UNITED STATES NATURAL GAS FUND, LP
10-Ks and 10-Qs
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
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x
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Quarterly
report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the quarterly period ended March 31,
2010.
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OR
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¨
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Transition
report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the transition period
from to .
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Commission
File Number: 001-33096
United
States Natural Gas Fund, LP
(Exact
name of registrant as specified in its charter)
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Delaware
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20-5576760
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(State
or other jurisdiction of
incorporation
or organization)
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(I.R.S.
Employer
Identification
No.)
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1320
Harbor Bay Parkway, Suite 145
Alameda,
California 94502
(Address
of principal executive offices) (Zip code)
(510)
522-9600
(Registrant’s
telephone number, including area code)
N/A
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
x
Yes
¨
No
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
¨
Yes
¨
No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
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Large
accelerated filer
x
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Accelerated
filer
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¨
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Non-accelerated
filer
¨
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Smaller
reporting company
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¨
|
|
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(Do
not check if a smaller reporting
company)
|
|||
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
¨
Yes
x
No
UNITED
STATES NATURAL GAS FUND, LP
Table
of Contents
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Page
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Part
I. FINANCIAL INFORMATION
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||
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Item
1. Condensed Financial Statements.
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1
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Item
2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations.
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17
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Item
3. Quantitative and Qualitative Disclosures About Market
Risk.
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35
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Item
4. Controls and Procedures.
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37
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Part
II. OTHER INFORMATION
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||
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Item
1. Legal Proceedings.
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38
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Item
1A. Risk Factors.
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38
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Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
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38
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Item
3. Defaults Upon Senior Securities.
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38
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Item
4. Reserved.
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38
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Item
5. Other Information.
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38
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Item
6. Exhibits.
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38
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Index
to Condensed Financial Statements
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Documents
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Page
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Condensed
Statements of Financial Condition at March 31, 2010 (Unaudited) and
December 31, 2009
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2
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Condensed
Schedule of Investments (Unaudited) at March 31, 2010
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3
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Condensed
Statements of Operations (Unaudited) for the three months ended March 31,
2010 and 2009
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5
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Condensed
Statement of Changes in Partners’ Capital (Unaudited) for the three months
ended March 31, 2010
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6
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Condensed
Statements of Cash Flows (Unaudited) for the three months ended March 31,
2010 and 2009
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7
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Notes
to Condensed Financial Statements for the period ended March 31, 2010
(Unaudited)
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8
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1
United
States Natural Gas Fund, LP
At
March 31, 2010 (Unaudited) and December 31, 2009
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March 31, 2010
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December 31, 2009
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|||||||
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Assets
|
||||||||
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Cash
and cash equivalents (Note 5)
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$ | 2,648,168,231 | $ | 3,896,493,193 | ||||
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Equity
in UBS Securities LLC trading accounts:
|
||||||||
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Cash
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470,318,455 | 733,693,664 | ||||||
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Unrealized
loss on open commodity futures and cleared swap contracts
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(143,372,125 | ) | (41,777,265 | ) | ||||
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Unrealized
loss on open swap contracts
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(58,141,269 | ) | (39,408,688 | ) | ||||
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Investment
receivable
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109,657,245 | - | ||||||
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Receivable
for units sold
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20,987,055 | - | ||||||
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Interest
receivable
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55,849 | 110,235 | ||||||
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Other
assets
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293,327 | 192,758 | ||||||
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Total
assets
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$ | 3,047,966,768 | $ | 4,549,303,897 | ||||
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Liabilities
and Partners’ Capital
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||||||||
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Investment
payable
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$ | - | $ | 19,112,096 | ||||
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Swap
premiums received
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230,574,218 | - | ||||||
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General
Partner management fees payable (Note 3)
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1,448,701 | 1,918,167 | ||||||
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Interest
payable
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- | 20,751 | ||||||
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Professional
fees payable
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2,553,622 | 2,609,981 | ||||||
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Brokerage
commission fees payable
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240,250 | 256,250 | ||||||
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License
fees payable
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222,608 | 231,345 | ||||||
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Directors’
fees payable
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47,201 | 48,144 | ||||||
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Total
liabilities
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235,086,600 | 24,196,734 | ||||||
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Commitments and Contingencies
(Notes 3, 4 and 5)
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||||||||
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Partners'
Capital
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||||||||
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General
Partner
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- | - | ||||||
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Limited
Partners
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2,812,880,168 | 4,525,107,163 | ||||||
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Total
Partners' Capital
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2,812,880,168 | 4,525,107,163 | ||||||
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Total
liabilities and partners' capital
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$ | 3,047,966,768 | $ | 4,549,303,897 | ||||
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Limited
Partners' units outstanding
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407,500,000 | 449,500,000 | ||||||
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Net
asset value per unit
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$ | 6.90 | $ | 10.07 | ||||
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Market
value per unit
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$ | 6.91 | $ | 10.08 | ||||
See accompanying notes to condensed
financial statements.
2
United
States Natural Gas Fund, LP
Condensed
Schedule of Investments (Unaudited)
At
March 31, 2010
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Number of
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Loss on Open
Commodity
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% of
Partners' |
||||||||||
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Contracts
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Contracts
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Capital
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||||||||||
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Open
Cleared Swap Contracts
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||||||||||||
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Foreign
Contracts
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||||||||||||
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ICE
Natural Gas Cleared Swap ICE LOT contracts, expire May
2010
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58,485 | $ | (70,748,125 | ) | (2.52 | ) | ||||||
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Open
Futures Contracts
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||||||||||||
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United
States Contracts
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||||||||||||
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NYMEX
Natural Gas Futures NG contracts, expire May 2010
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10,573 | (33,327,070 | ) | (1.18 | ) | |||||||
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NYMEX
Natural Gas Futures NN contracts, expire May 2010
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32,566 | (39,296,930 | ) | (1.40 | ) | |||||||
| 43,139 | (72,624,000 | ) | (2.58 | ) | ||||||||
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Total
Open Cleared Swap and Futures Contracts
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101,624 | $ | (143,372,125 | ) | (5.10 | ) | ||||||
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Principal
Amount
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Market
Value
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|
||||||||||
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Cash
Equivalents
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||||||||||||
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United
States Treasury Obligation
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||||||||||||
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U.S.
Treasury Bill, 0.15%, 4/15/2010
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$ | 200,015,000 | $ | 200,011,888 | 7.11 | |||||||
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United
States - Money Market Funds
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||||||||||||
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Fidelity
Institutional Government Portfolio – Class I
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1,026,105,990 | 1,026,105,990 | 36.48 | |||||||||
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Goldman
Sachs Financial Square Funds – Government Fund – Class SL
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625,274,847 | 625,274,847 | 22.23 | |||||||||
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Morgan
Stanley Institutional Liquidity Fund – Government
Portfolio
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350,097,851 | 350,097,851 | 12.44 | |||||||||
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Total
Money Market Funds
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2,001,478,688 | 71.15 | ||||||||||
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Total
Cash Equivalents
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$ | 2,201,490,576 | 78.26 | |||||||||
See
accompanying notes to condensed financial statements.
3
United
States Natural Gas Fund, LP
Condensed
Schedule of Investments (Unaudited) (Continued)
At
March 31, 2010
Open
Over-the-Counter Total Return Swap Contracts
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Notional
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Premiums
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Market
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Unrealized
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Termination
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|||||||||||||
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Amount
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Received
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Value
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Loss
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Date
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|||||||||||||
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Swap
agreement to receive return on the eXtra US1 Excess Return
Index
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135,942,318 | $ | - | $ | (1,862 | ) | $ | (1,862 | ) |
4/30/2010
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|||||||
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Swap
agreement to receive return on the eXtra US1 Excess Return
Index
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97,189,280 | - | (1,198 | ) | (1,198 | ) |
9/03/2010
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||||||||||
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Swap
agreement to receive return on the Custom
Natural
Gas Index (UNG) – Excess Return
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293,810,569 | - | (4,913 | ) | (4,913 | ) |
4/21/2010
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||||||||||
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Swap
agreement to receive return on the Custom
Natural
Gas Index (UNG)
–
Excess
Return
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99,735,750 | - | (492 | ) | (492 | ) |
6/02/2010
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||||||||||
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Swap
agreement to receive return on the Custom
Natural
Gas Index (UNG)
–
Excess
Return
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18,700,106 | - | (92 | ) | (92 | ) |
6/09/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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158,986,720 | - | (2,281 | ) | (2,281 | ) |
4/23/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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24,277,301 | - | (123 | ) | (123 | ) |
4/26/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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25,664,149 | - | (130 | ) | (130 | ) |
4/27/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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24,267,620 | - | (123 | ) | (123 | ) |
5/06/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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40,563,941 | - | (1,062,028 | ) | (1,062,028 | ) |
5/11/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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50,584,263 | - | (256 | ) | (256 | ) |
5/18/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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32,563,845 | - | (165 | ) | (165 | ) |
5/20/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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40,551,165 | - | (1,061,694 | ) | (1,061,694 | ) |
5/22/2010
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||||||||||
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Swap
agreement to receive return on the NYMEX Henry Hub TRS
Index
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34,629,273 | - | (175 | ) | (175 | ) |
6/03/2010
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||||||||||
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Swap
agreement to receive return on NYMEX
Henry
Hub Natural Gas Futures Contract
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286,630,247 | (31,651,665 | ) | (60,009,348 | ) | (28,358,684 | ) |
8/31/2010
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|||||||||
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Swap
agreement to receive return on NYMEX
Henry
Hub Natural Gas Futures Contract
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241,209,273 | (198,923,554 | ) | (226,570,606 | ) | (27,647,053 | ) |
5/28/2010
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|||||||||
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Total
unrealized loss on open swap contracts
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$ | (58,141,269 | ) | ||||||||||||||
See accompanying notes to condensed
financial statements.
4
United
States Natural Gas Fund, LP
For
the three months ended March 31, 2010 and 2009
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Three months ended
March 31, 2010
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Three months ended
March 31, 2009
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|||||||
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Income
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||||||||
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Loss
on trading of commodity contracts:
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||||||||
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Realized
loss on closed futures contracts
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$ | (465,823,610 | ) | $ | (278,570,580 | ) | ||
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Realized
loss on closed swaps contracts
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(697,388,429 | ) | - | |||||
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Change
in unrealized loss on open futures contracts
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(101,594,860 | ) | (19,270,520 | ) | ||||
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Change
in unrealized loss on open swaps contracts
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(18,732,581 | ) | - | |||||
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Interest
income
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219,888 | 498,606 | ||||||
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Other
income
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47,000 | 65,000 | ||||||
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Total
loss
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(1,283,272,592 | ) | (297,277,494 | ) | ||||
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Expenses
|
||||||||
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General
Partner management fees (Note 3)
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5,044,409 | 1,028,268 | ||||||
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Brokerage
commissions
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1,741,599 | 372,955 | ||||||
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Professional
fees
|
751,918 | 232,664 | ||||||
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Directors’
fees
|
49,156 | 13,867 | ||||||
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Other
expenses
|
262,662 | 79,728 | ||||||
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Total
expenses
|
7,849,744 | 1,727,482 | ||||||
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Net
loss
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$ | (1,291,122,336 | ) | $ | (299,004,976 | ) | ||
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Net
loss per limited partnership unit
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$ | (3.17 | ) | $ | (8.04 | ) | ||
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Net
loss per weighted average limited partnership unit
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$ | (3.04 | ) | $ | (7.86 | ) | ||
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Weighted
average limited partnership units outstanding
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424,221,111 | 38,052,222 | ||||||
See
accompanying notes to condensed financial statements.
5
United
States Natural Gas Fund, LP
Condensed
Statement of Changes in Partners’ Capital (Unaudited)
For
the three months ended March 31, 2010
|
General Partner
|
Limited Partners
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Total
|
||||||||||
|
Balances,
at December 31, 2009
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$ | - | $ | 4,525,107,163 | $ | 4,525,107,163 | ||||||
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Addition
of 26,000,000 partnership units
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- | 216,662,023 | 216,662,023 | |||||||||
|
Redemption
of 68,000,000 partnership units
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- | (637,766,682 | ) | (637,766,682 | ) | |||||||
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Net
loss
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- | (1,291,122,336 | ) | (1,291,122,336 | ) | |||||||
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Balances,
at March 31, 2010
|
$ | - | $ | 2,812,880,168 | $ | 2,812,880,168 | ||||||
|
Net
Asset Value Per Unit
|
||||||||||||
|
At
December 31, 2009
|
$ | 10.07 | ||||||||||
|
At
March 31, 2010
|
$ | 6.90 | ||||||||||
See
accompanying notes to condensed financial statements.
6
United
States Natural Gas Fund, LP
For
the three months ended March 31, 2010 and 2009
|
Three months ended
|
Three months ended
|
|||||||
|
March 31, 2010
|
March 31, 2009
|
|||||||
|
Cash
Flows from Operating Activities:
|
||||||||
|
Net
loss
|
$ | (1,291,122,336 | ) | $ | (299,004,976 | ) | ||
|
Adjustments
to reconcile net loss to net cash used in operating
activities:
|
||||||||
|
Decrease
(increase) in commodity futures trading account – cash
|
263,375,209 | (33,089,483 | ) | |||||
|
Unrealized
loss on open futures contracts
|
101,594,860 | 19,270,520 | ||||||
|
Unrealized
loss on open swap contracts
|
18,732,581 | - | ||||||
|
Increase
in investment receivable
|
(109,657,245 | ) | - | |||||
|
Increase
in interest receivable and other assets
|
(46,183 | ) | (96,682 | ) | ||||
|
Decrease
in General Partner management fees payable
|
(469,466 | ) | (31,615 | ) | ||||
|
Decrease
in investment payable
|
(19,112,096 | ) | - | |||||
|
Increase
in swap premiums received
|
230,574,218 | - | ||||||
|
Decrease
in interest payable
|
(20,751 | ) | - | |||||
|
Decrease
in professional fees payable
|
(56,359 | ) | (673,622 | ) | ||||
|
Increase
(decrease) in brokerage commission fees payable
|
(16,000 | ) | 30,250 | |||||
|
Decrease
in license fees payable
|
(8,737 | ) | (18,302 | ) | ||||
|
Decrease
in other liabilities
|
(943 | ) | (15,343 | ) | ||||
|
Net
cash used in operating activities
|
(806,233,248 | ) | (313,629,253 | ) | ||||
|
Cash
Flows from Financing Activities:
|
||||||||
|
Subscription
of partnership units
|
195,674,968 | 398,995,304 | ||||||
|
Redemption
of partnership units
|
(637,766,682 | ) | (85,397,721 | ) | ||||
|
Net
cash provided by (used in) financing activities
|
(442,091,714 | ) | 313,597,583 | |||||
|
Net
Decrease in Cash and Cash Equivalents
|
(1,248,324,962 | ) | (31,670 | ) | ||||
|
Cash and Cash
Equivalents
, beginning of period
|
3,896,493,193 | 419,929,831 | ||||||
|
Cash and Cash
Equivalents
, end of period
|
$ | 2,648,168,231 | $ | 419,898,161 | ||||
See
accompanying notes to condensed financial statements.
