For the first time since it was forced to suspend issuing new units in early July, the United States Natural Gas fund (UNG) grew the number of limited partnership units it has outstanding Oct. 5 by issuing seven million more to its authorized purchasers (AP). The fund now has 354.4 million units outstanding, but unlike the prodigious growth in units UNG saw in the first half of the year, the fund will likely struggle to grow its share count by a significant amount in the months ahead.
The reason is that any new purchasers of UNG units must first agree to provide the fund with over-the-counter natural gas swap contracts. As UNG first posted on its website Oct. 2, "acceptance of creation orders from APs as of today's date are subject to the condition that the AP arrange for a natural gas-based total return swap contract between UNG and the AP, an affiliate of the AP, or a third party on terms acceptable to UNG's management."
On Oct. 5 UNG exchanged seven million new shares for a natural gas swap contract with a notional value of 78.9 MMBtu. The transaction is part of UNG's ongoing strategy to shift more of its holdings away from exchange-traded futures and swaps contracts in light of potential position limits on exchange-traded commodities of finite supply (see NGI, Aug. 17). Over-the-counter swaps as of Oct. 6 represented 21.3% of UNG's net asset value, up from 19.7% on Oct. 2 and 0% in mid-June. Exchange-traded swap and futures contracts still represent 45% and 33.7% of the funds holdings, respectively.
UNG CFO Howard Mah first announced the new units-for-swaps strategy in an 8-K filing the fund made with the Securities & Exchange Commission on Sept. 11. At that time, UNG stated it would resume issuing new shares on Sept. 28, but the first actual issuance did not occur until Oct. 5 because of a lack of investors who would agree to honor UNG's terms. According to a report issued by Bloomberg.com, "many investors prefer swaps of a few weeks or less, while the fund wants six-month swaps."
UNG's willingness to issue new units has all but eliminated the premium that its units have been trading to the fund's net asset value. UNG traded as much as 19% above its underlying value in recent weeks and closed at a 16.1% premium on Sept. 11, the day UNG announced its swaps-for-units strategy (see NGI, Sept. 21). Since then, the premium has declined to less than 2%. "[APs] who deliver swaps can arbitrage the premium by selling UNG units in the open market, and that has slashed the premium," a trader with a Fortune 500 exploration and production company explained.
Interestingly, the premium of the iPath Dow Jones-UBS Natural Gas Subindex Total Return exchange traded note (GAZ) has also fallen by a similar amount, even though GAZ has no plans to issue new shares any time soon. The GAZ premium fell from 15% on Sept. 11 to 3.1% on Oct. 5.
But while the issuance of new UNG units and the subsequent erosion of the UNG trading premium may be relevant to the Wall Street community, what impact might it have on natural gas prices going forward? "Probably not much," the aforementioned trader predicted. "I'll bet UNG will continue to struggle to find too many investors willing to deliver many swap contracts to (UNG), especially in the short-term. Volatility is extremely high right now, and there is still a lot of regulatory uncertainly in the over-the-counter markets," he explained.
The first step in clarifying that uncertainty occurred last Wednesday when Commodities Futures Trading Commission (CFTC) Chairman Gary Gensler testified before Congress on potential over-the-counter derivative reforms, including those for swap contacts (see related story).
The CFTC has also set no concrete deadline on when it would issue any new rules on speculative trading positions for exchange-traded products. "Commissioner Gensler indicated that if and when the CFTC issues new rules on speculative trading limits, it will be sometime in the fall," a CFTC spokesperson told NGI.
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