Risks Associated With Investing Directly or Indirectly in Natural Gas
Investing in Natural Gas Interests subjects the Fund to the risks of the natural gas market, and this could result in substantial fluctuations in the price of the Fund’s Shares.
The Fund is subject to the risks and hazards of the natural gas market because it invests in Natural Gas Interests. The risks and hazards that are inherent in the natural gas market may cause the price of natural to fluctuate widely. If the changes in percentage terms of the Fund’s Shares accurately track the percentage changes in the Benchmark or the spot price of natural gas, then the price of its Shares will fluctuate accordingly.
The exploration for, and production of, natural gas is an uncertain process with many risks. The costs of drilling, completing and operating wells for natural gas is often uncertain, and a number of factors can delay or prevent drilling operations or production, including but not limited to: Unexpected drilling conditions; pressure or irregularities in formations; equipment failures or repairs; fires or other accidents; pipeline ruptures or spills; shortages or delays in the availability of drilling rigs and the delivery of equipment; adverse weather conditions; political conflicts; compliance with government regulations; and environmental hazards, including natural gas leaks, ruptures and discharges of toxic gases.
Natural gas production and distribution is primarily centralized to North America due to the limited means of transporting natural gas (i.e., natural gas is most efficiently transported through pipelines, although it can be liquefied and then transported outside of the pipeline distribution). Consequently, regulations on the production and distribution of natural gas are primarily concentrated in the United States, Canada and Mexico. Regulations by countries outside North America generally have little impact on the spot price of natural gas.
Natural gas production is subject to U.S. federal, state, and local policies and regulations that materially affect operations. Matters regulated include discharge permits for drilling operations, drilling and abandonment bonds, reports concerning operations, the spacing of wells and pooling of properties and taxation. At various times, regulatory agencies have imposed price controls and limitations on production. In order to conserve supplies of natural gas, these agencies have restricted the rates of flow of natural gas wells below actual production capacity. Federal, state and local laws regulate production, handling, storage, transportation and disposal of natural gas, by-products from natural gas and other substances and materials produced or used in connection with natural gas operations.
Natural gas transmission, distribution, gathering, and processing activities involve numerous risks that may affect the price of natural gas.
There are a variety of hazards inherent in natural gas transmission, distribution, gathering and processing, such as leaks, explosions, pollution, release of toxic substances, adverse weather conditions (such as hurricanes and flooding), pipeline failure, abnormal pressures, uncontrollable flows of natural gas, scheduled and unscheduled maintenance, physical damage to the gathering or transportation system, and other hazards which could affect the price of natural gas. To the extent these hazards limit the supply or delivery of natural gas, natural gas prices will increase.
The price of natural gas may fluctuate on a seasonal and quarterly basis and this would result in fluctuations in the price of the Fund’s Shares.
Natural gas prices fluctuate seasonally. For example, in some parts of the United States and other markets, the natural gas demand for power peaks during the cold winter months, with market prices peaking at that time. As a result, in the future, the overall price of natural gas may fluctuate substantially on a seasonal and quarterly basis and thus make consecutive period to period comparisons less relevant.
Natural gas transmission and storage operations are subject to government regulations and rate proceedings which could have an impact on the price of natural gas.
Natural gas transmission and storage operations in North America are subject to regulation and oversight by the Federal Energy Regulatory Commission, various state regulatory agencies, and Canadian regulatory authorities. These regulatory bodies have the authority to effect rate settlements on natural gas storage, transmission and distribution services. As a consequence, the price of natural gas may be affected by a change in the rate settlements effected by one or more of these regulatory bodies.
The limited method for transporting and storing natural gas may cause the price of natural gas to increase.
Natural gas is primarily transported and stored throughout the United States by way of pipeline and underground storage facilities. These systems may not be adequate to meet demand, especially in times of peak demand or in areas of the United States where natural gas service is already limited due to minimal pipeline and storage infrastructure. As a result of the limited method for transporting and storing natural gas, the price of natural gas may fluctuate.
The Benchmark is not designed to correlate exactly with the spot price of natural gas and this could cause the changes in the price of the Shares to substantially vary from the changes in the spot price of natural gas. Therefore, you may not be able to effectively use the Fund to hedge against natural gas-related losses or to indirectly invest in natural gas.