7
United
States Natural Gas Fund, LP
Notes
to Condensed Financial Statements
For
the period ended March 31, 2010 (Unaudited)
The
United States Natural Gas Fund, LP (“USNG”) was organized as a limited
partnership under the laws of the state of Delaware on September 11, 2006. USNG
is a commodity pool that issues limited partnership units (“units”) that may be
purchased and sold on the NYSE Arca, Inc. (the “NYSE Arca”). Prior to November
25, 2008, USNG’s units traded on the American Stock Exchange (the “AMEX”). USNG
will continue in perpetuity, unless terminated sooner upon the occurrence of one
or more events as described in its Second Amended and Restated Agreement of
Limited Partnership dated as of December 4, 2007 (the “LP Agreement”).
The investment objective of USNG is for the changes in percentage terms of its
units’ net asset value to reflect the changes in percentage terms of
the spot price of natural gas delivered at the Henry Hub, Louisiana as
measured by the changes in the price of the futures contract on natural gas as
traded on the New York Mercantile Exchange (the “NYMEX”) that is the near month
contract to expire, except when the near month contract is within two weeks of
expiration, in which case the futures contract will become, over a 4-day period,
the next month contract to expire, less USNG’s expenses. USNG accomplishes its
objective through investments in futures contracts for natural gas, crude oil,
heating oil, gasoline and other petroleum-based fuels that are traded on the
NYMEX, ICE Futures or other U.S. and foreign exchanges (collectively, “Futures
Contracts”) and other natural gas-related investments such as cash-settled
options on Futures Contracts, forward contracts for natural gas, cleared
swap contracts and over-the-counter transactions that are based on the price of
natural gas, crude oil and other petroleum-based fuels, Futures
Contracts and indices based on the foregoing (collectively, “Other Natural
Gas-Related Investments”). As of March 31, 2010, USNG held 10,573 NG Futures
Contracts and 32,566 NN Financially Settled Futures Contracts traded on the
NYMEX and 58,485 cleared swap contracts traded on the ICE Futures and
over-the-counter swap transactions with five counterparties.
USNG
commenced investment operations on April 18, 2007 and has a fiscal year ending
on December 31. United States Commodity Funds LLC (formerly known as Victoria
Bay Asset Management, LLC) (the “General Partner”) is responsible for the
management of USNG. The General Partner is a member of the National Futures
Association (the “NFA”) and became a commodity pool operator registered with the
Commodity Futures Trading Commission (the “CFTC”) effective December 1,
2005. The General Partner is also the general partner of the United
States Oil Fund, LP (“USOF”), the United States 12 Month Oil Fund, LP
(“US12OF”), the United States Gasoline Fund, LP (“UGA”) and the United States
Heating Oil Fund, LP (“USHO”), which listed their limited partnership units on
the AMEX under the ticker symbols “USO” on April 10, 2006, “USL” on December 6,
2007, “UGA” on February 26, 2008 and “UHN” on April 9, 2008, respectively. As a
result of the acquisition of the AMEX by NYSE Euronext, each of USOF’s,
US12OF’s, UGA’s and USHO’s units commenced trading on the NYSE Arca on November
25, 2008. The General Partner is also the general partner of the United States
Short Oil Fund, LP (“USSO”) and the United States 12 Month Natural Gas Fund, LP
(“US12NG”), which listed their limited partnership units on the NYSE Arca on
September 24, 2009 and November 18, 2009, respectively. The General Partner has
also filed registration statements to register units of the United States Brent
Oil Fund, LP (“USBO”) and the United States Commodity Index Fund
(“USCI”).
The
accompanying unaudited condensed financial statements have been prepared in
accordance with Rule 10-01 of Regulation S-X promulgated by the U.S. Securities
and Exchange Commission (the “SEC”) and, therefore, do not include all
information and footnote disclosure required under accounting principles
generally accepted in the United States of America. The financial
information included herein is unaudited; however, such financial information
reflects all adjustments which are, in the opinion of management, necessary for
the fair presentation of the condensed financial statements for the interim
period.
USNG issues
units to certain authorized purchasers (“Authorized Purchasers”) by offering
baskets consisting of 100,000 units (“Creation Baskets”) through ALPS
Distributors, Inc., as the marketing agent (the “Marketing Agent”). The purchase
price for a Creation Basket is based upon the net asset value of a unit
calculated shortly after the close of the core trading session on the NYSE Arca
on the day the order to create the basket is properly
received.
8
In
addition, Authorized Purchasers pay USNG a $1,000 fee for each order placed
to create one or more Creation Baskets or to redeem one or more baskets
consisting of 100,000 units (“Redemption Baskets”). Units may be purchased
or sold on a nationally recognized securities exchange in smaller increments
than a Creation Basket or Redemption Basket. Units purchased or sold on a
nationally recognized securities exchange are not purchased or sold at the net
asset value of USNG but rather at market prices quoted on such
exchange.
In April
2007, USNG initially registered 30,000,000 units on Form S-1 with the SEC. On
April 18, 2007, USNG listed its units on the AMEX under the ticker symbol “UNG”.
On that day, USNG established its initial net asset value by setting the price
at $50.00 per unit and issued 200,000 units in exchange for $10,001,000. USNG
also commenced investment operations on April 18, 2007, by purchasing Futures
Contracts traded on the NYMEX based on natural gas. As of March 31,
2010, USNG had registered a total of 1,480,000,000 units.
Revenue
Recognition
Commodity
futures contracts, forward contracts, physical commodities and related options
are recorded on the trade date. All such transactions are recorded on the
identified cost basis and marked to market daily. Unrealized gains or losses on
open contracts are reflected in the condensed statement of financial condition
and in the difference between the original contract amount and the market value
(as determined by exchange settlement prices for futures contracts and related
options and cash dealer prices at a predetermined time for forward contracts,
physical commodities, and their related options) as of the last business day of
the year or as of the last date of the condensed financial statements. Changes
in the unrealized gains or losses between periods are reflected in the condensed
statement of operations. USNG earns interest on its assets denominated
in U.S. dollars on deposit with the futures commission merchant at the
overnight Federal Funds Rate less 32 basis points. In addition, USNG earns
interest on funds held at the custodian at prevailing market rates earned on
such investments.
Investments
in over-the-counter total return swap contracts (see Note 5) are arrangements to
exchange a periodic payment for a market-linked return, each based on a notional
amount. To the extent that the total return of the commodity future,
security or index underlying the transaction exceeds or falls short of the
offsetting periodic payment obligation, USNG receives a payment from, or makes a
payment to, the swap counterparty. The over-the-counter swap
contracts are valued daily based upon the appreciation or depreciation of the
underlying securities subsequent to the effective date of the
contract. Changes in the value of the swaps are reported as
unrealized gains and losses and periodic payments are recorded as realized gains
or losses in the accompanying condensed statements of operations.
Brokerage
Commissions
Brokerage
commissions on all open commodity futures contracts are accrued on a full-turn
basis.
Swap
Premiums
Upfront
fees paid by USNG for over-the-counter swap contracts are reflected on the
Condensed Statements of Financial Condition and represent payments made upon
entering into a swap agreement to compensate for differences between the stated
terms of the agreement and prevailing market conditions. The fees are
amortized daily over the term of the swap agreement.
Income
Taxes
USNG is
not subject to federal income taxes; each partner reports his/her allocable
share of income, gain, loss deductions or credits on his/her own income tax
return.
Creations
and Redemptions
Authorized
Purchasers may purchase Creation Baskets or redeem Redemption Baskets only in
blocks of 100,000 units equal to the net asset value of the units calculated
shortly after the close of the core trading session on the NYSE Arca on the day
the order is placed.
9
USNG
receives or pays the proceeds from units sold or redeemed within three business
days after the trade date of the purchase or redemption. The amounts
due from Authorized Purchasers are reflected in USNG’s condensed statement of
financial condition as receivable for units sold, and amounts payable to
Authorized Purchasers upon redemption are reflected as payable for units
redeemed.
Partnership
Capital and Allocation of Partnership Income and Losses
Profit or
loss shall be allocated among the partners of USNG in proportion to the number
of units each partner holds as of the close of each month. The General Partner
may revise, alter or otherwise modify this method of allocation as described in
the LP Agreement.
Calculation
of Net Asset Value
USNG’s
net asset value is calculated on each NYSE Arca trading day by taking the
current market value of its total assets, subtracting any liabilities and
dividing the amount by the total number of units issued and outstanding.
USNG uses the closing price for the contracts on the relevant exchange on
that day to determine the value of contracts held on such exchange.
Net
Income (Loss) per Unit
Net
income (loss) per unit is the difference between the net asset value per
unit at the beginning of each period and at the end of each period. The weighted
average number of units outstanding was computed for purposes of disclosing net
income (loss) per weighted average unit. The weighted average units are
equal to the number of units outstanding at the end of the period, adjusted
proportionately for units redeemed based on the amount of time the units were
outstanding during such period. There were no units held by the General
Partner at March 31, 2010.
Offering
Costs
Offering
costs incurred in connection with the registration of additional units after the
initial registration of units are borne by USNG. These costs include
registration fees paid to regulatory agencies and all legal, accounting,
printing and other expenses associated with such offerings. These costs will be
accounted for as a deferred charge and thereafter amortized to expense over
twelve months on a straight-line basis or a shorter period if
warranted.
Cash
Equivalents
Cash
equivalents include money market funds and overnight deposits or time
deposits with original maturity dates of three months or less.
Use
of Estimates
The
preparation of condensed financial statements in conformity with accounting
principles generally accepted in the United States of America requires USNG’s
management to make estimates and assumptions that affect the reported amount of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the condensed financial statements, and the reported amounts of the
revenue and expenses during the reporting period. Actual results could differ
from those estimates and assumptions.
General
Partner Management Fee
Under the
LP Agreement, the General Partner is responsible for investing the assets of
USNG in accordance with the objectives and policies of USNG. In addition, the
General Partner has arranged for one or more third parties to provide
administrative, custody, accounting, transfer agency and other necessary
services to USNG. For these services, USNG is contractually obligated to
pay the General Partner a fee, which is paid monthly, that is equal to
0.60% per annum of average daily net assets of $1,000,000,000 or less and 0.50%
per annum of average daily net assets that are greater than
$1,000,000,000.
10
Ongoing
Registration Fees and Other Offering Expenses
USNG pays
all costs and expenses associated with the ongoing registration of its units
subsequent to the initial offering. These costs include registration or
other fees paid to regulatory agencies in connection with the offer and sale of
units, and all legal, accounting, printing and other expenses associated with
such offer and sale. For the three months ended March 31, 2010 and 2009, USNG
incurred $34,200 and $36,192, respectively, in registration fees and other
offering expenses.
Directors’
Fees and Expenses
USNG is
responsible for paying its portion of the directors’ and officers’ liability
insurance of the General Partner and the fees and expenses of the independent
directors of the General Partner who are also the General Partner’s audit
committee members. Effective as of April 1, 2010, USNG is responsible for paying
its portion of any payments that may become due to
the independent
directors
pursuant to
the
deferred
compensation
agreements entered into
between the independent directors, the General Partner and each of the
funds. USNG shares these fees and expenses with USOF, US12OF,
UGA, USHO, USSO and US12NG based on the relative assets of each fund, computed
on a daily basis.
Licensing
Fees
As
discussed in Note 4, USNG entered into a licensing agreement with the NYMEX
on May 30, 2007. Pursuant to the agreement, USNG and the affiliated funds
managed by the General Partner pay a licensing fee that is equal to 0.04% for
the first $1,000,000,000 of combined assets of the funds and 0.02% for
combined assets above $1,000,000,000. During the three months ended
March 31, 2010 and 2009, USNG incurred $222,636 and $42,977, respectively, under
this arrangement.
Investor
Tax Reporting Cost
The fees
and expenses associated with USNG’s audit expenses and tax accounting and
reporting requirements are paid by USNG. These costs were
approximately $467,813 as of March 31, 2010.
Other
Expenses and Fees
In
addition to the fees described above, USNG pays all brokerage fees,
transaction costs for over-the-counter swaps and other expenses in connection
with the operation of USNG, excluding costs and expenses paid by the
General Partner as outlined in Note 4.
USNG is
party to a marketing agent agreement, dated as of April 17, 2007, with the
Marketing Agent and the General Partner, whereby the Marketing Agent provides
certain marketing services for USNG as outlined in the agreement. The fee of the
Marketing Agent, which is borne by the General Partner, is equal to 0.06% on
USNG’s assets up to $3 billion; and 0.04% on USNG’s assets in excess of $3
billion.
The above
fee does not include the following expenses, which are also borne by the General
Partner: the cost of placing advertisements in various periodicals; web
construction and development; or the printing and production of various
marketing materials.
USNG is
also party to a custodian agreement, dated January 12, 2007, with Brown Brothers
Harriman & Co. (“BBH&Co.”) and the General Partner, whereby BBH&Co.
holds investments on behalf of USNG. The General Partner pays the fees of
the custodian, which are determined by the parties from time to time. In
addition, USNG is party to an administrative agency agreement, dated March 5,
2007, with the General Partner and BBH&Co., whereby
BBH&Co. acts as the administrative agent, transfer agent and registrar
for USNG. The General Partner also pays the fees of BBH&Co. for its services
under this agreement and such fees are determined by the parties from time to
time.
