filmfoto The ProShares Ultra Bloomberg Natural Gas ETF (NYSEARCA:BOIL) combines the worst features of a ‘rolling’ futures fund and a levered ETF. It suffers from futures roll decay, as well as volatility decay. The combination of these two features has caused the fund to lose an average of 41% p.a. despite natural gas prices doubling over the past decade. Investors should stay away from BOIL unless they want to express a short-term bullish view on natural gas prices. Fund Overview The ProShares Ultra Bloomberg Natural Gas ETF seeks daily returns that are 2x the return of the Bloomberg Natural Gas Subindex (“Index”). The index reflects the daily performance of a rolling position in front-month natural gas futures. As the expiry date for the futures contract approaches, the index replaces expiring contracts with later expirations. The BOIL ETF is a favourite among day traders, with over $500 million in net assets. It charges an expense ratio of 0.95%. Whatever You Do, Don’t Buy And Hold The first thing investors should realize about the BOIL ETF is that due to its rolling position in natural gas futures, the BOIL ETF should only be used to speculate on short-term moves in natural gas futures prices. For example, Figure 1 shows the long-term historical returns of the BOIL ETF, to November 30, 2022. Notice that aside from the short-term period of 1 Year, the ETF has annualized losses ranging -22.4% on 3Yr to -41.3% on 10Yr. If an investor invested $100 into BOIL 10 years ago, that investment would be worth $0.49! Figure 1 – BOIL historical returns (proshares.com) In contrast, spot natural gas prices at the end of November 2022 were $6.93, almost a double from $3.58 at the end of November 2012 (Figure 2). Figure 2 – Long term natural gas spot prices (stockcharts.com) Futures Typically Lose Value During Roll Unlike exchange traded precious metals funds like the SPDR Gold Trust (GLD) that holds physical gold bars stored in bank vaults, the BOIL ETF does not hold physical natural gas. Instead, BOIL holds natural gas futures and cash (Figure 3). Figure 3 – BOIL ETF holdings (proshares.com) Every time its futures holdings expire, the BOIL ETF must sell the expiring futures (in the example above, the March 2023 Futures) and buy futures with a longer time to expiry. Commodity futures are typically in contango, where longer-dated futures are higher in price. So the BOIL ETF loses value during most futures ‘roll’ when they sell ‘cheap’ expiring futures and buy ‘expensive’ futures further out (Figure 4). Figure 4 – Illustrative contango chart (cmegroup.com) Daily Leverage Introduces Volatility Decay Another feature of the BOIL ETF is its 2x daily leverage. Levered ETFs have two key features that investors should be aware of. First, they have ‘positive convexity’ in the direction of the bet. What this means is that one’s exposure to a given underlying asset grows if the price action is in one’s favour. For example, assume you invested $100 in BOIL. If the underlying index returns 5% on day 1, the position will grow to $110 (2 times 5% return). If the index returns 5% again on day 2, the position will grow to $121. This is more than twice the theoretical 2-day compounded return of 10.25% or $120.50. If the return experience is +5% followed by -5%, investors end up with $99.00, significantly less than twice the 2-day compounded loss of 0.25% or $99.50. This slippage is due to ‘volatility decay’, a second feature of levered ETFs. While the ‘volatility decay’ may seem small on a 1-day basis, over the long-run, this can turn into very significant underperformance, especially for a volatile asset class like natural gas futures. The BOIL ETF combines the ‘roll decay’ of a rolling-futures fund with the ‘volatility decay’ of a levered ETF. No wonder it has a 10Yr average annual return of -41.3%! Natural Gas Needs More Time As I wrote in a recent article on the United States Natural Gas Fund (UNG), December to February is typically not a good time to be a natural gas investor (Figure 5). Figure 5 – Natural gas seasonality (equityclock.com) This is because investors tend to bet on the upcoming winter gas demand between September to November, and then by December, investors have a good sense of whether there is sufficient gas in storage to last the winter and prices start to come back to earth. This year, unusually warm weather in the U.S. and Europe have allowed gas storage to build, with European gas storage currently above 80% full and U.S. gas storage trending near 5-Year averages (Figure 6). Figure 6 – U.S. natural gas in storage (EIA) This has caused natural gas spot prices to plummet, from over $10 in September to $4 recently (Figure 7). Figure 7 – Natural gas spot price (stockcharts.com) In my opinion, investors wishing to speculate in natural gas prices may have to wait until the spring, when speculators start betting on summer gas demand (to fuel air conditioners). Risks To My Call Of course, the biggest risk to my cautious call is simply the volatility of the asset class. Natural gas spot prices can easily rise or fall 5-10% a day, so one can easily be offsides when betting with a leveraged ETF like BOIL. Another wildcard to U.S. natural gas prices is the status of the Freeport LNG plant. Freeport LNG represents 15% of U.S. LNG export capacity and had been out of commission since the summer. Investors were speculating that the plant would be up and running by the end of December, but I was more sceptical. In my UNG note, I wrote: However, the latest update on the facility has now pushed the restart timeline to the end of the year due to regulatory delays. With the upcoming holiday season, I would not be surprised if the restart is pushed further out into 2023. Since Freeport LNG expects to ramp up in a slow and deliberate manner, even if the latest timeline is accurate, it will not reach 85% nameplate capacity until sometime in mid-January. Indeed, the actual restart timeline, as recently reported, is even slower than I had anticipated: Given the time needed for the regulatory agencies to review the company’s responses and to seek any necessary clarification, Freeport LNG now does not anticipate commencing the initial restart of its liquefaction facility until the second half of January 2023. If the plant recommences liquefaction in the second half of January, then it will likely not reach nameplate capacity until sometime in February. Conclusion In summary, the BOIL ETF combines the worst features of a ‘rolling’ futures fund and a levered ETF. It suffers from futures roll decay, as well as volatility decay. That is the primary reason why over 10 years, the fund has lost an average of 41% p.a., despite spot natural gas prices actually doubling. For most investors, I would recommend they stay away from the BOIL ETF.