The Benchmark Component Futures Contracts reflect the price of natural gas for future delivery, not the current spot price of natural gas, so at best the correlation between changes in such Natural Gas Futures Contracts and the spot price of natural gas will be only approximate. Weak correlation between the Benchmark and the spot price of natural gas may result from the typical seasonal fluctuations in natural gas prices discussed above. Imperfect correlation may also result from speculation in Natural Gas Interests, technical factors in the trading of Natural Gas Futures Contracts, and expected inflation in the economy as a whole. If there is a weak correlation between the Benchmark and the spot price of natural gas, then the price of Shares may not accurately track the spot price of natural gas and you may not be able to effectively use the Fund as a way to hedge the risk of losses in your natural gas-related transactions or as a way to indirectly invest in natural gas.
Changes in the Fund’s NAV may not correlate well with changes in the price of the Benchmark. If this were to occur, you may not be able to effectively use the Fund as a way to hedge against natural gas-related losses or as a way to indirectly invest in natural gas.
The Sponsor endeavors to invest the Fund’s assets as fully as possible in Natural Gas Interests so that the changes in percentage terms in the NAV closely correlate with the changes in percentage terms in the Benchmark. However, changes in the Fund’s NAV may not correlate with the changes in the Benchmark for various reasons, including those set forth below:
• The Fund does not intend to invest only in the Benchmark Component Futures Contracts. While its investments in Natural Gas Futures Contracts other than the Benchmark Component Futures Contracts, Cleared Natural Gas Swaps and Other Natural Gas Interests would be for the purpose of causing the Fund’s performance to track that of the Benchmark most effectively and efficiently, the performance of these Natural Gas Interests may not correlate well with the performance of the Benchmark Component Futures Contracts, resulting in a greater potential for error in tracking price changes in those futures contracts. Additionally, if the trading market for Natural Gas Futures Contracts is suspended or closed, the Fund may not be able to purchase these investments at the last reported price for such investments.
• The Fund will incur certain expenses in connection with its operations, and will hold most of its assets in income-producing, short-term securities for margin and other liquidity purposes and to meet redemptions that may be necessary on an on-going basis. These expenses and income will cause imperfect correlation between changes in the Fund’s NAV and changes in the Benchmark.
• The Sponsor may not be able to invest the Fund’s assets in Natural Gas Interests having an aggregate notional amount exactly equal to the Fund’s NAV. As a standardized contract, a single Natural Gas Futures Contract or Cleared Natural Gas Swap is for a specified amount of natural gas, and the Fund’s NAV and the proceeds from the sale of a Creation Basket is unlikely to be an exact multiple of that amount. In such case, the Fund could not invest the entire proceeds from the purchase of the Creation Basket in such futures contracts. (For example, assuming the Fund receives $1,250,000 for the sale of a Creation Basket and that the value (i.e., the notional amount) of a Natural Gas Futures Contract is $42,000, the Fund could only enter into 29 Natural Gas Futures Contracts with an aggregate value of $1,218,000). While the Fund may be better able to achieve the exact amount of exposure to the natural gas market through the use of over-the-counter Other Natural Gas Interests, there is no assurance that the Sponsor will be able to continually adjust the Fund’s exposure to such Other Natural Gas Interests to maintain such exact exposure. Furthermore, as noted above, the use of Other Natural Gas Interests may itself result in imperfect correlation with the Benchmark. Any amounts not invested in Natural Gas Interests will be held in Treasury Securities, cash and/or cash equivalents.
• As Fund assets increase, there may be more or less correlation. On the one hand, as the Fund grows it should be able to invest in Natural Gas Futures Contracts with a notional amount that is closer on a percentage basis to the Fund’s NAV. For example, if the Fund’s NAV is equal to 4.9 times the value of a single futures contract, it can purchase only four futures contracts, which would cause only 81.6% of the Fund’s assets to be exposed to the natural gas market. On the other hand, if the Fund’s NAV is equal to 100.9 times the value of a single Natural Gas Futures Contract, it can purchase 100 such contracts, resulting in 99.1% exposure. However, at certain asset levels the Fund may be limited in its ability to purchase Natural Gas Futures Contracts due to applicable accountability levels and position limits. In these instances, the Fund would likely invest to a greater extent in Natural Gas Interests not subject to these accountability levels and position limits. To the extent that the Fund invests in Cleared Natural Gas Swaps and Other Natural Gas Interests, the correlation between the Fund’s NAV and the Benchmark may be lower. In certain circumstances, accountability levels and position limits could limit the number of Creation Baskets that will be sold.
If changes in the Fund’s NAV do not correlate with changes in the Benchmark, then investing in the Fund may not be an effective way to hedge against natural gas-related losses or indirectly invest in natural gas.
Changes in the price of the Fund’s Shares on the NYSE Arca may not correlate perfectly with changes in the NAV of the Fund’s Shares. If this variation occurs, then you may not be able to effectively use the Fund to hedge against natural gas-related losses or to indirectly invest in natural gas.