11
Currently,
the General Partner pays BBH&Co. for its services, in the foregoing
capacities, a minimum amount of $75,000 annually for its custody, fund
accounting and fund administration services rendered to USNG and each of the
affiliated funds managed by the General Partner, as well as a $20,000 annual fee
for its transfer agency services. In addition, the General Partner pays
BBH&Co. an asset-based charge of (a) 0.06% for the first $500 million of
USNG’s, USOF’s, US12OF’s, UGA’s, USHO’s, USSO’s and US12NG’s combined net
assets, (b) 0.0465% for USNG’s, USOF’s, US12OF’s, UGA’s, USHO’s, USSO’s and
US12NG’s combined net assets greater than $500 million but less than $1 billion,
and (c) 0.035% once USNG’s, USOF’s, US12OF’s, UGA’s, USHO’s, USSO’s and US12NG’s
combined net assets exceed $1 billion. The annual minimum amount will not apply
if the asset-based charge for all accounts in the aggregate exceeds $75,000. The
General Partner also pays transaction fees ranging from $7.00 to $15.00 per
transaction.
USNG has
entered into a brokerage agreement with UBS Securities LLC (“UBS
Securities”). The agreement requires UBS Securities to provide services to USNG
in connection with the purchase and sale of Futures Contracts and Other
Natural Gas-Related Investments that may be purchased and sold by or through UBS
Securities for USNG’s account. The agreement provides that UBS
Securities charge USNG commissions of approximately $7 per round-turn
trade, including applicable exchange and NFA fees for Futures Contracts and
options on Futures Contracts.
On May
30, 2007, USNG and the NYMEX entered into a licensing agreement whereby
USNG was granted a non-exclusive license to use certain of the NYMEX’s
settlement prices and service marks. Under the licensing agreement, USNG
and the affiliated funds managed by the General Partner pay
the NYMEX an asset-based fee for the license, the terms of which are
described in Note 3.
USNG
expressly disclaims any association with the NYMEX or endorsement of USNG by the
NYMEX and acknowledges that “NYMEX” and “New York Mercantile Exchange” are
registered trademarks of the NYMEX.
USNG engages
in the trading of futures contracts, options on futures contracts,
cleared swaps and over-the-counter swaps (collectively, “derivatives”).
USNG is exposed to both market risk, which is the risk arising from changes
in the market value of the contracts, and credit risk, which is the risk of
failure by another party to perform according to the terms of a
contract.
USNG may
enter into futures contracts, options on futures contracts, cleared swaps and
over-the-counter swaps to gain exposure to changes in the value of an underlying
commodity. A futures contract obligates the seller to deliver (and
the purchaser to accept) the future delivery of a specified quantity and type of
a commodity at a specified time and place. Some futures contracts may
call for physical delivery of the asset, while others are settled in cash. The
contractual obligations of a buyer or seller may generally be satisfied by
taking or making physical delivery of the underlying commodity or by making an
offsetting sale or purchase of an identical futures contract on the same or
linked exchange before the designated date of delivery. Cleared swaps
are over-the-counter agreements that are eligible to be cleared by a
clearinghouse,
e.g
.,
ICE Clear Europe., but which are not traded on an exchange. A cleared
swap is created when the parties to an off-exchange over-the-counter transaction
agree to extinguish their over-the-counter contract and replace it with a
cleared swap. Cleared swaps are intended to provide the efficiencies and
benefits that centralized clearing on an exchange offers to traders of futures
contracts, including credit risk intermediation and the ability to offset
positions initiated with different counterparties.
The
purchase and sale of futures contracts, options on futures contracts and cleared
swaps require margin deposits with a futures commission merchant.
Additional deposits may be necessary for any loss on contract value. The
Commodity Exchange Act requires a futures commission merchant to segregate all
customer transactions and assets from the futures commission merchant’s
proprietary activities.
Futures
contracts and cleared swaps involve, to varying degrees, elements of market risk
(specifically commodity price risk) and exposure to loss in excess of the amount
of variation margin. The face or contract amounts reflect the extent of the
total exposure USNG has in the particular classes of instruments. Additional
risks associated with the use of futures contracts are an imperfect correlation
between movements in the price of the futures contracts and the market value of
the underlying securities and the possibility of an illiquid market for a
futures contract.
12
All of
USNG’s investment contracts through March 31, 2010 have been exchange-traded
futures contracts, cleared swaps or fully-collateralized over-the-counter swaps.
The liquidity and credit risks associated with exchange-traded contracts and
cleared swaps are generally perceived to be less than those associated with
over-the-counter transactions since, in over-the-counter transactions, USNG must
rely solely on the credit of its respective individual
counterparties. As of March 31, 2010, USNG has entered into
over-the-counter transactions with five counterparties. Over-the
counter transactions subject USNG to the credit risk associated with
counterparty non-performance. The credit risk from counterparty non-performance
associated with such instruments is the net unrealized gain, if any, on the
transaction. USNG also has credit risk under its futures contracts since the
sole counterparty to all domestic and foreign futures contracts is the
clearinghouse for the exchange on which the relevant contracts are
traded. However, as compared to its over-the-counter transactions, it
may more easily realize value by reselling its futures contracts. In
addition, USNG bears the risk of financial failure by the clearing
broker.
At March
31, 2010, USNG’s counterparties posted $10,260,000 in cash as collateral with
USNG’s custodian, as compared with the prior period for which no collateral was
posted since USNG had not yet entered into any swaps. Under these agreements,
USNG posted collateral with respect to its obligations of $25,965,288,869 in
cash and $6,132,000 in securities, such as U.S. Treasuries, at March 31, 2010,
while no collateral was posted for the prior period.
USNG’s
cash and other property, such as U.S. Treasuries, deposited with a futures
commission merchant are considered commingled with all other customer funds
subject to the futures commission merchant’s segregation requirements. In the
event of a futures commission merchant’s insolvency, recovery may be limited to
a pro rata share of segregated funds available. It is possible that the
recovered amount could be less than the total of cash and other property
deposited. The insolvency of a futures commission merchant could result in the
complete loss of USNG’s assets posted with that futures commission merchant;
however, the vast majority of USNG’s assets are held in Treasuries, cash and/or
cash equivalents with USNG’s custodian and would not be impacted by the
insolvency of a futures commission merchant. Also, the failure or insolvency of
USNG’s custodian could result in a substantial loss of USNG’s
assets.
USNG invests
a portion of its cash in money market funds that seek to maintain a stable net
asset value. USNG is exposed to any risk of loss associated with an
investment in these money market funds. As of March 31, 2010 and December 31,
2009, USNG had deposits in domestic and foreign financial institutions,
including cash investments in money market funds, in the amounts of
$3,118,486,686 and $4,630,186,857, respectively. This amount is subject to loss
should these institutions cease operations.
For
derivatives, risks arise from changes in the market value of the contracts.
Theoretically, USNG is exposed to a market risk equal to the value of
futures contracts purchased and unlimited liability on such contracts sold
short. As both a buyer and a seller of options, USNG pays or receives a premium
at the outset and then bears the risk of unfavorable changes in the price of the
contract underlying the option.
USNG’s
policy is to continuously monitor its exposure to market and counterparty risk
through the use of a variety of financial, position and credit exposure
reporting controls and procedures. In addition, USNG has a policy of
requiring review of the credit standing of each broker or counterparty with
which it conducts business.
The
financial instruments held by USNG are reported in its condensed statement of
financial condition at market or fair value, or at carrying amounts that
approximate fair value, because of their highly liquid nature and short-term
maturity.
USNG
values it investments in accordance with Accounting Standards Codification 820 –
Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines
fair value, establishes a framework for measuring fair value in generally
accepted accounting principles, and expands disclosures about fair value
measurement. The changes to past practice resulting from the
application of ASC 820 relate to the definition of fair value, the methods used
to measure fair value, and the expanded disclosures about fair value
measurement. ASC 820 establishes a fair value hierarchy that distinguishes
between (1) market participant assumptions developed based on market data
obtained from sources independent of USNG (observable inputs) and (2) USNG’s own
assumptions about market participant assumptions developed based on the best
information available under the circumstances (unobservable
inputs). The three levels defined by the ASC 820 hierarchy are as
follows:
13
Level I –
Quoted prices (unadjusted) in active markets for
identical
assets or
liabilities that the reporting entity has the ability to access at the
measurement date.
Level II
– Inputs other than quoted prices included within Level I that are observable
for the asset or liability, either directly or indirectly. Level II assets
include the following: quoted prices for
similar
assets or liabilities
in active markets, quoted prices for identical or similar assets or liabilities
in markets that are not active, inputs other than quoted prices that are
observable for the asset or liability, and inputs that are derived principally
from or corroborated by observable market data by correlation or other means
(market-corroborated inputs).
Level III
– Unobservable pricing input at the measurement date for the asset or liability.
Unobservable inputs shall be used to measure fair value to the extent that
observable inputs are not available.
In some
instances, the inputs used to measure fair value might fall in different levels
of the fair value hierarchy. The level in the fair value hierarchy within which
the fair value measurement in its entirety falls shall be determined based on
the lowest input level that is significant to the fair value measurement in its
entirety.
|
At March
31, 2010
|
Total
|
Level I
|
Level II
|
Level III
|
||||||||||||
|
Short-Term
Investments
|
$ | 2,201,490,576 | $ | 2,201,490,576 | $ | - | $ | - | ||||||||
|
Exchange-Traded
Futures Contracts
|
(72,624,000 | ) | (72,624,000 | ) | - | - | ||||||||||
|
Exchange-Traded
Cleared Swap Contracts
|
(70,748,125 | ) | (70,748,125 | ) | - | - | ||||||||||
|
Over-the-Counter
Total Return Swap Contracts
|
(58,141,269 | ) | - | - | (58,141,269 | ) | ||||||||||
During
the three months ended March 31, 2010, there were no significant transfers
between Level I and Level II.
Following
is a reconciliation of assets in which significant observable inputs (Level III)
were used in determining fair value:
|
Total
Return Swap Contracts
|
||||
|
Beginning
balance as of 12/31/09
|
$ | (39,408,688 | ) | |
|
Realized
gain (loss)*
|
- | |||
|
Change
in unrealized gain (loss)
|
(18,732,581 | ) | ||
|
Ending
balance as of 03/31/10
|
$ | (58,141,269 | ) | |
*The
realized loss incurred during the three months ended March 31, 2010 for total
return swaps was $697,388,429.
Effective
January 1, 2009, USNG adopted the provisions of Accounting Standards
Codification 815 - Derivatives and Hedging, which require
presentation of qualitative disclosures about objectives and strategies for
using derivatives, quantitative disclosures about fair value amounts and gains
and losses on derivatives.
14
Fair
Value of Derivative Instruments
|
At
|
At
|
|||||||||
|
March
31,
|
December 31,
|
|||||||||
|
2010
|
2009
|
|||||||||
|
Derivatives not
|
Statement of
|
|||||||||
|
Accounted
|
Financial
|
|||||||||
|
for as Hedging
|
Condition
|
|||||||||
|
Instruments
|
Location
|
Fair
Value
|
Fair
Value
|
|||||||
|
Futures
-
|
||||||||||
|
Commodity
Contracts
|
Assets
|
$ | (143,372,125 | ) | $ | (41,777,265 | ) | |||
|
Swaps
-
|
||||||||||
|
Commodity
Contracts
|
Assets
-
|
$ | (58,141,269 | ) | $ | (39,408,688 | ) | |||
|
Unrealized
|
||||||||||
|
Loss
|
||||||||||
The
Effect of Derivative Instruments on the Statements of Operations
|
For the three months ended
|
For the three
months ended
|
|||||||||||||||||
|
March
31, 2010
|
March
31, 2009
|
|||||||||||||||||
|
Location of
|
Realized
|
Change in
|
Realized
|
Change in
|
||||||||||||||
|
Derivatives not
|
Gain or (Loss)
|
Gain or (Loss)
|
Unrealized
|
Gain or (Loss)
|
Unrealized
|
|||||||||||||
|
Accounted
|
on Derivatives
|
on Derivatives
|
Gain or (Loss)
|
on Derivatives
|
Gain or (Loss)
|
|||||||||||||
|
for as Hedging
|
Recognized
|
Recognized
|
Recognized
|
Recognized
|
Recognized
|
|||||||||||||
|
Instruments
|
in Income
|
in Income
|
in Income
|
in Income
|
in Income
|
|||||||||||||
|
Futures
-
|
Realized
gain (loss) on
|
$ | (465,823,610 | ) | $ | (278,570,580 | ) | |||||||||||
|
Commodity Contracts
|
closed
futures contracts
|
|||||||||||||||||
|
Change
in unrealized
|
$ | (101,594,860 | ) | $ | (19,270,520 | ) | ||||||||||||
|
gain
(loss) on open
|
||||||||||||||||||
|
futures
contracts
|
||||||||||||||||||
|
Swaps
-
|
Realized
gain (loss) on
|
(697,388,429 | ) | - | ||||||||||||||
|
Commodity Contracts
|
closed
swap contracts
|
|||||||||||||||||
|
Change
in unrealized
|
(18,732,581 | ) | - | |||||||||||||||
|
gain
(loss) on open
|
||||||||||||||||||
|
swap
contracts
|
||||||||||||||||||
The
following table presents per unit performance data and other supplemental
financial data for the three months ended March 31, 2010 and 2009 for the
unitholders. This information has been derived from information presented in the
condensed financial statements.
|
For the three months
ended March 31, 2010
(Unaudited)
|
For the three months
ended March 31, 2009
(Unaudited)
|
|||||||
|
Per Unit Operating
Performance:
|
||||||||
|
Net
asset value, beginning of period
|
$ | 10.07 | $ | 23.27 | ||||
|
Total
loss
|
(3.15 | ) | (7.99 | ) | ||||
|
Total
expenses
|
(0.02 | ) | (0.05 | ) | ||||
|
Net
decrease in net asset value
|
(3.17 | ) | (8.04 | ) | ||||
|
Net
asset value, end of period
|
$ | 6.90 | $ | 15.23 | ||||
|
Total
Return
|
(31.48 | )% | (34.55 | )% | ||||
|
Ratios
to Average Net Assets
|
||||||||
|
Total
loss
|
(32.98 | )% | (42.77 | )% | ||||
|
Expenses
excluding management fees*
|
0.29 | % | 0.41 | % | ||||
|
Management
fees*
|
0.53 | % | 0.60 | % | ||||
|
Net
loss
|
(33.18 | )% | (43.02 | )% | ||||
*Annualized
15
Total
returns are calculated based on the change in value during the period. An
individual unitholder’s total return and ratio may vary from the above total
returns and ratios based on the timing of contributions to and withdrawals from
USNG.
