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Potential CFTC Rules May Force UNG to Exit Futures Trading

The United States Natural Gas Fund (UNG) reiterated its stance last Tuesday that "futures contracts will remain its principal investment," but left open the possibility that it may be forced to abandon the futures market altogether because of anticipated changes in the regulatory environment from the Commodity Futures Trading Commission (CFTC).

UNG made the pronouncement in an 8-K filing with the Securities & Exchange Commission (SEC) on Tuesday. The document is largely a repeat of information the fund has already disclosed. UNG first revealed that it would start liquidating its exchange-traded natural gas positions in an 8-K filing it made with the SEC on July 29. "The Nymex futures contracts and the [IntercontinentalExchange] LD1 contract, the economic equivalent of UNG's benchmark futures contract, have to date provided the best means for UNG to meet its investment objective of tracking percentage changes in the price of the benchmark futures contract. However, UNG has been forced to consider other investment alternatives in order to avoid violating these new limits and to avoid regulatory action," the fund wrote at the time.

The most recent 8-K filing also contains much of the same language UNG included in its 8-K filing on Aug. 12, especially concerning the increased counterparty credit risk and tracking error the fund will likely experience in the wake of adding more over-the-counter derivative and other non-U.S. exchange-traded energy products. However, the filing added the key language from CFO Howard Mah: "UNG's management has determined that UNG may need to invest a larger portion, or potentially all, of its investments in Other Natural Gas-Related Investments in order to continue to meet its investment objective and comply with these regulatory changes."

One New York-based analyst does not believe UNG would fully exit the Nymex futures ring, but he acknowledged that the fund will be exposed to more risk in the months ahead. "Today's filing was kind of like the health warning on cigarette packages. UNG was largely reiterating the counterparty credit risk and potential tracking error that the fund will likely experience in the future as less of its holdings are in exchange-traded futures. It's no secret UNG has been moving more to swaps," he told NGI.

"I really doubt UNG will abandon futures entirely, or will even be forced to, since the fund does provide a measure of liquidity," the analyst continued. "But this is a major victory for the CFTC, since their goal was to curb what it perceived to be speculative trading in the first place, and if UNG liquidates even more (futures) contracts, that's one step closer to their goal."

UNG currently has 34% of its $4.1 billion net asset value holdings in the November 2009 Nymex natural gas futures contract, 30% in the IntercontinentalExchange (ICE) November 2009 cleared swap contract, and 15% in the November 2009 Nymex cleared swap contract. The remaining 21% is invested in over-the-counter total return swaps.

Compounding the issue for UNG is that it may be experiencing difficulty in locating counterparties with which to enter into over-the-counter swap deals (see NGI, Oct. 12). "So, if UNG wants to sell more futures contracts, it may not have many viable options in which to place the proceeds. That may cause the size of the fund to shrink over time, everything else being equal," the analyst warned. UNG has been able to enter into only one small over-the-counter swap contract since the fund made that a condition for issuing new limited partner units beginning Sept. 28 (see NGI, Sept. 21).

UNG's future holdings of products on the Nymex and ICE exchanges will no doubt hinge on the actions of the CFTC. However, the CFTC has set no concrete deadline on when it would issue any new rules on speculative trading positions for exchange-traded energy products. "Commissioner [Gary] 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 last week.

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