much less (and even benefits the power companies) than it does the producers held in the first fund. Furthermore, demand for cheap North American natural gas is expected to continue to grow for years to come, making the businesses held in this fund a potentially great source of predictable, long-term cash flows.
The fund pays a 3.2% dividend at recent prices, and there's a solid chance that gets increased as demand for midstream services increases. The fund paid out $0.61 per share in 2014, and is on track to pay out a similar amount in 2015.
How about an investment on natural gas itself?
One way to gain from a recovery in natural gas prices is to invest in United States Natural Gas Fund, LP (NYSEMKT:UNG). Here's how the fund manager describes it:
The investment objective of UNG is for the daily changes in percentage terms of its shares' net NAV to reflect the daily changes in percentage terms of the price of natural gas delivered at the Henry Hub, Louisiana, as measured by the daily changes in the Benchmark Futures Contract, less UNG's expenses.
In other words, the price tracks to Henry Hub natural gas wholesale prices, less management fees. Here's how that has worked out:
In a steadily declining market since it launched, the losses have been compounded by management fees, while the returns get muted by them. If you're convinced that natural gas prices are set to rebound, you can pay this fund manager a 0.60% expense ratio and invest in shares of this ETF.
Foolish bottom line
Predicting a rebound in natural gas prices can be dangerous. There are a lot of factors that affect prices, and even some of the top minds in the business routinely get it wrong. Commodity prices aren't guaranteed to be higher over time After all, natural gas costs half what it did in 1997:
In other words, the United States Natural Gas Fund isn't a "buy and hold" fund, but one where you have to be willing to follow gas markets, and actively buy and sell shares in order to make a profit by timing fluctuations in natural gas prices. Before investing in this fund, answer this question for yourself: Most people who attempt short-term trading lose money. What makes you different?
However, taking a long-term approach to investing in a basket of top businesses via the other two ETFs, is much more likely to work out. If gas prices don't recover, it will at least be partly because the best producers figure out how to make money in the current environment. If that happens, the midstream operators will benefit from steady and growing volumes. Gas prices increasing would be nice, but it's not a guarantee.
Which ETF is best? First Trust ISE Revere Natural Gas ETF has the most upside as well as the most risk, while Alerian Energy Infrastructure ETF should pay a steady dividend with some potential for price appreciation, and less risk (but not zero risk) of losing value. The one that's best for you depends on your risk profile, short- and long-term objectives.