In
January 2010, the Financial Accounting Standards Board issued Accounting
Standards Update (“ASU”)
No. 2010-06 “Improving
Disclosures about Fair Value Measurements.” ASU No. 2010-06 clarifies existing
disclosure and
requires additional
disclosures regarding fair value measurements. Effective for fiscal years
beginning
after
December 15, 2010, and for interim periods within those fiscal years, entities
will need to disclose information
about purchases, sales,
issuances and settlements of Level 3 securities on a gross basis, rather than as
a net number as
currently required. The
General Partner is currently evaluating the impact ASU No. 2010-06 will have on
USNG’s financial statement
disclosures.
USNG has
performed an evaluation of subsequent events through the date the financial
statements were available to be issued. This evaluation did not result in any
subsequent events that necessitated disclosures and/or
adjustments.
16
The
following discussion should be read in conjunction with the condensed financial
statements and the notes thereto of the United States Natural Gas Fund, LP
(“USNG”) included elsewhere in this quarterly report on Form 10-Q.
Forward-Looking
Information
This
quarterly report on Form 10-Q, including this “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” contains
forward-looking statements regarding the plans and objectives of management for
future operations. This information may involve known and unknown risks,
uncertainties and other factors that may cause USNG’s actual results,
performance or achievements to be materially different from future results,
performance or achievements expressed or implied by any forward-looking
statements. Forward-looking statements, which involve assumptions and describe
USNG’s future plans, strategies and expectations, are generally identifiable by
use of the words “may,” “will,” “should,” “expect,” “anticipate,” “estimate,”
“believe,” “intend” or “project,” the negative of these words, other
variations on these words or comparable terminology. These forward-looking
statements are based on assumptions that may be incorrect, and USNG cannot
assure investors that the projections included in these forward-looking
statements will come to pass. USNG’s actual results could differ
materially from those expressed or implied by the forward-looking statements as
a result of various factors.
USNG has
based the forward-looking statements included in this quarterly report on Form
10-Q on information available to it on the date of this quarterly report on Form
10-Q, and USNG assumes no obligation to update any such forward-looking
statements. Although USNG undertakes no obligation to revise or update any
forward-looking statements, whether as a result of new information, future
events or otherwise, investors are advised to consult any additional disclosures
that USNG may make directly to them or through reports that USNG in the
future files with the U.S. Securities and Exchange Commission (the “SEC”),
including annual reports on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K.
Introduction
USNG, a
Delaware limited partnership, is a commodity pool that issues units that may be
purchased and sold on the NYSE Arca, Inc. (the “NYSE Arca”). The investment
objective of USNG is for the changes in percentage terms of its units’ net
asset value (“NAV”) to reflect the changes in percentage terms of the spot price
of natural gas delivered at the Henry Hub, Louisiana, as measured by the changes
in the price of the futures contract for natural gas traded on the New York
Mercantile Exchange (the “NYMEX”) that is the near month contract to expire,
except when the near month contract is within two weeks of expiration, in which
case it will become, over a 4-day period, the futures contract that is the next
month contract to expire (the “Benchmark Futures Contract”), less USNG’s
expenses.
USNG
seeks to achieve its investment objective by investing in a combination of
natural gas futures contracts and other natural gas-related investments such
that changes in its NAV, measured in percentage terms, will closely track
the changes in the price of the Benchmark Futures Contract, also measured
in percentage terms. USNG’s general partner believes changes in the price of the
Benchmark Futures Contract have historically exhibited a close correlation with
the changes in the spot price of natural gas. It is not the intent of USNG to be
operated in a fashion such that the NAV will equal, in dollar terms, the spot
price of natural gas or any particular futures contract based on natural gas.
Management believes that it is not practical to manage the portfolio to achieve
such an investment goal when investing in listed natural gas futures contracts
and other natural gas-related investments.
On any
valuation day, the Benchmark Futures Contract is the near
month futures contract for natural gas traded on the NYMEX unless the near
month contract is within two weeks of expiration, in which case the
Benchmark Futures Contract becomes, over a 4-day period, the next
month contract for natural gas traded on the NYMEX. “Near month contract”
means the next contract traded on the NYMEX due to expire. “Next month contract”
means the first contract traded on the NYMEX due to expire after the near month
contract.
17
USNG
invests in futures contracts for crude oil, heating oil, gasoline and other
petroleum-based fuels that are traded on the NYMEX, ICE Futures or other U.S.
and foreign exchanges (collectively, “Futures Contracts”) and other natural
gas-related investments such as cash-settled options on Futures Contracts,
forward contracts for natural gas, cleared swap contracts and over-the-counter
transactions that are based on the price of natural gas, crude oil and other
petroleum-based fuels, Futures Contracts and indices based on the foregoing
(collectively, “Other Natural Gas-Related Investments”). For
convenience and unless otherwise specified, Futures Contracts and Other Natural
Gas-Related Investments collectively are referred to as “Natural Gas Interests”
in this quarterly report on Form 10-Q. Due, in part, to the increased size of
USNG over the last several quarters and its obligation to comply with regulatory
limits, it is likely that it will invest in increased numbers of Other Natural
Gas-Related Investments in order to fulfill its investment
objective.
The
regulation of commodity interests in the United States is a rapidly
changing area of law and is subject to ongoing modification by governmental and
judicial action. As stated under the heading, “Risk Factors” in Item 1A of
USNG’s annual report on Form 10-K for the year ended December 31, 2009,
regulation of the commodity interests and energy markets is extensive and
constantly changing; future regulatory developments in the commodity interests
and energy markets are impossible to predict but may significantly and adversely
affect USNG.
Currently,
a number of proposals to alter the regulation of commodity
interests are being considered by federal regulators and
legislators. These proposals include the imposition of hard position
limits on energy-based commodity futures contracts, extension of position and
accountability limits to futures contracts on non-U.S. exchanges previously
exempt from such limits, and the forced use of clearinghouse mechanisms for all
over-the-counter transactions. An additional proposal would aggregate
and limit all positions in energy futures held by a single entity, whether such
positions exist on U.S. futures exchanges, non-U.S. futures exchanges, or in
over-the-counter contracts. The U.S. Commodity Futures Trading
Commission (the “CFTC”) has also recently published a proposed rule that would
impose fixed position limits on certain energy futures contracts, including the
Benchmark Futures Contract, without the need for any new legislation to be
passed. If any of the aforementioned proposals is implemented, USNG’s
ability to meet its investment objective may be negatively impacted and
investors could be adversely affected.
In
addition, due to potential regulatory limitations, USNG may determine to hold
greater amounts of cash and cash equivalents and lesser amounts of Natural Gas
Interests, or greater amounts of Other Natural Gas-Related Investments if it
determines that will most appropriately satisfy USNG’s investment
objective. Holding more cash and cash equivalents and less Natural
Gas Interests, or more Other Natural Gas-Related Investments for some period of
time may result in increased tracking error. Increasing USNG’s investments in
Other Natural Gas-Related Investments, such as through increased investments in
over-the-counter swaps, may result in increased tracking error due to the fact
that transaction costs for over-the-counter swaps are significantly higher as
compared to those for exchange-traded Natural Gas Interests, which to date are
the principal investment of USNG. In the event that USNG determines
that suitable Other Natural Gas-Related Investments are not obtainable, USNG
will need to consider other actions to protect its unitholders and to permit
USNG to achieve its investment objectives.
The general
partner of USNG, United States Commodity Funds LLC (the “General Partner”),
which is registered as a commodity pool operator (“CPO”) with the CFTC, is
authorized by the Second Amended and Restated Agreement of Limited
Partnership of USNG (the “LP Agreement”) to manage USNG. The General
Partner is authorized by USNG in its sole judgment to employ and establish the
terms of employment for, and termination of, commodity trading advisors or
futures commission merchants.
Natural
gas futures prices exhibited a general downtrend during the three months ended
March 31, 2010. The price of the Benchmark Futures Contract started the year at
$5.572. It hit a peak on January 6, 2010 of $6.009 and then fell
over the course of the period. The low price of the period was on March 31,
2010, the period end date, when the Benchmark Futures Contract was $3.869, for a
return of approximately -30.56% over the period. Similarly,
USNG’s NAV initially rose during the period from a starting level of $10.07
per unit to a high on
January 6, 2010 of $10.86 per unit. USNG’s NAV reached its low for the period on
March 31, 2010 at $6.90 per unit. The NAV on March 31, 2010 was $6.90, for a
return of approximately -31.48% over the period.
18
From
January 1 to February 18, 2010, the natural gas futures market remained in a
state of backwardation,, meaning that the price of the near month natural gas
futures contract was typically higher than the price of the next month natural
gas futures contract, or contracts further away from expiration. For the rest of
the first quarter of 2010, the natural gas futures market moved into a contango
market. A contango market is one in which the price of the near
month natural gas futures contract is less than the price of the next month
natural gas futures contract, or contracts further away from expiration. As a
result of contango or backwardation, as the case may be, the return of
approximately -30.56%% on the Benchmark Futures Contract listed above is a
hypothetical return only and could not actually be achieved by an investor
holding futures contracts. For a discussion of the impact of
backwardation and contango on total returns, see “Term Structure of Natural Gas
Futures Prices and the Impact on Total Returns.”
Valuation
of Futures Contracts and the Computation of the NAV
The NAV
of USNG’s units is calculated once each NYSE Arca trading day. The
NAV for a particular trading day is released after 4:00 p.m. New York time.
Trading during the core trading session on the NYSE Arca typically closes at
4:00 p.m. New York time. USNG’s administrator uses the NYMEX closing price
(determined at the earlier of the close of the NYMEX or 2:30 p.m. New York
time) for the contracts held on the NYMEX, but calculates or determines the
value of all other USNG investments, including cleared swaps or other futures
contracts, as of the earlier of the close of the NYSE Arca or 4:00 p.m. New York
time.
Results
of Operations and the Natural Gas Market
Results of
Operations.
On April 18, 2007, USNG listed its units on the
American Stock Exchange (the “AMEX”) under the ticker symbol “UNG.” On that day,
USNG established its initial offering price at $50.00 per unit and issued
200,000 units to the initial authorized purchaser, Merrill Lynch Professional
Clearing Corp., in exchange for $10,001,000 in cash. As a result of the
acquisition of the AMEX by NYSE Euronext, USNG’s units no longer trade on the
AMEX and commenced trading on the NYSE Arca on November 25, 2008.
Since its
initial offering of 30,000,000 units, USNG has made four subsequent
offerings of its units: 50,000,000 units which were registered with the SEC
on November 21, 2007, 100,000,000 units which were registered with the SEC on
August 28, 2008, 300,000,000 units which were registered with the SEC on May 6,
2009 and an additional 1,000,000,000 units which were registered with the SEC on
August 12, 2009. On August 11, 2009, USNG’s management determined to
suspend offerings of USNG’s units since it could not invest the proceeds from
such offerings in investments that would permit it to meet its investment
objective due to current and anticipated new regulatory restrictions and
limitations on its investments in Futures Contracts. This suspension of
creation activity may have led to an increase in USNG’s tracking error and, at
times, a greater premium paid for transactions in its units on the NYSE Arca
when compared to its per unit NAV on the same day. On September 28, 2009,
USNG resumed offerings of units subject to certain limitations including that
(1) USNG may require authorized purchasers (“Authorized Purchasers”) of its
units to sell USNG specified investments, including the arrangement of an
over-the-counter swap contract between the Authorized Purchaser and USNG, (2)
USNG may limit its issuance of creation baskets to an Authorized Purchaser to a
specified minimum or maximum number of baskets, (3) USNG’s management may vary
the terms and conditions of investments to be delivered or arranged by an
Authorized Purchaser in order to purchase a creation basket and (4) USNG’s
management may decide to offer creation baskets only on particular days. Units
offered by USNG in the subsequent offerings were sold by it for cash at the
units’ NAV as described in the applicable prospectus. As of March 31,
2010, USNG had issued 582,100,000 units, 407,500,000 of which were outstanding.
As of March 31, 2010, there were 897,900,000 units registered but not yet
issued.
More
units may have been issued by USNG than are outstanding due to the redemption of
units. Unlike funds that are registered under the Investment Company Act of
1940, as amended, units that have been redeemed by USNG cannot be resold by
USNG. As a result, USNG contemplates that additional offerings of its units will
be registered with the SEC in the future in anticipation of additional
issuances and redemptions.
For the Three Months Ended
March 31, 2010 Compared to the Three Months Ended March 31,
2009
As of
March 31, 2010, the total unrealized loss on natural gas Futures Contracts,
cleared swap contracts and over-the-counter swap contracts owned or held on that
day was $201,513,394 and USNG established cash deposits, including cash
investments in money market funds, that were equal to $3,118,486,686. USNG
held 84.92% of its cash assets in overnight deposits and money market funds at
its custodian bank, while 15.08%
of the
cash balance was held as margin deposits for the Futures Contracts purchased.
The ending per unit NAV on March 31, 2010 was $6.90.
19
By
comparison, as of March 31, 2009, the total unrealized loss on natural gas
Futures Contracts owned or held on that day was $26,975,390 and USNG established
cash deposits, including cash investments in money market funds
,
that were equal to
$746,607,198. USNG held 56.24% of its cash assets in overnight deposits and
money market funds at its custodian bank, while 43.76% of the cash balance was
held as margin deposits for the Futures Contracts purchased. The increase in
cash assets in overnight deposits and money market funds for March 31, 2009
compared to March 31, 2010 was the result of a greater portion of USNG’s assets
consisting of over-the-counter contracts and cleared swaps. The
ending per unit NAV on March 31, 2009 was $15.23. The decrease in the per unit
NAV from March 31, 2009 to March 31, 2010 was primarily a result of sharply
lower prices for natural gas and the related decline in the value of the natural
gas futures contracts that USNG had invested in between the period ended March
31, 2009 and the period ended March 31, 2010.