While it is expected that the trading prices of the Shares will fluctuate in accordance with the changes in the Fund’s NAV, the prices of Shares may also be influenced by other factors, including the supply of and demand for the Shares, whether for the short term or the longer term. There is no guarantee that the Shares will not trade at appreciable discounts from, and/or premiums to, the Fund’s NAV. This could cause the changes in the price of the Shares to substantially vary from the changes in the spot price of natural gas, even if the Fund’s NAV was closely tracking movements in the spot price of natural gas. If this occurs, you may not be able to effectively use the Fund to hedge the risk of losses in your natural gas-related transactions or to indirectly invest in natural gas.
The Fund may experience a loss if it is required to sell Treasury Securities or cash equivalents at a price lower than the price at which they were acquired.
If the Fund is required to sell Treasury Securities or cash equivalents at a price lower than the price at which they were acquired, the Fund will experience a loss. This loss may adversely impact the price of the Shares and may decrease the correlation between the price of the Shares, the Benchmark, and the spot price of natural gas. The value of Treasury Securities and other debt securities generally moves inversely with movements in interest rates. The prices of longer maturity securities are subject to greater market fluctuations as a result of changes in interest rates. While the short-term nature of the Fund’s investments in Treasury Securities and cash equivalents should minimize the interest rate risk to which the Fund is subject, it is possible that the Treasury Securities and cash equivalents held by the Fund will decline in value.
Certain of the Fund’s investments could be illiquid, which could cause large losses to investors at any time or from time to time.
The Fund may not always be able to liquidate its positions in its investments at the desired price. As to futures contracts, it may be difficult to execute a trade at a specific price when there is a relatively small volume of buy and sell orders in a market. Limits imposed by futures exchanges or other regulatory organizations, such as accountability levels, position limits and price fluctuation limits, may contribute to a lack of liquidity with respect to some exchange traded Natural Gas Interests. In addition, over-the-counter contracts and cleared swaps may be illiquid because they are contracts between two parties and generally may not be transferred by one party to a third party without the counterparty’s consent. Conversely, a counterparty may give its consent, but the Fund still may not be able to transfer an over-the-counter Natural Gas Interest to a third party due to concerns regarding the counterparty’s credit risk.
A market disruption, such as a foreign government taking political actions that disrupt the market in its currency, its natural gas production or exports, or in another major export, can also make it difficult to liquidate a position. Unexpected market illiquidity may cause major losses to investors at any time or from time to time. In addition, the Fund does not intend at this time to establish a credit facility, which would provide an additional source of liquidity, but instead will rely only on the Treasury Securities, cash and/or cash equivalents that it holds to meet its liquidity needs. The anticipated large value of the positions in Natural Gas Interests that the Sponsor will acquire or enter into for the Fund increases the risk of illiquidity. Because Natural Gas Interests may be illiquid, the Fund’s holdings may be more difficult to liquidate at favorable prices in periods of illiquid markets and losses may be incurred during the period in which positions are being liquidated.
If the nature of the participants in the futures market shifts such that natural gas purchasers are the predominant hedgers in the market, the Fund might have to reinvest at higher futures prices or choose Other Natural Gas Interests.
The changing nature of the participants in the natural gas market will influence whether futures prices are above or below the expected future spot price. Natural gas producers and distributors will typically seek to hedge against falling natural gas prices by selling Natural Gas Futures Contracts. Therefore, if natural gas producers and distributors become the predominant hedgers in the futures market, prices of Natural Gas Futures Contracts will typically be below expected future spot prices. Conversely, if the predominant hedgers in the futures market are the purchasers of natural gas who purchase Natural Gas Futures Contracts to hedge against a rise in prices, the prices of Natural Gas Futures Contracts will likely be higher than expected future spot prices. This can have significant implications for the Fund when it is time to sell a Natural Gas Futures Contract that is no longer a Benchmark Component Futures Contract and purchase a new Natural Gas Futures Contract or to sell a Natural Gas Futures Contract to meet redemption requests.
While the Fund does not intend to take physical delivery of natural gas under its Natural Gas Interests, the possibility of physical delivery impacts the value of the contracts.
