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For the better part of a decade, natural gas investing has been a volatile and overall disappointing asset class to be invested in. Previous spikes in natural gas have historically been followed by long and protracted drawdowns. That might be changing: are current natural gas prices potentially staying or hitting new highs in the future?

Natural Gas: Why is It Hitting Fresh Highs? 

Natural gas prices have recently spiked in response to increasing global demand and tightening supply chains. Initially seen as a transitory fuel source on the way to greener, alternative energy, natural gas has become a crucial alternative to coal in the last two decades as a key source of heating and electricity. With increasing economic activity as COVID-19 restrictions are loosened, the demand for natural gas has placed a strain on the supply chain; a supply chain already under heavy pressure from investors and environmental groups to eliminate further expansion in favour of ESG initiatives.

Following the 2008 global financial crisis, an abundance of cheap, natural gas became available as shale extraction techniques advanced, opening up new resources in the U.S. allowing them to become one of the leading global producers and exporters of the commodity. With many major economies committing to a net zero carbon emission future, natural gas helped forge a path there.

After peaking at nearly USD$13 MMBtu pre- 08’ crash, consumers enjoyed a cheap and abundant resource. But now demand is beginning to outstrip supply and the world could be facing yet another energy crisis. Europe and Asia are among those that are already feeling the strain heavily; demand has also increased in natural gas usage in the United States. With very little supply cushion of their own, Americans are already facing potential price increases and likely have limited ability to export natural gas to other markets.

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With the growing sentiment around greener initiatives, and investors and climate activists placing further pressure, there is no more capital to allow for a supply increase. Even so, the International Energy Agency (IEA) has advised that investments in new upstream fields needs to stop now to reach net zero by 2050. So what’s the alternative?     

North America will face steep price increases to their energy costs but should still be able to meet demand. The price elasticity of the past, where prices could swing downward after hitting new highs might be a feature of the past. It’s quite possible that natural gas prices could remain elevated well above its current US$5 per MMBtu for the foreseeable future. 

The International Energy Agency forecasts demand for the commodity will increase 7% by 2024 from 2019’s pre-COVID levels. In plain, the recent move in gas prices may have been catalyzed by supply shortage, but structurally higher prices are likely here to stay. To head towards a greener future, using natural gas is essential.

Prices could potentially go even higher though if supply issues in Europe and other international markets cannot be addressed. For example, failures in the U.K power market and the continent’s largest chemicals producer cutting output are a few early examples of how this supply shortage could have long-lasting inflationary impact on prices. Higher demand for residential heating due to a cold winter and widespread remote working pushed up overall European gas demand by 7.6% in the first quarter of 2021 according to Bruegel in a September 13, 2021 article.

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Source: https://www.bruegel.org/2021/09/is-europes-gas-and-electricity-price-surge-a-one-off/

Investing in Natural Gas ETFs:

Investing in natural gas is a little more complex than other asset classes since it generally requires investing in futures contracts or an ETF that invests in futures contracts.

While there are numerous compelling reasons to invest in natural gas exchange traded funds (ETFs), for buy and hold investors, returns can be diminished in a market environment known as contango.

Contango exists when the price of future delivery is higher than the spot price. For an investor using futures there is no way to eliminate the impact of contago on returns. Most ETFs buy the shortest-term futures contract (typically the near month or one month futures contract) because that is usually the contract most closely correlated to the spot price of natural gas however, using ETFs that track a deferred or long dated futures contract can help reduce this structural decay as well as lower the cost of monthly contract rolls.

Most ETFs that track commodities need to roll over their contracts on a regular basis. If you’re an investor in oil for example, while the spot price of crude oil may increase, it will generally have to increase by more than the premium paid on the next month’s futures contract (the rollover contract) in order for the ETF to increase in value at the time the contracts roll over.

It is almost impossible for an individual investor in the futures market to eliminate the effects of contango – there is no free lunch in commodity investing. Contango takes into account several factors including, where applicable, storage costs for the physical commodity. Mispricing between the spot price of a physically held asset and a futures contract is generally eliminated by market arbitrage.

ETFs that track the price of natural gas futures are designed to be a convenient and cost-effective means to access the futures market for investors, limiting risk to the amount invested and not subjecting investors to margin calls.

The Horizons Natural Gas ETF uses a unique futures-roll structure that seeks to reduce the premiums investors would pay in taking a long position in natural gas. 