Portfolio Expenses
. USNG’s
expenses consist of investment management fees, brokerage fees and
commissions, certain offering costs, licensing fees, the fees and expenses of
the independent directors of the General Partner and expenses relating to tax
accounting and reporting requirements. The management fee that
USNG pays to the General Partner is calculated as a percentage of the total net
assets of USNG. For total net assets of up to $1 billion, the
management fee is 0.60%. For total net assets over $1 billion, the management
fee is 0.50% on the incremental amount of assets. The fee is accrued daily and
paid monthly.
During
the three months ended March 31, 2010, the daily average total net assets of
USNG were $3,891,576,206. The management fee paid by USNG during the period
amounted to $5,044,409
,
which was calculated at the 0.60% rate on total net assets up to and including
$1 billion and at the rate of 0.50% on total net assets over $1 billion, and
accrued daily. Management fees as a percentage of average net assets averaged
0.53% over the course of this three month period. By comparison,
during the three months ended March 31, 2009, the daily average total net assets
of USNG were $695,033,254. The management fee paid by USNG during the
period amounted to $1,028,268, which was calculated at the 0.60% rate for total
net assets up to and including $1 billion and at the rate of 0.50% on total net
assets over $1 billion, and accrued daily. Management fees as a percentage of
average net assets averaged 0.60% over the course of this three month period.
USNG’s management fees as a percentage of total net assets were lower for the
three months ended March 31, 2010 compared to the three months ended March 31,
2009 due to USNG having had a limited number of days in which total net assets
exceeded $1 billion and were therefore charged the lower rate of
0.50%.
In
addition to the management fee, USNG pays all brokerage fees, transaction
costs for over-the-counter swaps and other expenses, including certain tax
reporting costs, licensing fees for the use of intellectual property, ongoing
registration or other fees paid to the SEC, the Financial Industry
Regulatory Authority (“FINRA”) and any other regulatory agency in
connection with offers and sales of its units subsequent to the initial
offering and all legal, accounting, printing and other expenses associated
therewith. The total of these fees and expenses for the three months ended
March 31, 2010 was $2,805,335, as compared to $699,214 for the three months
ended March 31, 2009. The increase in expenses from the three months ended March
31, 2009 as compared to the three months ended March 31, 2010 was primarily due
to the relative size of USNG and activity that resulted from its increased size,
increased brokerage fees, increased transaction costs for over-the-counter
swaps, increased licensing fees and increased tax reporting costs due to the
greater number of unitholders during the three months ended March 31, 2010. For
the three months ended March 31, 2010, USNG incurred $34,200 in
ongoing registration fees and other expenses relating to the registration and
offering of additional units. By comparison, for the three months ended March
31, 2009, USNG incurred $36,192 in ongoing registration fees and other expenses
relating to the registration and offering of additional units.
20
USNG is
responsible for paying its portion of the directors’ and officers’ liability
insurance of the General Partner and the fees and expenses of the independent
directors of the General Partner who are also the General Partner’s audit
committee members. USNG shares these fees and expenses with the United
States Oil Fund, LP (“USOF”), the United States 12 Month Oil Fund, LP
(“US12OF”), the United States Gasoline Fund, LP (“UGA”), the United States
Heating Oil Fund, LP (“USHO”), the
United
States Short Oil Fund, LP (“USSO”) and the United States 12 Month Natural Gas
Fund, LP (“US12NG”), based on the relative assets of each fund computed on a
daily basis. These fees for calendar year 2010 are estimated to be a
total of $538,870 for all funds. By comparison, for the year ended December 31,
2009, these fees amounted to a total of $433,046 for all funds, and USNG’s
portion of such fees was $159,942. Directors’ expenses are expected to increase
in 2010 due to an increase in the amount of directors’ and officers’ liability
insurance coverage. Effective as of March 3, 2009, the General
Partner has obtained directors’ and officers’ liability insurance covering all
of the directors and officers of the General Partner. Previously, the General
Partner did not have liability insurance for its directors and officers;
instead, the independent directors received a payment in lieu of directors’ and
officers’ liability insurance coverage. Effective as of April 1, 2010, USNG is
also responsible for paying its portion of any payments that may become due
to
the independent
directors
pursuant to
the
deferred
compensation
agreements entered into
between the independent directors, the General Partner and each of the
funds.
USNG also
incurs commissions to brokers for the purchase and sale of Futures Contracts,
Other Natural Gas-Related Investments or short-term obligations of the
United States of two years or less (“Treasuries”). During the three months ended
March 31, 2010, total commissions paid to brokers amounted to $1,741,599. By
comparison, during the three months ended March 31, 2009, total commissions paid
to brokers amounted to $372,955. The increase in the total commissions paid to
brokers from the three months ended March 31, 2009 to the three months ended
March 31, 2010 was primarily a function of increased brokerage fees due to a
higher number of Natural Gas Interests being held and traded as a result of the
increase in USNG’s average total net assets, the decrease in the price of
Natural Gas Interests and the increase in redemptions and creations of units
during the three months ended March 31, 2010. The increase in assets
required USNG to purchase a greater number of Natural Gas Interests and incur a
larger amount of commissions. As an annualized percentage of total net assets,
the figure for the three months ended March 31, 2010 represents
approximately 0.18% of total net assets. By comparison, the figure for the three
months ended March 31, 2009 represented approximately 0.22% of total net assets.
However, there can be no assurance that commission costs and portfolio turnover
will not cause commission expenses to rise in future quarters.
USNG’s
transaction fees also increased during the three months ended March 31, 2010 due
to the increased investment in Other Natural Gas-Related Investments, including
over-the-counter swaps, during that period. In particular, the transaction costs
for over-the-counter swaps, including up front fees and spreads charged by
counterparties, are significantly higher as compared to those for
exchange-traded Natural Gas Interests, which, through March 31, 2010, are the
principal investment of USNG. USNG incurred $2,107,009 in transaction costs
during the three months ended March 31, 2010 as compared to no transaction costs
during the three months ended March 31, 2009.
The fees
and expenses associated with USNG’s audit expenses and tax accounting and
reporting requirements are paid by USNG. These costs are estimated to
be $2,145,293 for the calendar year 2010.
Interest Income
. USNG seeks
to invest its assets such that it holds Futures Contracts and Other Natural
Gas-Related Investments in an amount equal to the total net assets of its
portfolio. Typically, such investments do not require USNG to pay the full
amount of the contract value at the time of purchase, but rather require USNG to
post an amount as a margin deposit against the eventual settlement of the
contract. As a result, USNG retains an amount that is approximately equal to its
total net assets, which USNG invests in Treasuries, cash and/or cash
equivalents. This includes both the amount on deposit with the futures
commission merchant as margin, as well as unrestricted cash and cash equivalents
held with USNG’s custodian bank. The Treasuries, cash and/or cash equivalents
earn interest that accrues on a daily basis. For the three months ended March
31, 2010, USNG earned $219,888 in interest income on such cash and/or cash
equivalents. Based on USNG’s average daily total net assets, this was equivalent
to an annualized yield of 0.02%. USNG purchased Treasuries
during the three months ended March 31, 2010 and held only cash and/or cash
equivalents during this time period. By comparison, for the three
months ended March 31, 2009, USNG earned $498,606 in interest income on such
cash and/or cash equivalents. Based on USNG’s average daily total net assets,
this was equivalent to an annualized yield of 0.29%. USNG did not
purchase Treasuries during the three months ended March 31, 2009 and held
only cash and/or cash equivalents during this time period. Interest
rates on short-term investments in the United States, including cash, cash
equivalents, and short-term Treasuries, were sharply lower during the three
months ended March 31, 2010 compared to the same time period in 2009. As a
result, the amount of interest earned by USNG as a percentage of total net
assets was lower during the three months ended March 31, 2010 compared to the
three months ended March 31, 2009.
21
Tracking
USNG’s Benchmark
USNG
seeks to manage its portfolio such that changes in its average daily NAV, on a
percentage basis, closely track the changes in the average daily price of the
Benchmark Futures Contract, also on a percentage basis. Specifically, USNG seeks
to manage the portfolio such that over any rolling period of 30 valuation days,
the average daily change in its NAV is within a range of 90% to 110% (0.9 to
1.1) of the average daily change in the price of the Benchmark Futures Contract.
As an example, if the average daily movement of the price of the Benchmark
Futures Contract for a particular 30-day time period was 0.5% per day, USNG’s
management would attempt to manage the portfolio such that the average daily
movement of the NAV during that same time period fell between 0.45% and 0.55%
(
i.e
., between 0.9 and
1.1 of the benchmark’s results). USNG’s portfolio management goals do
not include trying to make the nominal price of USNG’s NAV equal to the nominal
price of the current Benchmark Futures Contract or the spot price for natural
gas. Management believes that it is not practical to manage the portfolio to
achieve such an investment goal when investing in listed natural gas Futures
Contracts and Other Natural Gas-Related Investments.
For the
30 valuation days ended March 31, 2010, the simple average daily change in the
Benchmark Futures Contract was -1.121%, while the simple average daily change in
the NAV of USNG over the same time period was-1.126%. The average daily
difference was -0.005% (or -0.5 basis points, where 1 basis point equals 1/100
of 1%). As a percentage of the daily movement of the Benchmark Futures Contract,
the average error in daily tracking by the NAV was 0.0655%, meaning that over
this time period USNG’s tracking error was within the plus or minus 10% range
established as its benchmark tracking goal. The first chart below shows the
daily movement of USNG’s NAV versus the daily movement of the Benchmark Futures
Contract for the 30-day period ended March 31, 2010.
*PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
22
*PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
Since the offering of USNG’s units to the public on April 18, 2007 to March 31, 2010, the simple average daily change in the Benchmark Futures Contract was -0.214%, while the simple average daily change in the NAV of USNG over the same time period was -0.212%. The average daily difference was 0.002% (or 0.2 basis points, where 1 basis point equals 1/100 of 1%). As a percentage of the daily movement of the Benchmark Futures Contract, the average error in daily tracking by the NAV was -0.215%, meaning that over this time period USNG’s tracking error was within the plus or minus 10% range established as its benchmark tracking goal.
An
alternative tracking measurement of the return performance of USNG versus the
return of its Benchmark Futures Contract can be calculated by comparing the
actual return of USNG, measured by changes in its NAV, versus the
expected
changes in its NAV
under the assumption that USNG’s returns had been exactly the same as the daily
changes in its Benchmark Futures Contract.
For the
three months ended March 31, 2010, the actual total return of USNG as measured
by changes in its NAV was -31.48%. This is based on an initial NAV of
$10.07 on December 31, 2009 and an ending NAV as of March 31, 2010 of
$6.90. During this time period, USNG made no distributions to its
unitholders. However, if USNG’s daily changes in its NAV had instead exactly
tracked the changes in the daily return of the Benchmark Futures Contract, USNG
would have ended the first quarter of 2010 with an estimated NAV of $6.92, for a
total return over the relevant time period of -31.25%. The difference between
the actual NAV total return of USNG of -31.48% and the expected total return
based on the Benchmark Futures Contract of -31.25% was an error over the time
period of 0.23%, which is to say that USNG’s NAV trailed the benchmark result by
that percentage. Management believes that a portion of the difference
between the actual return and the expected benchmark return can be attributed to
the net impact of the expenses and the interest that USNG collects on its cash
and cash equivalent holdings. During the three months ended March 31, 2010, USNG
received interest income of $219,888, which is equivalent to a weighted average
interest rate of 0.02% for such period. In addition, during the three
months ended March 31, 2010, USNG also collected $47,000 from its Authorized
Purchasers creating or redeeming baskets of units. This income contributed to
USNG’s actual return. However, if the total assets of USNG increase, management
believes that the impact on total returns of these fees from creations and
redemptions will diminish as a percentage of the total return. During the three
months ended March 31, 2010, USNG incurred total expenses of $7,849,744. Income
from interest and Authorized Purchaser collections net of expenses was
$(7,582,856), which is equivalent to a weighted average net interest rate of
-0.79% for the three months ended March 31, 2010.
23
By
comparison, for the three months ended March 31, 2009, the actual total return
of USNG as measured by changes in its NAV was -34.55%. This was based on an
initial NAV of $23.27 on December 31, 2008 and an ending NAV as of
March 31, 2009 of $15.23. During this time period, USNG made no distributions to
its unitholders. However, if USNG’s daily changes in its NAV had instead exactly
tracked the changes in the daily return of the Benchmark Futures Contract, USNG
would have ended the first quarter of 2009 with an estimated NAV of $15.18, for
a total return over the relevant time period of -34.76%. The difference between
the actual NAV total return of USNG of -34.55% and the expected total return
based on the Benchmark Futures Contract of -34.76% was an error over the
time period of 0.21%, which is to say that USNG’s actual total return exceeded
the benchmark result by that percentage. Management believes that a portion
of the difference between the actual return and the expected benchmark
return can be attributed to the impact of the expenses and interest that USNG
collected on its cash and cash equivalent holdings. During the three months
ended March 31, 2009, USNG received interest income of $498,606, which is
equivalent to a weighted average interest rate of 0.29% for such
period. In addition, during the three months ended March 31, 2009,
USNG also collected $65,000 from Authorized Purchasers creating or redeeming
baskets of units. This income contributed to USNG’s actual
return. During the three months ended March 31, 2009, USNG incurred
total expenses of $1,727,482. Income from interest and Authorized Purchaser
collections net of expenses was $(1,163,876), which is equivalent to a weighted
average net interest rate of -0.68% for the three months ended March 31,
2009.
There are
currently three factors that have impacted or are most likely
to impact USNG’s ability to accurately track its Benchmark Futures
Contract.
First,
USNG may buy or sell its holdings in the then current Benchmark Futures Contract
at a price other than the closing settlement price of that contract on the day
during which USNG executes the trade. In that case, USNG may pay a price that is
higher, or lower, than that of the Benchmark Futures Contract, which could
cause the changes in the daily NAV of USNG to either be too high or too low
relative to the changes in the Benchmark Futures Contract. During the three
months ended March 31, 2010, management attempted to minimize the effect of
these transactions by seeking to execute its purchase or sale of the Benchmark
Futures Contract at, or as close as possible to, the end of the day settlement
price. However, it may not always be possible for USNG to obtain the closing
settlement price and there is no assurance that failure to obtain the closing
settlement price in the future will not adversely impact USNG’s attempt to track
the Benchmark Futures Contract over time.