While it is not the current intention of the Fund to take physical delivery of natural gas under its Natural Gas Interests, Natural Gas Futures Contracts are traditionally not cash-settled contracts, and it is possible to take delivery under these and some Other Natural Gas Interests. Storage costs associated with purchasing natural gas could result in costs and other liabilities that could impact the value of Natural Gas Futures Contracts or certain Other Natural Gas Interests. Storage costs include the time value of money invested in natural gas as a physical commodity plus the actual costs of storing the natural gas less any benefits from ownership of natural gas that are not obtained by the holder of a futures contract. In general, Natural Gas Futures Contracts have a one-month delay for contract delivery and the pricing of back month contracts (the back month is any future delivery month other than the spot month) includes storage costs. To the extent that these storage costs change for natural gas while the Fund holds Natural Gas Interests, the value of the Natural Gas Interests, and therefore the Fund’s NAV, may change as well.
The price relationship between the Benchmark Component Futures Contracts at any point in time and the Natural Gas Futures Contacts that will become Benchmark Component Futures Contracts on the next roll date will vary and may impact both the Fund’s total return and the degree to which its total return tracks that of natural gas price indices.
The design of the Fund’s Benchmark is such that the Benchmark Component Futures Contracts will change four times per year, and the Fund’s investments must be rolled periodically to reflect the changing composition of the Benchmark. For example, when the second-to-expire Natural Gas Futures Contract becomes the first-to-expire contract, such contract will no longer be a Benchmark Component Futures Contract and the Fund’s position in it will no longer be consistent with tracking the Benchmark. In the event of a Natural Gas futures market where near-to-expire contracts trade at a higher price than longer-to-expire contracts, a situation referred to as “backwardation,” then absent the impact of the overall movement in natural gas prices the value of the Benchmark Component Futures Contracts would tend to rise as they approach expiration. As a result the Fund may benefit because it would be selling more expensive contracts and buying less expensive ones on an on-going basis. Conversely, in the event of a natural gas futures market where near-to-expire contracts trade at a lower price than longer-to-expire contracts, a situation referred to as “contango,” then absent the impact of the overall movement in natural gas prices the value of the Benchmark Component Futures Contracts would tend to decline as they approach expiration. As a result the Fund’s total return may be lower than might otherwise be the case because it would be selling less expensive contracts and buying more expensive ones. The impact of backwardation and contango may lead the total return of the Fund to vary significantly from the total return of other price references, such as the spot price of natural gas. In the event of a prolonged period of contango, and absent the impact of rising or falling natural gas prices, this could have a significant negative impact on the Fund’s NAV and total return.
Regulation of the commodity interests and commodity markets is extensive and constantly changing; future regulatory developments are impossible to predict but may significantly and adversely affect the Fund.
The regulation of futures contracts and futures exchanges has historically been comprehensive. The CFTC and the exchanges are authorized to take extraordinary actions in the event of a market emergency, including, for example, the retroactive implementation of speculative position limits or higher margin requirements, the establishment of daily price limits and the suspension of trading.
The regulation of commodity interest transactions in the United States is a rapidly changing area of the law and is subject to on-going modification by governmental and judicial action. Considerable regulatory attention has recently been focused on both over-the-counter commodity interests and non-traditional publicly distributed investment pools such as the Fund, and a number of proposals that would alter the regulation of Natural Gas Interests are being considered by federal regulators and Congress. These proposals include the extension of position and accountability limits to futures contracts on non-U.S. exchanges and to over-the-counter commodity interests previously exempt from such limits, and the forced use of certain clearinghouse mechanisms for all over-the-counter transactions. There is a possibility that future regulatory changes would result in changes, perhaps to a material extent, to the nature of an investment in the Fund and the investments that may be available to the Fund, and that could affect the ability of the Fund to continue to implement its investment strategy. In addition, various national governments have expressed concern regarding the disruptive effects of speculative trading in certain commodity markets and the need to regulate the derivatives markets in general. The effect of any future regulatory change on the Fund is impossible to predict, but could be substantial and adverse.
On July 21, 2010, “The Dodd-Frank Wall Street Reform and Consumer Protection Act” was signed into law. It includes provisions altering the regulation of commodity interests. Provisions in the new law include the requirement that position limits on energy-based commodity futures contracts be established; new registration, recordkeeping, capital and margin requirements for “swap dealers” and “major swap participants”; and the forced use of clearing house mechanisms for most over-the-counter transactions. Additionally, the new law requires the aggregation, for purposes of position limits, of all positions in energy futures held by a single entity and its affiliates, whether such positions exist on U.S. futures exchanges, non-U.S. futures exchanges, or in over-the-counter contracts. The CFTC, along with the SEC and other federal regulators, has been tasked with developing the rules and regulations enacting the provisions noted above. The new law and rules to be promulgated may negatively impact the Fund’s ability to meet its investment objective either through limits or requirements imposed on it or upon its counterparties. In particular, new position limits imposed on the Fund or its counterparty may impact the Fund’s ability to invest in a manner that most efficiently meets its investment objective, and new requirements, including capital and mandatory clearing, may increase the cost of the Fund’s investments and doing business.
