How to invest in natural gas

One of the few commodities that has yet to benefit from rising inflation is natural gas. A lot of investors think that’s going to change soon, and here are some ways you can invest in natural gas.

One of the few commodities that hasn’t benefited from rising inflation is natural gas. Part of the reason is because it’s so plentiful. Indeed, some energy experts believe we have enough domestic natural gas in the ground to supply America’s energy needs for the next 100 years.

As I wrote recently in a post titled Natural gas prices on verge of breaking out?, it appears the market’s betting on the commodity as a key piece of the energy puzzle moving forward. The time to invest is BEFORE a major move in the natural gas market, and here’s a handful of ways you can do that:

1) Natural gas ETFs. The safest and easiest way to invest in natural gas is via an exchange-traded fund (ETF). ETFs trade just like stocks, but rather than investing in a specific company, they invest in an underlying commodity, currency, asset or derivative. In the case of natural gas ETFs, there are two dominant players: United States Natural Gas Fund, LP (NYSE:UNG) and First Trust ISE Revere Natural Gas ETF (NYSE:FCG).

UNG and FCG take two entirely different approaches. UNG, which is the most-traded natural gas ETF, invests in futures contracts for the commodity. Betting on UNG is a bet that the market price for natural gas is going to go up in the near-term. FCG, on the other hand, invests in a basket of natural gas stocks. A bet on FCG isn’t much different than buying stock in several different natural gas producers. By spreading your bet across several different natural gas companies, though, you limit the risk that you might pick a dud.

Check out my post on the Top 5 best natural gas ETFs for more.

2) Natural gas stocks. Should natural gas prices start to rise, so too will the fortunes of natural gas producers. Picking winning stocks in the sector could yield better returns than investing in a diversified ETF. Here’s a short list of some of my favorite natural gas stocks and their performance year-to-date:

  • Petrohawk Energy Corporation (NYSE:HK), YTD: +33%
  • Stone Energy Corporation (NYSE:SGY), YTD: +31%
  • Chesapeake Energy Corporation (NYSE:CHK), YTD: +17%
  • EnCana Corporation (NYSE:ECA), YTD: +13%
  • EXCO Resources, Inc. (NYSE:XCO), YTD: +5%
  • Questar Corporation (NYSE:STR), YTD: -2% (yields 3.5%)

Keep in mind that natural gas companies aren’t all equal. As with any industry, natural gas companies could be involved in some or all of the production chain: from exploration to production, transportation, storage or even companies that supply parts or technology to larger natural gas companies. Do your research and know what part of the supply chain you’d like to invest in before you pick your stock. Large, diversified multinational gas producers will likely be the safest stocks, but they probably won’t yield as large a return as a small natural gas exploration company with a track record of uncovering fresh deposits.

3) Natural gas futures. Sophisticated investors can dip their toes into commodities exchanges like the NYMEX in order to invest directly in natural gas. You’ll need quite a bit of capital to get started and a high risk tolerance as natural gas can be volatile. NYMEX futures contracts trade in increments of 10,000 million British thermal units (mmBtu).

When you buy a natural gas futures contract, you’re agreeing to purchase 10,000 mmBtu at a fixed price at the time of the contract’s expiration, which could range from next month to six years in the future. Most commodities traders roll their contracts into new contracts or sell them outright before they reach expiration date. E-mini Natural Gas futures contracts are also available on the NYMEX. Mini contracts are a quarter of the size of a standard contract (2,500 mmBtu).

4) Natural gas mutual funds. Fidelity offers a natural gas mutual fund called the Select Natural Gas Portfolio (Ticker: FSNGX). The fund invests predominantly in the common stocks of natural gas producers, refineries, and distributors. The minimum initial investment in the fund is $2,500 and your returns will be subject to expenses and fees. Plan to keep your money in the fund for at least 30 days, or you’ll be subject to a short-term redemption fee of 0.75%.

5) Cars of the future? The automotive industry has started experimenting with natural gas vehicles (NGVs), and Honda Motor Co. (NYSE:HMC) has made a big bet on natural gas. In fact, Honda’s the only company that’s currently selling NGVs in showrooms in the U.S. You can walk away with a 2011 Honda Civic GX, which is powered by compressed natural gas (CNG), for a starting price of $25,490. If NGVs catch on, Honda stock should be a big beneficiary. If NGVs falter, fear not, as Honda’s diversified into hybrids, hydrogen-powered cars and electric vehicles as well.

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