Second,
USNG earns interest on its cash, cash equivalents and Treasury
holdings. USNG is not required to distribute any portion of its income to its
unitholders and did not make any distributions to unitholders during the three
months ended March 31, 2010. Interest payments, and any other income, were
retained within the portfolio and added to USNG’s NAV. When this income exceeds
the level of USNG’s expenses for its management fee, brokerage commissions and
other expenses (including ongoing registration fees, licensing fees and
the fees and expenses of the independent directors of the General Partner),
USNG will realize a net yield that will tend to cause daily changes in the NAV
of USNG to track slightly higher than daily changes in the Benchmark Futures
Contract. During the three months ended March 31, 2010, USNG earned, on an
annualized basis, approximately 0.02% on its cash holdings. It also incurred
cash expenses on an annualized basis of 0.53% for management fees and
approximately 0.18% in brokerage commission costs related to the purchase and
sale of futures contracts, and 0.11% for other expenses. The foregoing fees and
expenses resulted in a net yield on an annualized basis of approximately (0.80)%
and affected USNG’s ability to track its benchmark. If short-term interest rates
rise above the current levels, the level of deviation created by the yield would
decrease. Conversely, if short-term interest rates were to decline, the amount
of error created by the yield would increase. When short-term yields drop to a
level lower than the combined expenses of the management fee and the brokerage
commissions, then the tracking error becomes a negative number and would tend to
cause the daily returns of the NAV to underperform the daily returns of the
Benchmark Futures Contract.
24
Third,
USNG may hold Other Natural Gas-Related Investments in its portfolio that
may fail to closely track the Benchmark Futures Contract’s total return
movements. In that case, the error in tracking the Benchmark Futures Contract
could result in daily changes in the NAV of USNG that are either too high, or
too low, relative to the daily changes in the Benchmark Futures Contract. During
the three months ended March 31, 2010, USNG held Other Natural Gas-Related
Investments. These holdings included a financially settled natural gas futures
contract traded on NYMEX whose settlement price tracks the settlement price of
the Benchmark Futures Contract. USNG also held investments in cleared swaps
traded on the ICE Futures whose settlement price also tracks the settlement
price of the Benchmark Futures Contract and fully-collateralized
over-the-counter swaps designed to track the settlement price of the Benchmark
Futures Contract. Due, in part, to the increased size of USNG over
the last several quarters and its obligations to comply with regulatory limits,
USNG has invested in Other Natural Gas-Related Investments, such as
over-the-counter swaps, which have increased transaction-related expenses and
may result in increased tracking error. Over-the-counter swaps increase
transaction-related expenses due to the fact that USNG must pay to the swap
counterparty certain fees that USNG does not have to pay for transactions
executed on an exchange. Finally, due to potential regulatory limitations, USNG
may determine to hold greater amounts of cash and cash equivalents and lesser
amounts of Natural Gas Interests, if it determines that will most appropriately
satisfy USNG’s investment objective. Holding more cash and cash equivalents and
less Natural Gas Interests for some period of time may result in increased
tracking error. There are additional Other Natural Gas-Related
Investments that USNG is permitted to invest in whose price movements may not
track the settlement price of the Benchmark Futures Contract.
On August
12, 2009, USNG’s management determined to suspend offerings of USNG’s units
since it could not invest the proceeds from such offerings in investments that
would permit it to meet USNG’s investment objective due to current and
anticipated new regulatory restrictions and limitations. As a result of this
suspension of creation activity, USNG’s shares may have been trading at a
premium during a portion of the period from August 12, 2009 to September 28,
2009, when creation activity resumed subject to certain
limitations. These limitations included the following: (1) USNG may
require Authorized Purchasers of its units to sell USNG specified investments,
including the arrangement of an over-the-counter swap contract between the
Authorized Purchaser and USNG, (2) USNG may limit its issuance of creation
baskets to an Authorized Purchaser to a specified minimum or maximum number of
baskets, (3) USNG’s management may vary the terms and conditions of investments
to be delivered or arranged by an Authorized Purchaser in order to purchase a
creation basket and (4) USNG’s management may decide to offer creation baskets
only on particular days. The trading of USNG’s units at a premium may have
caused an increase in tracking error. These limitations may continue to be
imposed as needed at management's discretion.
Term Structure of Natural Gas
Futures Prices and the Impact on Total Returns.
Several factors determine
the total return from investing in a futures contract position. One factor that
impacts the total return that will result from investing in near
month natural gas futures contracts and “rolling” those contracts forward
each month is the price relationship between the current near month contract and
the next month contract. For example, if the price of the near month
contract is higher than the next month contract (a situation referred to as
“backwardation” in the futures market), then absent any other change there is a
tendency for the price of a next month contract to rise in value as it becomes
the near month contract and approaches expiration. Conversely, if the price of a
near month contract is lower than the next month contract (a situation referred
to as “contango” in the futures market), then absent any other change there is a
tendency for the price of a next month contract to decline in value as it
becomes the near month contract and approaches expiration.
As an
example, assume that the price of natural gas for immediate delivery (the “spot”
price), was $7 per 10,000 million British thermal units (“MMBtu”), and the value
of a position in the near month futures contract was also $7. Over time, the
price of 10,000 MMBtu of natural gas will fluctuate based on a number of
market factors, including demand for natural gas relative to its supply. The
value of the near month contract will likewise fluctuate in reaction to a
number of market factors. If investors seek to maintain their position in a near
month contract and not take delivery of the natural gas, every month they must
sell their current near month contract as it approaches expiration and invest in
the next month contract.
If the
futures market is in backwardation,
e.g.
, when the expected price
of natural gas in the future would be less, the investor would be buying a next
month contract for a lower price than the current near month contract.
Hypothetically, and assuming no other changes to either prevailing natural gas
prices or the price relationship between the spot price, the near month contract
and the next month contract (and ignoring the impact of commission costs and the
interest earned on Treasuries, cash and/or cash equivalents), the value of the
next month contract would rise as it approaches expiration and becomes the new
near month contract. In this example, the value of the $7 investment would tend
to rise faster than the spot price of natural gas, or fall slower. As a result,
it would be possible in this hypothetical example for the price of spot natural
gas to have risen to $9 after some period of time, while the value of the
investment in the futures contract would have risen to $10, assuming
backwardation is large enough or enough time has elapsed. Similarly, the spot
price of natural gas could have fallen to $5 while the value of an investment in
the futures contract could have fallen to only $6. Over time, if backwardation
remained constant, the difference would continue to increase.
25
If the
futures market is in contango, the investor would be buying a next month
contract for a higher price than the current near month contract.
Hypothetically, and assuming no other changes to either prevailing natural gas
prices or the price relationship between the spot price, the near month contract
and the next month contract (and ignoring the impact of commission costs and the
interest earned on cash), the value of the next month contract would fall as it
approaches expiration and becomes the new near month contract. In this example,
it would mean that the value of the $7 investment would tend to rise slower than
the spot price of natural gas, or fall faster. As a result, it would be possible
in this hypothetical example for the spot price of natural gas to have
risen to $9 after some period of time, while the value of the investment in the
futures contract will have risen to only $8, assuming contango is large enough
or enough time has elapsed. Similarly, the spot price of natural gas could have
fallen to $6 while the value of an investment in the futures contract could have
fallen to $5. Over time, if contango remained constant, the difference would
continue to increase.
The chart
below compares the price of the near month contract to the average price of the
near 12 month contracts over the last 10 years (2000-2009) for natural gas. When
the price of the near month contract is higher than the average price of the
near 12 month contracts, the market would be described as being in
backwardation. When the price of the near month contract is lower than the
average price of the near 12 month contracts, the market would be described as
being in contango. Although the prices of the near month contract and the
average price of the near 12 month contracts do tend to move up or down
together, it can be seen that at times the near month prices are clearly higher
than the average price of the near 12 month contracts (backwardation), and other
times they are below the average price of the near 12 month contracts
(contango). In addition, investors can observe that natural gas
prices, both front month and second month, often display a seasonal pattern in
which the price of natural gas tends to rise in the early winter months and
decline in the summer months. This mirrors the physical demand for natural gas,
which typically peaks in the winter.
26
*PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
An
alternative way to view backwardation and contango data over time is to subtract
the dollar price of the near month natural gas Futures Contract from the dollar
price of the near 12 month natural gas Futures Contracts. If the resulting
number is a positive number, then the near month price is higher than the
average price of the near 12 months and the market could be described as being
in backwardation. If the resulting number is a negative number, then the near
month price is lower than the average price of the near 12 months and the market
could be described as being in contango. The chart below shows the
results from subtracting the average dollar price of the near 12 month contracts
from the near month price for the 10 year period between 2000 and 2009.
Investors will note that the natural gas market spent time in both backwardation
and contango. Investors will further note that the markets display a seasonal
pattern that corresponds to the seasonal demand patterns for natural gas above.
That is, in many, but not all, cases the average price of the near 12 month
contracts is higher than the near month during the approach to the winter months
as the price of natural gas for delivery in those winter months rises on
expectations of demand. At the same time, the price of the near month, when that
month is just
before
the onset of
winter, does not rise as far or as fast as the average price of the near 12
month contracts whose delivery falls during the winter season.
27
*PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
An
investment in a portfolio that involved owning only the near month contract
would likely produce a different result than an investment in a portfolio that
owned an equal number of each of the near 12 months’ worth of contracts.
Generally speaking, when the natural gas futures market is in backwardation, the
near month only portfolio would tend to have a higher total return than the 12
month portfolio. Conversely, if the natural gas futures market was in contango,
the portfolio containing 12 months’ worth of contracts would tend to outperform
the near month only portfolio. The chart below shows the annual results of
owning a portfolio consisting of the near month contract versus a portfolio
containing the near 12 months’ worth of contracts. In addition, the
chart shows the annual change in the spot price of natural gas. In
this example, each month, the near month only portfolio would sell the near
month contract at expiration and buy the next month out contract. The portfolio
holding an equal number of the near 12 months’ worth of contracts would sell the
near month contract at expiration and replace it with the contract that becomes
the new twelfth month contract.
28
*PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS
As seen
in the chart above, there have been periods of both positive and negative annual
total returns for both hypothetical portfolios over the last 10 years. In
addition, there have been periods during which the near month only approach had
higher returns, and periods where the 12 month approach had higher total
returns. The above chart does not represent the performance history of USNG or
any affiliated funds.
Historically,
the natural gas futures markets have experienced periods of contango
and backwardation. Because natural gas demand is seasonal, it is possible for
the price of Futures Contracts for delivery within one or two months to
rapidly move from backwardation into contango and back again within a relatively
short period of time of less than one year. While the investment objective of
USNG is not to have the market price of its units match, dollar for dollar,
changes in the spot price of natural gas, contango impacted the total return on
an investment in USNG units during the three months ended March 31, 2010
relative to a hypothetical direct investment in natural gas. For example,
an investment in USNG units made on December 31, 2009 and held to March 31, 2010
decreased, based upon the changes in the NAV for USNG units on those days, by
approximately -31.48%, while the spot price of natural gas for immediate
delivery during the same period decreased by approximately 30.56% (note: this
comparison ignores the potential costs associated with physically owning and
storing natural gas, which could be substantial). By comparison, during the
period from December 31, 2008 to March 31, 2009, contago impacted the total
return on an investment in USNG units relative to a hypothetical direct
investment in natural gas. For example, an investment in USNG units made on
December 31, 2008 and held to March 31, 2009 decreased, based upon the changes
in the NAV for USNG units on those days, by approximately -34.55%, while the
spot price of natural gas for immediate delivery during the same period
decreased by approximately -32.84% (note: this comparison ignores the potential
costs associated with physically owning and storing natural gas, which could be
substantial).
29
Periods
of contango or backwardation do not materially impact USNG’s investment
objective of having the percentage changes in its per unit NAV track the
percentage changes in the price of the Benchmark Futures Contract since the
impact of backwardation and contango tended to equally impact the percentage
changes in price of both USNG’s units and the Benchmark Futures Contract.
It is impossible to predict with any degree of certainty whether backwardation
or contango will occur in the future. It is likely that both conditions will
occur during different periods and, because of the seasonal nature of natural
gas demand, both may occur within a single year’s time.
Natural Gas Market.
During
the three months ended March 31, 2010, natural gas prices in the United States
were impacted by several factors. During the first quarter of 2010,
the amount of natural gas in storage rose to higher than average levels versus
the previous five years. Colder temperatures during January and February of
2010 followed by warmer temperatures during March contributed to the
decline in prices. In addition, increased natural gas production also
contributed to a decline in natural gas prices during the three months
ended March 31, 2010, with prices reaching a low at the end of the quarter
of $3.869 on March 31, 2010.
Natural Gas Price Movements in
Comparison to other Energy Commodities and Investment Categories.
The
General Partner believes that investors frequently measure the degree to which
prices or total returns of one investment or asset class move up or down in
value in concert with another investment or asset class. Statistically, such a
measure is usually done by measuring the correlation of the price movements of
the two different investments or asset classes over some period of time. The
correlation is scaled between 1 and -1, where 1 indicates that the two
investment options move up or down in price or value together, known as
“positive correlation,” and -1 indicating that they move in completely opposite
directions, known as “negative correlation.” A correlation of 0 would mean that
the movements of the two are neither positively or negatively correlated, known
as “non-correlation.” That is, the investment options sometimes move up and down
together and other times move in opposite directions.
For the
ten year time period between 2000 and 2009, the chart below compares the monthly
movements of natural gas prices versus the monthly movements of the prices of
several other energy commodities, such as crude oil, heating oil, and unleaded
gasoline, as well as several major non-commodity investment asset classes such
as large cap U.S. equities, U.S. government bonds and global equities. It can be
seen that over this particular time period, the movement of natural gas on a
monthly basis was not strongly correlated, positively or negatively, with the
movements of large cap U.S. equities, U.S. government bonds or global equities.
However, movements in natural gas had a positive, but weak, correlation to
movements in heating oil. Finally, natural gas had a positive, but very weak,
correlation with crude oil but was not strongly correlated, either positively or
negatively, with unleaded gasoline.
|
10 Year Correlation
Matrix 2000-2009
|
Large
Cap U.S.
Equities
(S&P
500)
|
U.S. Govt.
