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UNG's Market Impact Still Generates More Questions Than Answers

Traders are still discussing the potential impacts of the large position held by the United States Natural Gas Fund (UNG), especially as the exchange-traded fund (ETF) rolled its front-month positions on the New York Mercantile Exchange (Nymex) and the IntercontinentalExchange (ICE).

Some in the market are concerned that the fund, which has seen its assets swell to $3.7 billion from $2.6 billion earlier this month and from about $670 million in February, is having an undue influence on the markets due to its position size (see NGI, June 8; May 18).

By some accounts, that position actually got a little smaller last Monday. "UNG actually dropped their position in the natural gas market Monday [June 15] for the first time in over a month," said Gene McGillian, a broker at Tradition Energy. "It slipped back down to below 97,000 contracts on a Nymex futures basis. Despite the drop, it is still a sizeable position. The thing to note is that they decreased their position even though gas prices were up nearly a half percent Monday. They might be reaching a level where some of the specs in it probably thought it might be time to take some profits."

UNG is clearly suffering growing pains, in large part due to a huge influx of speculative money. Earlier this month the fund had approximately 120 million shares in reserve, but that could be consumed in as few as 10 business days. Commodity funds normally face stiff restrictions on the number of shares they can issue and it appears that UNG is almost at the limit. If the fund can't meet investor demand, shares could trade at prices higher than the fund's holdings value, which is a no-no for ETFs and could influence prices in natural gas futures. "The UNG guys have actually petitioned the Securities and Exchange Commission to increase their outstanding shares that they are allowed to have out," McGillian said. Earlier this month UNG managers sought permission to issue 1 billion new units, which would add to the previously approved 200 million units.

The central issue, many say, is whether purely speculative participants should be allowed unfettered access to the price determination mechanism of a commodity that is such an integral component of the nation's energy portfolio.

Despite the sizeable position, McGillian said he had not seen any waves created in natural gas futures that could be attributed to UNG -- at least not yet. "I haven't seen any discernible kind of price swings on the front spread for this roll period, but I do think the larger that any position gets -- especially considering UNG's is technically a spec position -- the more unwieldy it might be," he told NGI. "Whether or not it is actually going to lead to some sort of distortion remains to be seen."

McGillian said the Commodity Futures Trading Commission (CFTC) is taking notice. "The CFTC reported that they are going to be looking at the ICE market to see if the ETF involvement might be cause for some sort of price aberration," he said.

The tide of large pools of trading capital moving in and out of the markets is music to the ears of exchanges like ICE and Nymex. Traders have suggested that these large pools often trade in a purely mechanical fashion and don't necessarily pay attention to the fundamental factors of the market. "When the market starts moving and you have a massive component of the market that basically reacts to [price] momentum rather than fundamentals, it just makes sense that those guys are going to exacerbate the volatility," said a manager with a large California gas marketer. "You can bet that the exchanges don't really want any changes in position sizes or other factors, for they are direct beneficiaries to the volatility-driven trading in the form of clearing and exchange fees."

Others are a bit more circumspect in their assessment of UNG and its impact on the market. "It doesn't look to me that UNG was a factor in the price spike Monday or the sell-off [Tuesday]," said Jim Ritterbusch of Ritterbusch and Associates. He added that those who were buying the fund were "not hedging it off anywhere" and are "making a one-sided bet on the long-term direction of natural gas prices and they are not 'in-and-out' traders who are going to affect natural gas prices on a day-to-day basis. Their time frame is significantly different than your typical natural gas trader."

Last Friday the CFTC issued a notice of intent and called for comments on a proposed determination that ICE's Henry Hub lookalike contract, the Henry Financial LD1 Fixed Price contract, qualifies as a significant price discovery contract in the natural gas market and therefore should be subject to reporting rules and position limits applicable to designated contract markets such as Henry Hub futures contracts offered by Nymex (see related story).

Ever since the farm bill was passed last year, which effectively closed the "Enron Loophole" (see NGI, May 26, 2008), ICE has said it has been operating under the premise that it would be considered a significant price discovery contract. The exchange has been issuing participant notices to get the processes and reporting schedules set up so it would have all of the data that needs to be collected and reported.

For its part ICE, which doesn't have position limits on the contract, has said it's been reporting large trader positions in natural gas to the CFTC since 2006 so that the government agency can look at positions across both ICE and Nymex in order to determine whether action is warranted.

Nymex said it couldn't comment on any of its customers. "We don't talk about any specific entity that trades on the exchange because we are anonymous, so we could never say any specific customer holds 'x' number of contracts," said Anu Ahluwalia, a Nymex spokeswoman. "The exchange as a self-regulatory organization oversees who's holding what and if there are specific concerns we can reach out to customers. There are examples like Amaranth where it has been documented that we've done it."

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