The No-Brainer Natural Gas Investment?

Natural gas is the hip commodity on Wall Street these days, and many investors are clamoring for a piece of the action. The problem is that the energy sector is daunting and complex. The same market shift that sends one stock skyrocketing can send others to new lows.

The "get rich quick" devil on your shoulders may suggest a few easy ways out: natural gas ETFs and ETNs. While these can act as valuable hedging devices and can be better for investors holding the commodity directly, you'd be wrong to think of the following options as home runs in the natural gas revolution.

The bad
United States Natural Gas
(NYS: UNG) , iPath Seasonal Natural GasETN (NYS: DCNG) , and Teucrium Natural Gas Fund (NYS: NAGS) are three vehicles that invest in natural gas futures contracts. UNG focuses on near-month contracts, DCNG tracks an Index with an annual contract, and NAGS splits the difference by investing in the four most liquid contract months of the year.

What this means is that each instrument rolls its natural gas contract positions forward at certain points in the year and picks up new contracts for the next period. For United States Natural Gas, this is a monthly ritual, but for Tucrium's ETF it happens only four times a year.

These may seem like a no-brainer, passive way to get a piece of the natural gas revolution, but there are inherent problems. The first is contango. When the price of a far-off contract exceeds that of the "front-month" contract, these funds lose money because futures prices must move to match the spot price and therefore underperform the commodity. However, these vehicles must sell their positions to purchase another contract further into the future to avoid actual delivery -- an unprofitable Catch-22. This has been a particular problem with natural gas, because prices of the commodity have been consistently falling lately. The following chart shows the 10-year volatility of natural gas prices.


Another problem is structure. Many of these vehicles are LLCs, so investors get a K-1 instead of a 1099 each year. Complicated tax handling with these instruments also makes recording gains a big headache. Fortunately for current investors, there are no gains to report. In addition, ETNs, or exchange-traded notes, do not carry the same repayment structure that ETFs do. If the ETN provider goes belly-up, then investors are left empty-handed. The fact that the best-performing of these three instruments, iPaths ETN, has fallen by only 45% in the past six months should be a red flag as well.

The good
If this has scared you away from investing in natural gas, it shouldn't. Instead, take it as a caution against the seemingly "no-brainer" natural gas plays, and do your research about individual companies instead. There are incredible opportunities for the astute and amateur energy investor alike in this industry, and here are just a few.

First, Westport Innovations (NAS: WPRT) has been a Motley Fool favorite for a little while now, and for good reason. The stock has risen 143% in the past 12 months, and it has the legs to run. The company specializes in converting diesel engines to run on natural gas. With advancements in fracking upping the natural gas supply, the energy source remains cheap. As oil continues to rise, natural gas becomes an increasingly more economical fuel source, especially for a fuel-dependent sector like trucking.

Which brings us to another great pick: Clean Energy Fuels (NAS: CLNE) . This company develops natural gas fueling stations in the United States and Canada. This is a huge win for one of its target markets: truckers. Converting to natural gas can save these companies up to 40% of their fuel costs compared with oil and keep them competitive against the rails as an affordable method of shipping. Not only that, but also the huge number of garbage trucks -- notably those from Waste Management -- that are converting to natural gas serves as further vindication that this can be a viable fuel source.

The best
As good as these natural gas stocks are, there is one energy stock that could be even better. In fact, it could be The Only Energy Stock You'll Ever Need. It's a well-positioned equipment provider that's poised to make investors today rich off the next energy spike. Read more about it.

At the time thisarticle was published Austin Smith owns no shares of the companies mentioned here. The Motley Fool owns shares of Waste Management.Motley Fool newsletter serviceshave recommended buying shares of Clean Energy Fuels, Waste Management, and Westport Innovations and creating a write covered strangle position in Waste Management. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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