If you are investing in the Fund for purposes of hedging, you might be subject to several risks, including the possibility of losing the benefit of favorable market movements.
Participants in the natural gas industry may use the Fund as a vehicle to hedge the risk of losses in their natural gas-related transactions. There are several risks in connection with using the Fund as a hedging device. While hedging can provide protection against an adverse movement in market prices, it can also preclude a hedger’s opportunity to benefit from a favorable market movement. For instance, in a hedging transaction the hedger may be a user of a commodity concerned that the hedged commodity will increase in price, but must recognize the risk that the price may instead decline. If this happens, the hedger will have lost the benefit of being able to purchase the commodity at the lower price because the hedging transaction will result in a loss that would offset (at least in part) this benefit. Thus, the hedger forgoes the opportunity to profit from favorable price movements. In addition, if the hedge is not a perfect one, the hedger can lose on the hedging transaction and not realize an offsetting gain in the value of the underlying item being hedged.
When using Natural Gas Interests as a hedging technique, at best, the correlation between changes in prices of futures contracts and of the items being hedged can be only approximate. The degree of imperfection of correlation depends upon circumstances such as: variations in speculative markets, demand for futures and for natural gas products, technical influences in futures trading, and differences between anticipated costs being hedged and the instruments underlying the standard futures contracts available for trading. Even a well-conceived hedge may be unsuccessful to some degree because of unexpected market behavior as well as the expenses associated with creating the hedge.
In addition, using an investment in the Fund as a hedge for changes in energy costs generally may not be successful because changes in the price of natural gas may vary substantially from changes in the prices of other energy-related products. In addition, the price of natural gas and the Fund’s NAV would not reflect the refining, transportation, and other costs that are specific to the hedger.
An investment in the Fund may provide you little or no diversification benefits. Thus, in a declining market, the Fund may have no gains to offset your losses from other investments, and you may suffer losses on your investment in the Fund at the same time you incur losses with respect to other asset classes.
Historically, Natural Gas Interests have not generally been correlated to the performance of other asset classes such as stocks and bonds. Non-correlation means that there is a low statistical relationship between the performance of Natural Gas Interests, on the one hand, and stocks or bonds, on the other hand. However, there can be no assurance that such non-correlation will continue during future periods. If, contrary to historic patterns, the Fund’s performance were to move in the same general direction as the financial markets, you will obtain little or no diversification benefits from an investment in the Shares. In such a case, the Fund may have no gains to offset your losses from other investments, and you may suffer losses on your investment in the Fund at the same time you incur losses with respect to other investments.
Variables such as floods, weather, embargoes, tariffs and other political events may have a larger impact on natural gas and Natural Gas Interest prices than on traditional securities. These additional variables may create additional investment risks that subject the Fund’s investments to greater volatility than investments in traditional securities.
Non-correlation should not be confused with negative correlation, where the performance of two asset classes would be opposite of each other. There is no historic evidence that the spot price of natural gas and prices of other financial assets, such as stocks and bonds, are negatively correlated. In the absence of negative correlation, the Fund cannot be expected to be automatically profitable during unfavorable periods for the stock market, or vice versa.
NAGS has no operating history, so there is no performance history to serve as a basis for you to evaluate an investment in the Trust. Investing in Natural Gas Interests subjects NAGS to the risks of the natural gas market, and this could result in substantial fluctuations in the price of NAGS’ shares. Unlike mutual funds, NAGS generally will not distribute dividends to Shareholders.
Investors may choose to use NAGS as a means of investing indirectly in natural gas or as a vehicle to hedge against the risk of loss, and there are risks involved in such investments and activities. The Sponsor has limited experience in operating a commodity pool, which is defined as an enterprise in which several individuals contribute funds in order to trade futures or futures options collectively.
Commodities and futures generally are volatile and are not suitable for all investors.
The Teucrium Natural Gas Fund is not a mutual fund or any other type of Investment Company within the meaning of the Investment Company Act of 1940, as amended, and is not subject to regulation thereunder.
Shares of the Teucrium Natural Gas Fund are not FDIC insured, may lose value, and have no bank guarantee.
All supporting documentation will be provided upon request.
Foreside Fund Services, LLC is the distributor for the Teucrium Natural Gas Fund.
© 2012 TEUCRIUM TRADING, LLC All rights reserved.