Bonds
(EFFAS
U.S.
Government
Bond
Index)
|
Global
Equities
(FTSE
World
Index)
|
Crude
Oil
|
Heating
Oil
|
Unleaded
Gasoline
|
Natural
Gas
|
|||||||||||||||||||||
|
Large
Cap U.S. Equities (
S&P
500)
|
1.000 | -0.259 | 0.966 | 0.152 | 0.087 | 0.135 | 0.023 | |||||||||||||||||||||
|
U.S.
Govt. Bonds (EFFAS U.S. Government Bond Index)
|
1.000 | -0.237 | -0.127 | -0.078 | -0.214 | 0.128 | ||||||||||||||||||||||
|
Global
Equities (FTSE World Index)
|
1.000 | 0.246 | 0.165 | 0.196 | 0.084 | |||||||||||||||||||||||
|
Crude
Oil
|
1.000 | 0.783 | 0.724 | 0.334 | ||||||||||||||||||||||||
|
Heating
Oil
|
1.000 | 0.613 | 0.446 | |||||||||||||||||||||||||
|
Unleaded
Gasoline
|
1.000 | 0.257 | ||||||||||||||||||||||||||
|
Natural
Gas
|
1.000 | |||||||||||||||||||||||||||
|
Source:
Bloomberg, NYMEX
|
||||||||||||||||||||||||||||
30
PAST
PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE
RESULTS
The chart
below covers a more recent, but much shorter, range of dates than the above
chart. It can be seen that over this particular time period, the movement of
natural gas on a monthly basis was not strongly correlated, positively or
negatively, with the movements of large-cap U.S. equities, U.S. government
bonds, global equities, or the other three energy commodities of crude oil,
gasoline or heating oil.
|
12 months ended March 31, 2010
|
Large
Cap U.S.
Equities
(S&P
500)
|
U.S. Gov't
Bonds
(EFFAS
U.S.
Govt
Bond
Index)
|
Global
Equities
(FTSE
World
Index)
|
Unleaded
Gasoline
|
Heating
Oil
|
Natural
Gas
|
Crude
Oil
|
|||||||||||||||||||||
|
Large
Cap U.S. Equities (S&P 500)
|
1.000 | -0.086 | 0.952 | 0.317 | 0.204 | -0.146 | 0.243 | |||||||||||||||||||||
|
U.S.
Gov't Bonds (EFFAS U.S. Govt Bond Index)
|
1.000 | -0.229 | -0.316 | -0.321 | -0.088 | -0.273 | ||||||||||||||||||||||
|
Global
Equities (FTSE World Index)
|
1.000 | 0.425 | 0.329 | -0.056 | 0.372 | |||||||||||||||||||||||
|
Unleaded
Gasoline
|
1.000 | 0.856 | -0.267 | 0.848 | ||||||||||||||||||||||||
|
Heating
Oil
|
1.000 | 0.152 | 0.937 | |||||||||||||||||||||||||
|
Natural
Gas
|
1.000 | 0.098 | ||||||||||||||||||||||||||
|
Crude
Oil
|
1.000 | |||||||||||||||||||||||||||
|
Source: Bloomberg,
NYMEX
|
||||||||||||||||||||||||||||
PAST PERFORMANCE IS NOT NECESSARILY
INDICATIVE OF FUTURE RESULTS
Investors
are cautioned that the historical price relationships between natural gas and
various other energy commodities, as well as other investment asset classes, as
measured by correlation may not be reliable predictors of future price movements
and correlation results. The results pictured above would have been different if
a different range of dates had been selected. The General Partner believes that
natural gas has historically not demonstrated a strong correlation with equities
or bonds over long periods of time. However, the General Partner also believes
that in the future it is possible that natural gas could have long term
correlation results that indicate prices of natural gas more closely track the
movements of equities or bonds. In addition, the General Partner believes that,
when measured over time periods shorter than ten years, there will always be
some periods where the correlation of natural gas to equities and bonds will be
either more strongly positively correlated or more strongly negatively
correlated than the long term historical results suggest.
The correlations between
natural gas, crude oil, heating oil and gasoline are relevant because the
General Partner endeavors to invest USNG’s assets in natural gas Futures
Contracts and Other Natural Gas-Related Investments so that daily changes in
percentage terms in USNG’s NAV correlate as closely as possible with daily
changes in percentage terms in the price of the Benchmark Futures Contract. If
certain other fuel-based commodity futures contracts do not closely
correlate with the natural gas Futures Contract, then their use could lead to
greater tracking error. As noted above, the General Partner also believes that
the changes in percentage terms in the price of the Benchmark Futures Contract
will closely correlate with changes in percentage terms in the spot price of
natural gas.
Critical
Accounting Policies
Preparation
of the condensed financial statements and related disclosures in compliance with
accounting principles generally accepted in the United States of America
requires the application of appropriate accounting rules and guidance, as well
as the use of estimates. USNG’s application of these policies involves judgments
and actual results may differ from the estimates used.
31
The
General Partner has evaluated the nature and types of estimates that
it makes in preparing USNG’s condensed financial statements and related
disclosures and has determined that the valuation of its investments which
are not traded on a United States or internationally recognized futures exchange
(such as forward contracts and over-the-counter contracts) involves a critical
accounting policy. The values which are used by USNG for its futures
contracts are provided by its commodity broker who uses market prices when
available, while over-the-counter contracts are valued based on the
present value of estimated future cash flows that would be received from or paid
to a third party in settlement of these derivative contracts prior to their
delivery date and valued on a daily basis. In addition, USNG estimates
interest income on a daily basis using prevailing interest rates earned on its
cash and cash equivalents. These estimates are adjusted to the actual amount
received on a monthly basis and the difference, if any, is not considered
material.
Liquidity
and Capital Resources
USNG has
not made, and does not anticipate making, use of borrowings or other lines of
credit to meet its obligations. USNG has met, and it is anticipated
that USNG will continue to meet, its liquidity needs in the normal
course of business from the proceeds of the sale of its investments, or from the
Treasuries, cash and/or cash equivalents that it intends to hold at all times.
USNG’s liquidity needs include: redeeming units, providing margin deposits for
its existing Futures Contracts or the purchase of additional Futures Contracts
and posting collateral for its over-the-counter contracts and payment of its
expenses, summarized below under “Contractual Obligations.”
USNG
currently generates cash primarily from (i) the sale of baskets consisting of
100,000 units (“Creation Baskets”) and (ii) interest earned on Treasuries, cash
and/or cash equivalents. USNG has allocated substantially all of its net assets
to trading in Natural Gas Interests. USNG invests in Natural Gas Interests to
the fullest extent possible without being leveraged or unable to satisfy its
current or potential margin or collateral obligations with respect to its
investments in Futures Contracts and Other Natural Gas-Related Investments. A
significant portion of the NAV is held in cash and cash equivalents that
are used as margin and as collateral for USNG’s trading in Natural Gas
Interests. The balance of the net assets is held in USNG’s account at its
custodian bank. Interest earned on USNG’s interest-bearing funds is paid to
USNG. In prior periods, the amount of cash earned by USNG from the sale of
Creation Baskets and from interest earned has exceeded the amount of cash
required to pay USNG’s expenses. However, during the three months ended March
31, 2010, USNG’s expenses exceeded the interest income USNG earned and the cash
earned by the sale of Creation Baskets. During the three months ended March 31,
2010, USNG was forced to use other assets to pay cash expenses, which could
cause a drop in USNG’s NAV over time. To the extent expenses have
exceeded interest income, USNG’s NAV will be negatively impacted.
USNG’s
investments in Natural Gas Interests may be subject to periods of illiquidity
because of market conditions, regulatory considerations and other reasons. For
example, most commodity exchanges limit the fluctuations in futures
contracts prices during a single day by regulations referred to as “daily
limits.” During a single day, no trades may be executed at prices beyond the
daily limit. Once the price of a futures contract has increased or decreased by
an amount equal to the daily limit, positions in the contracts can neither be
taken nor liquidated unless the traders are willing to effect trades at or
within the specified daily limit. In addition, USNG’s over-the-counter
contracts have very limited liquidity since they are negotiated agreements that
are not transferable by USNG except with the consent of its counterparty, and
even if consent were granted, there may not be an available transferee. Such
market conditions or contractual limits could prevent USNG from promptly
liquidating its positions in Natural Gas Interests. During the three months
ended March 31, 2010, USNG was not forced to purchase or liquidate any of its
positions while daily limits were in effect; however, USNG cannot predict
whether such an event may occur in the future.
Since the
initial offering of units, USNG has been responsible for expenses relating to
(i) management fees, (ii) brokerage fees and commissions and fees
associated with its over-the-counter transactions, (iii) licensing fees for the
use of intellectual property, (iv) ongoing registration expenses in connection
with offers and sales of its units subsequent to the initial offering, (v)
other expenses, including certain tax reporting costs, (vi) fees and expenses of
the independent directors of the General Partner and (vii) other extraordinary
expenses not in the ordinary course of business, while the General Partner has
been responsible for expenses relating to the fees of USNG’s marketing agent,
administrator and custodian and registration expenses relating to the initial
offering of units. If the General Partner and USNG are unsuccessful in
raising sufficient funds to cover these respective expenses or in locating any
other source of funding, USNG will terminate and investors may lose all or part
of their investment.
32
Market
Risk
Trading
in Futures Contracts and Other Natural Gas-Related Investments, such as
forwards, involves USNG entering into contractual commitments to purchase
or sell natural gas at a specified date in the future. The aggregate market
value of the contracts will significantly exceed USNG’s future cash
requirements since USNG intends to close out its open positions prior to
settlement. As a result, USNG is generally only subject to the risk of
loss arising from the change in value of the contracts. USNG considers the “fair
value” of its derivative instruments to be the unrealized gain or loss on the
contracts. The market risk associated with USNG’s commitments to purchase
natural gas is limited to the aggregate market value of the contracts held.
However, should USNG enter into a contractual commitment to sell natural gas, it
would be required to make delivery of the natural gas at the contract price,
repurchase the contract at prevailing prices or settle in cash. Since there are
no limits on the future price of natural gas, the market risk to USNG could be
unlimited.
USNG’s
exposure to market risk depends on a number of factors, including the
markets for natural gas, the volatility of interest rates and foreign exchange
rates, the liquidity of the Futures Contracts and Other Natural Gas-Related
Investments markets and the relationships among the contracts held by
USNG. Drastic market occurrences could ultimately lead to the loss of
all or substantially all of an investor’s capital.
Credit
Risk
When USNG
enters into Futures Contracts and Other Natural Gas-Related Investments, it is
exposed to the credit risk that the counterparty will not be able to meet its
obligations. The counterparty for the Futures Contracts traded on the NYMEX and
on most other foreign futures exchanges is the clearinghouse associated
with the particular exchange. In general, in addition to margin required to be
posted by the exchange or clearinghouse in connection with trades on the
exchange or through the clearinghouse, clearinghouses are backed by their
members who may be required to share in the financial burden resulting from the
nonperformance of one of their members and, therefore, this additional member
support should significantly reduce credit risk. Some foreign exchanges are not
backed by their clearinghouse members but may be backed by a consortium of banks
or other financial institutions. There can be no assurance that any
counterparty, clearinghouse, or their members or their financial backers will
satisfy their obligations to USNG in such circumstances.
During
the three months ended March 31, 2010, USNG has entered into
fully-collateralized over-the-counter transactions with five counterparties.
Unlike most of the exchange-traded Futures Contracts, cleared swaps or
exchange-traded options on such futures, each party to an over-the-counter
contract bears the credit risk that the other party may not be able to perform
its obligations under its contract. See “Item 3. Quantitative and
Qualitative Disclosures About Market Risk” of this quarterly report on Form 10-Q
for a discussion of over-the-counter contracts.
The
General Partner attempts to manage the credit risk of USNG by following
various trading limitations and policies. In particular, USNG generally posts
margin and/or holds liquid assets that are approximately equal to the market
value of its obligations to counterparties under the Futures Contracts and Other
Natural Gas-Related Investments it holds. The General Partner has implemented
procedures that include, but are not limited to, executing and clearing trades
only with creditworthy parties and/or requiring the posting of collateral or
margin by such parties for the benefit of USNG to limit its credit exposure. UBS
Securities LLC, USNG’s commodity broker, or any other broker that may be
retained by USNG in the future, when acting as USNG’s futures commission
merchant in accepting orders to purchase or sell Futures Contracts on United
States exchanges, is required by CFTC regulations to separately account for
and segregate as belonging to USNG, all assets of USNG relating to domestic
Futures Contracts trading. These futures commission merchants are not allowed to
commingle USNG’s assets with its other assets. In addition, the CFTC requires
commodity brokers to hold in a secure account USNG’s assets related to foreign
Futures Contracts trading and, in some cases, to cleared swaps executed through
the Futures Commission Merchant. Similarly, under its current
over-the-counter agreements, USNG requires that collateral it posts or receives
be posted with its custodian and, under agreements among the custodian, USNG and
its counterparties, such collateral is segregated.
33
USNG
purchases over-the-counter contracts, see “Item 3. Quantitative and Qualitative
Disclosures About Market Risk” of this quarterly report on Form 10-Q for a
discussion of over-the-counter contracts.
As of
March 31, 2010, USNG had deposits in domestic and foreign financial
institutions, including cash investments in money market funds, in the amount of
$3,118,486,686. This amount is subject to loss should these institutions cease
operations.
Off
Balance Sheet Financing
As of
March 31, 2010, USNG has no loan guarantee, credit support or other off-balance
sheet arrangements of any kind other than agreements entered into in the normal
course of business, which may include indemnification provisions relating to
certain risks that service providers undertake in performing services which are
in the best interests of USNG. While USNG’s exposure under these indemnification
provisions cannot be estimated, they are not expected to have a material impact
on USNG’s financial position.
Redemption
Basket Obligation
In order
to meet its investment objective and pay its contractual obligations described
below, USNG requires liquidity to redeem units, which redemptions must be
in blocks of 100,000 units called “Redemption Baskets”. USNG has to date
satisfied this obligation by paying from the cash or cash equivalents it holds
or through the sale of its Treasuries in an amount proportionate to the number
of units being redeemed.