HUN seeks investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs, that endeavour to correspond to the performance of the Solactive Natural Gas Winter MD Rolling Futures Index ER. Instead of rolling its future’s exposure monthly, this strategy rolls the contract exposure of the ETF once a year to the winter natural gas contract, which at the time of this writing was January 2022. 

Typically, the ETF rolls its exposure to the next year’s winter contract, so to use the example of November 2021, the ETF will roll into the January 2023 winter contract. By reducing the frequency through which HUN rolls its exposure to natural gas contracts it reduces the total annual cost of paying premiums to roll its exposure. This can result in significant long-term performance advantages as highlighted below.

HUN has generated a better long-term return than the monthly natural gas futures contract tracking ETFs, such as the USO Natural Gas ETF (UNG), the largest natural gas fund by AUM.

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For investors looking to take a longer time horizon, HUN might be a superior way to take a buy and hold approach to owning natural gas, particularly for those investors who believe that higher prices are finally here to stay.

HUN:

HUN seeks investment results, before fees, expenses, distributions, brokerage commissions and other transaction costs, that endeavour to correspond to the performance of the Solactive Natural Gas Winter MD Rolling Futures Index ER. Horizons HUN is denominated in Canadian dollars. Any U.S. dollar gains or losses as a result of the ETF’s investment will be hedged back to the Canadian dollar to the best of the ETF’s ability.

Management Fee: 0.75% (Plus applicable sales tax)

United States Natural Gas Fund, LP (UNG)

The investment objective of UNG is for the changes in percentage terms of the units’ net asset value to reflect the changes in percentage terms of the price of natural gas delivered at Henry Hub, Louisiana, as measured by the changes in the price of the futures contract on natural gas traded on the New York Mercantile Exchange that is the near-month contract to expire, except when the near-month contract is within two weeks of expiration, in which case it will be measured by the futures contract that is the next month contract to expire, less UNG’s expenses.

Management Fee: 0.60% (Plus applicable sales tax)

Source: www.unitedstatesnaturalgasfund.com

The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.
 
Certain statements may constitute a forward-looking statement, including those identified by the expression “expect” and similar expressions (including grammatical variations thereof). The forward-looking statements are not historical facts but reflect the author’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These and other factors should be considered carefully and readers should not place undue reliance on such forward looking statements. These forward-looking statements are made as of the date hereof and the authors do not undertake to update any forward-looking statement that is contained herein, whether as a result of new information, future events or otherwise, unless required by applicable law.

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Commissions, management fees and expenses all may be associated with an investment in exchange traded products managed by Horizons ETFs Management (Canada) Inc. (the "Horizons Exchange Traded Products"). The Horizons Exchange Traded Products are not guaranteed, their value changes frequently and past performance may not be repeated. Certain ETFs may have exposure to leveraged investment techniques that magnify gains and losses and which may result in greater volatility in value and could be subject to aggressive investment risk and price volatility risk. Such risks are described in the prospectus. The prospectus contains important detailed information about the ETF. Please read the relevant prospectus before investing.

The Horizons Exchange Traded Products include our BetaPro products (the “BetaPro Products”). The BetaPro Products are alternative mutual funds within the meaning of National Instrument 81-102 Investment Funds, and are permitted to use strategies generally prohibited by conventional mutual funds: the ability to invest more than 10% of their net asset value in securities of a single issuer, to employ leverage, and engage in short selling to a greater extent than is permitted in conventional mutual funds. While these strategies will only be used in accordance with the investment objectives and strategies of the BetaPro Products, during certain market conditions they may accelerate the risk that an investment in shares of a BetaPro Product decreases in value. The BetaPro Products consist of our Daily Bull and Daily Bear ETFs (“Leveraged and Inverse Leveraged ETFs”), Inverse ETFs (“Inverse ETFs”) and our BetaPro S&P 500 VIX Short-Term Futures™ ETF (the “VIX ETF”). Included in the Leveraged and Inverse Leveraged ETFs and the Inverse ETFs are the BetaPro Marijuana Companies 2x Daily Bull ETF (“HMJU”) and BetaPro Marijuana Companies Inverse ETF (“HMJI”), which track the North American MOC Marijuana Index (NTR) and North American MOC Marijuana Index (TR), respectively. The Leveraged and Inverse Leveraged ETFs and certain other BetaPro Products use leveraged investment techniques that can magnify gains and losses and may result in greater volatility of returns. These BetaPro Products are subject to leverage risk and may be subject to aggressive investment risk and price volatility risk, among other risks, which are described in their respective prospectuses. Each Leveraged and Inverse Leveraged ETF seeks a return, before fees and expenses, that is either up to, or equal to, either 200% or –200% of the performance of a specified underlying index, commodity futures index or benchmark (the “Target”) for a single day. Each Inverse ETF seeks a return that is –100% of the performance of its Target. Due to the compounding of daily returns a Leveraged and Inverse Leveraged ETF’s or Inverse ETF’s returns over periods other than one day will likely differ in amount and, particularly in the case of the Leveraged and Inverse Leveraged ETFs, possibly direction from the performance of their respective Target(s) for the same period. For certain Leveraged and Inverse Leveraged ETFs that seek up to 200% or up to or -200% leveraged exposure, the Manager anticipates, under normal market conditions, managing the leverage ratio as close to two times (200%) as practicable however, the Manager may, at its sole discretion, change the leverage ratio based on its assessment of the current market conditions and negotiations with the respective ETF’s counterparties at that time. Hedging costs charged to BetaPro Products reduce the value of the forward price payable to that ETF. Due to the high cost of borrowing the securities of marijuana companies in particular, the hedging costs charged to HMJI are expected to be material and are expected to materially reduce the returns of HMJI to unitholders and materially impair the ability of HMJI to meet its investment objectives. Currently, the manager expects the hedging costs to be charged to HMJI and borne by unitholders will be between 10.00% and 45.00% per annum of the aggregate notional exposure of HMJI’s forward documents. The hedging costs may increase above this range. The manager publishes on its website, the updated monthly fixed hedging cost for HMJI for the upcoming month as negotiated with the counterparty to the forward documents, based on the then current market conditions. The VIX ETF, which is a 1x ETF, as described in the prospectus, is a speculative investment tool that is not a conventional investment. The VIX ETF’s Target is highly volatile. As a result, the VIX ETF is not intended as a stand-alone long-term investment. Historically, the VIX ETF’s Target has tended to revert to a historical mean. As a result, the performance of the VIX ETF’s Target is expected to be negative over the longer term and neither the VIX ETF nor its target is expected to have positive long-term performance. BetaPro Bitcoin ETF (“HBIT”), and BetaPro Inverse Bitcoin ETF (“BITI”), which are a 1X ETF, and an up to -1X ETF, respectively, as described in the prospectus, are speculative investment tools that are not conventional investments. Their Target, an index which replicates exposure to rolling Bitcoin Futures and not the spot price of Bitcoin, is highly volatile. As a result, neither ETF is intended as a stand-alone investment. There are inherent risks associated with products linked to crypto-assets, including Bitcoin Futures. While Bitcoin Futures are traded on a regulated exchange and cleared by regulated central counterparties, direct or indirect exposure to the high level of risk of Bitcoin Futures will not be suitable for all types of investors. An investment in any of the BetaPro Products is not intended as a complete investment program and is appropriate only for investors who have the capacity to absorb a loss of some or all of their investment. Please read the full risk disclosure in the prospectus before investing. Investors should monitor their holdings in BetaPro Products and their performance at least as frequently as daily to ensure such investment(s) remain consistent with their investment strategies.

Horizons Total Return Index ETFs (“Horizons TRI ETFs”) are generally index-tracking ETFs that use an innovative investment structure known as a Total Return Swap to deliver index returns in a low-cost and tax-efficient manner. Unlike a physical replication ETF that typically purchases the securities found in the relevant index in the same proportions as the index, most Horizons TRI ETFs use a synthetic structure that never buys the securities of an index directly. Instead, the ETF receives the total return of the index through entering into a Total Return Swap agreement with one or more counterparties, typically large financial institutions, which will provide the ETF with the total return of the index in exchange for the interest earned on the cash held by the ETF. Any distributions which are paid by the index constituents are reflected automatically in the net asset value (NAV) of the ETF. As a result, the Horizons TRI ETF receives the total return of the index (before fees), which is reflected in the ETF’s share price, and investors are not expected to receive any taxable distributions. Certain Horizons TRI ETFs (Horizons Nasdaq-100 ® Index ETF and Horizons US Large Cap Index ETF) use physical replication instead of a total return swap. The Horizons Cash Maximizer ETF and Horizons USD Cash Maximizer ETF use cash accounts and do not track an index but rather a compounding rate of interest paid on the cash deposits that can change over time.

*The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the ETF or returns on investment in the ETF. Only the returns for periods of one year or greater are annualized returns.