Contractual
Obligations
USNG’s
primary contractual obligations are with the General Partner. In return for its
services, the General Partner is entitled to a management fee calculated monthly
as a fixed percentage of USNG’s NAV, currently 0.60% for a NAV of $1 billion or
less, and thereafter 0.50% for a NAV above $1 billion.
The
General Partner agreed to pay the start-up costs associated with the
formation of USNG, primarily its legal, accounting and other costs in connection
with the General Partner’s registration with the CFTC as a CPO and the
registration and listing of USNG and its units with the SEC, FINRA and the
AMEX, respectively. However, since USNG’s initial offering of units, offering
costs incurred in connection with registering and listing additional units of
USNG are directly borne on an ongoing basis by USNG, and not by the General
Partner.
The
General Partner pays the fees of USNG’s marketing agent, ALPS Distributors,
Inc., and the fees of the custodian and transfer agent, Brown Brothers Harriman
& Co. (“BBH&Co.”), as well as BBH&Co.’s fees for performing
administrative services, including those in connection with the preparation of
USNG’s condensed financial statements and its SEC and CFTC reports. The General
Partner and USNG have also entered into a licensing agreement with the NYMEX
pursuant to which USNG and the affiliated funds managed by the General Partner
pay a licensing fee to the NYMEX. USNG also pays the fees and expenses
associated with its tax accounting and reporting requirements.
In
addition to the General Partner’s management fee, USNG pays its brokerage fees
(including fees to a futures commission merchant), over-the-counter dealer
spreads and up-front fees, any licensing fees for the use of intellectual
property, and, subsequent to the initial offering, registration and other fees
paid to the SEC, FINRA, or other regulatory agencies in connection with the
offer and sale of units, as well as legal, printing, accounting and other
expenses associated therewith, and extraordinary expenses. The latter are
expenses not incurred in the ordinary course of USNG’s business, including
expenses relating to the indemnification of any person against liabilities and
obligations to the extent permitted by law and under the LP Agreement, the
bringing or defending of actions in law or in equity or otherwise conducting
litigation and incurring legal expenses and the settlement of claims and
litigation. Commission payments to a futures commission merchant are on a
contract-by-contract, or round turn, basis. USNG also pays a portion of the fees
and expenses of the independent directors of the General Partner. See Note 3 to
the Notes to Condensed Financial Statements (Unaudited).
34
The
parties cannot anticipate the amount of payments that will be required under
these arrangements for future periods, as USNG’s NAVs and trading levels to meet
its investment objectives will not be known until a future date. These
agreements are effective for a specific term agreed upon by the parties with an
option to renew, or, in some cases, are in effect for the duration of USNG’s
existence. Either party may terminate these agreements earlier for certain
reasons described in the agreements.
On March
31, 2010, USNG’s portfolio consisted of 10,573 Natural Gas NG Futures Contracts
traded on NYMEX, 32,566 Natural Gas NN Futures Contracts traded on the NYMEX,
58,485 cleared swaps traded on the ICE Futures and total return swaps with an
aggregate market value of $(58,141,269). For a list of USNG’s current
holdings, please see USNG’s website at
www.unitedstatesnaturalgasfund.com.
Over-the-Counter
Derivatives
As of
March 31, 2010, USNG has entered into fully-collateralized over-the-counter swap
transactions with five counterparties and was in the process of negotiating
agreements governing over-the-counter transactions with additional
counterparties. Unlike most of the exchange-traded Futures Contracts,
cleared swaps or exchange-traded options on such futures, each party to an
over-the-counter contract bears the credit risk that the other party may not be
able to perform its obligations under its contract.
Some
natural gas-based derivatives transactions contain fairly generic terms and
conditions and are available from a wide range of participants. Other natural
gas-based derivatives have highly customized terms and conditions and are not as
widely available. Many of these over-the-counter contracts are cash-settled
forwards for the future delivery of natural gas- or petroleum-based fuels that
have terms similar to the Futures Contracts. Others take the form of
“swaps” in which the two parties exchange cash flows based on pre-determined
formulas tied to the spot price of natural gas, forward natural gas
prices or natural gas futures prices. For example, USNG may enter into
over-the-counter derivative contracts whose value will be tied to changes in the
difference between the spot price of natural gas, the price of Futures
Contracts traded on the NYMEX and the prices of other Futures Contracts in
which USNG may invest.
To
protect itself from the credit risk that arises in connection with such
contracts, USNG has entered into agreements with each counterparty that provide
for the netting of its overall exposure to such counterparty, such as the
agreements published by the International Swaps and Derivatives Association,
Inc. USNG also requires that the counterparty be highly rated and/or
provide collateral or other credit support to address USNG’s exposure to the
counterparty (
i.e.
, the
amount the counterparty would have to pay to USNG if the transaction with the
counterparty were to terminate on that day). USNG must, to the extent
its counterparty has exposure to it under the transaction, also post
collateral. In addition, it is also possible for USNG and its
counterparty to agree to clear their agreement through an established futures
clearinghouse such as those connected to the NYMEX or the ICE Futures. In that
event, USNG would no longer bear the credit risk of its original counterparty,
as the clearinghouse would now be USNG’s counterparty. USNG would still retain
any price risk associated with its transaction and would be required to deposit
margin to secure the clearinghouse’s exposure to USNG.
The
creditworthiness of each potential counterparty is assessed by the General
Partner. The General Partner assesses or reviews, as appropriate, the
creditworthiness of each potential or existing counterparty to an
over-the-counter contract pursuant to guidelines approved by the General
Partner's board of directors (the “Board”). Furthermore, the General Partner on
behalf of USNG only enters into over-the-counter contracts with counterparties
who are, or are affiliates of, (a) banks regulated by a United States federal
bank regulator, (b) broker-dealers regulated by the SEC, (c) insurance companies
domiciled in the United States, or (d) producers, users or traders of energy,
whether or not regulated by the CFTC. Any entity acting as a counterparty shall
be regulated in either the United States or the United Kingdom unless otherwise
approved by the Board after consultation with its legal counsel. Existing
counterparties are also reviewed periodically by the General
Partner.
USNG
anticipates that the use of Other Natural Gas-Related Investments together with
its investments in Futures Contracts will produce price and total return results
that closely track the investment goals of USNG. However, there can be no
assurance of this. Over-the-counter contracts may result in higher
transaction-related expenses than the brokerage commissions paid in connection
with the purchase of Futures Contracts, which may impact USNG’s ability to
successfully track the Benchmark Futures Contract.
35
USNG may
employ spreads or straddles in its trading to mitigate the differences in its
investment portfolio and its goal of tracking the price of the
Benchmark Futures Contract. USNG would use a spread when it chooses to take
simultaneous long and short positions in futures written on the same underlying
asset, but with different delivery months. The effect of holding such combined
positions is to adjust the sensitivity of USNG to changes in the price
relationship between futures contracts which will expire sooner and those that
will expire later. USNG would use such a spread if the General Partner felt that
taking such long and short positions, when combined with the rest of its
holdings, would more closely track the investment goals of USNG, or if the
General Partner felt it would lead to an overall lower cost of trading to
achieve a given level of economic exposure to movements in natural gas prices.
USNG would enter into a straddle when it chooses to take an option position
consisting of a long (or short) position in both a call option and put option.
The economic effect of holding certain combinations of put options and call
options can be very similar to that of owning the underlying futures contracts.
USNG would make use of such a straddle approach if, in the opinion of the
General Partner, the resulting combination would more closely track the
investment goals of USNG or if it would lead to an overall lower cost of trading
to achieve a given level of economic exposure to movements in natural gas
prices.
During
the three months ended March 31, 2010, USNG employed hedging methods such as
those described above to the extent it invested in fully-collateralized
over-the-counter swap transactions designed to track percentage changes in the
price of the Benchmark Futures Contract. During the three months ended March 31,
2010, USNG was exposed to counterparty risk on its fully-collateralized
over-the-counter swap transactions with five counterparties.
The
counterparty credit ratings for the exposure on over-the-counter swap
transactions to which USNG was a party that would be owed to USNG due to a
default or early termination by USNG’s counterparties at March 31, 2010 and
December 31, 2009 were:
|
December 31, 2009
|
|||||||||||||||||||
|
Moody’s
Credit
Rating
|
Number of
Counterparties
|
Notional
Amount
|
Credit
Exposure
|
Collateral
Held
|
Exposure,
Net of
Collateral*
|
||||||||||||||
|
Aa1
|
1
|
$ | 1,031,083,313 | $ | - | $ | - | $ | - | ||||||||||
|
A2
|
1
|
197,724,486 | 24,272,748 | 33,708,890 | (9,436,142 | ) | |||||||||||||
|
Aa3
|
1
|
614,340,863 | - | - | - | ||||||||||||||
|
Unrated
|
3
|
630,898,411 | - | - | - | ||||||||||||||
|
Total
|
6
|
$ | 2,474,070,073 | $ | 24,272,748 | $ | 33,708,890 | $ | (9,436,142 | ) | |||||||||
|
March 31, 2010
|
|||||||||||||||||||
|
Moody’s
Credit
Rating
|
Number of
Counterparties
|
Notional
Amount
|
Credit
Exposure
|
Collateral
Held
|
Exposure,
Net of
Collateral*
|
||||||||||||||
|
Aa1
|
1
|
$ | 527,839,520 | $ | - | $ | - | $ | - | ||||||||||
|
A2
|
1
|
233,131,597 | - | - | - | ||||||||||||||
|
Aa3
|
1
|
412,246,426 | - | - | - | ||||||||||||||
|
Unrated
|
2
|
432,088,277 | (11,517,599 | ) | 10,260,000 | (1,257,599 | ) | ||||||||||||
|
Total
|
5
|
$ | 1,605,305,820 | $ | $ | $ | |||||||||||||
* The
difference reflects minimum transfer amounts for collateral and potentially one
day’s movement in the underlying total return, which would be collateralized the
following business day.
36
The
aggregate notional amount of USNG’s over-the-counter derivative transactions,
most of which consisted of total return swaps, increased to $1,605,305,820 at
March 31, 2010, as compared with no swaps for the prior period. The aggregate
notional amount of these derivative transactions, which is not included in the
Condensed Schedule of Investments (Unaudited), is indicative of USNG’s
activities in derivative transactions, but is not an indicator of the level of
credit risk associated with these transactions.
At March
31, 2010, USNG’s counterparties posted $10,260,000 in cash and no securities as
collateral with USNG’s custodian, as compared with the prior period for which no
collateral was posted since USNG had not yet entered into any swaps. Under
these over-the-counter swap agreements, USNG posted collateral with respect to
its obligations of $259,652,888.69 in cash and $6,132,000 in securities at March
31, 2010, while no collateral was posted for the prior period.
Disclosure
Controls and Procedures
USNG
maintains disclosure controls and procedures that are designed to ensure that
material information required to be disclosed in USNG’s periodic reports filed
or submitted under the Securities Exchange Act of 1934, as amended, is recorded,
processed, summarized and reported within the time period specified in the SEC’s
rules and forms.
The duly
appointed officers of the General Partner, including its chief executive officer
and chief financial officer, who perform functions equivalent to those
of a principal executive officer and principal financial officer of
USNG if USNG had any officers, have evaluated the effectiveness of USNG’s
disclosure controls and procedures and have concluded that the
disclosure controls and procedures of USNG have been effective as of the end of
the period covered by this quarterly report on Form 10-Q.
Change
in Internal Control Over Financial Reporting
There
were no changes in USNG’s internal control over financial reporting during
USNG’s last fiscal quarter that have materially affected, or are reasonably
likely to materially affect, USNG’s internal control over financial
reporting.
37
Not
applicable.
There has
not been a material change from the risk factors previously disclosed in USNG’s
Annual Report on Form 10-K for the fiscal year ended December 31,
2009.
Not applicable.
Not applicable.
Monthly
Account Statements
Pursuant
to the requirement under Rule 4.22 under the Commodity Exchange Act, each month
USNG publishes an account statement for its unitholders, which includes a
Statement of Income (Loss) and a Statement of Changes in NAV. The account
statement is furnished to the SEC on a current report on Form 8-K pursuant
to Section 13 or 15(d) of the Exchange Act and posted each month on USNG’s
website at www.unitedstatesnaturalgasfund.com.
Listed
below are the exhibits which are filed as part of this quarterly report on Form
10-Q (according to the number assigned to them in Item 601 of Regulation
S-K):
|
Exhibit
|
||
|
Number
|
Description of Document
|
|
|
31.1*
|
Certification
by Principal Executive Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
31.2*
|
Certification
by Principal Financial Officer Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
|
32.1*
|
Certification
by Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
|
32.2*
|
Certification
by Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
|
99.1**
|
Form
of United States Commodity Funds LLC Director Deferred Compensation
Agreement.
|
|
*
|
Filed
herewith.
|
|
**
|
Incorporated
by reference to the Registrant’s Current Report on Form 8-K filed on April
1, 2010.
|
38
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
United
States Natural Gas Fund, LP (Registrant)
|
||
|
By: United
States Commodity Funds LLC, its general partner
|
||
|
By:
|
/s/ Nicholas D. Gerber | |
|
Nicholas
D. Gerber
|
||
|
President
and Chief Executive Officer
|
||
|
(Principal
executive officer)
|
||
|
Date: May
10, 2010
|
||
|
By:
|
/s/ Howard Mah | |
|
Howard
Mah
|
||
|
Chief
Financial Officer
|
||
|
(Principal
financial and accounting officer)
|
||
|
Date: May 10,
2010
|
||
39
TABLE OF CONTENTS
Part I. Financial InformationItem 1. Condensed Financial StatementsNote 1 - Organization and BusinessNote 2 - Summary Of Significant Accounting PoliciesNote 3 - Fees Paid By The Fund and Related Party TransactionsNote 4 - Contracts and AgreementsNote 5 - Financial Instruments, Off-balance Sheet Risks and ContingenciesNote 6 Fair Value Of Financial InstrumentsNote 7 - Financial HighlightsNote 8 Recent Accounting PronouncementsNote 9 Subsequent EventsItem 2. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPart II. Other InformationItem 1. Legal ProceedingsItem 1A. Risk FactorsItem 2. Unregistered Sales Of Equity Securities and Use Of ProceedsItem 3. Defaults Upon Senior SecuritiesItem 4. ReservedItem 5. Other InformationItem 6. Exhibits