Natural Gas Has Spiked 60% Since Labor Day. Why?

As reported by Zero Hedge on Thursday, September 10, 2009, natural gas was up by about 16% on no real change in the fundamentals of the commodity. By the end of the trading day, natural gas saw its biggest one-day gain of 15% in almost five years (Fig. 1, click to enlarge). Natural gas price has spiked almost 60 % since Labor Day and prompted investors to believe a V-shaped recovery might be near for the brutally battered U.S. natural gas market. However, don’t break out the champagne just yet until you learn more about two of the major factors driving this latest spike, pipeline Operation Flow Orders and from the trader's perspective.



Operation Flow Orders (OFOs)...What?

On the surface, the Thursday gain was sparked mainly by the Energy Department’s weekly data that showed a “smaller-than-forecast” increase in U.S. stockpiles. Though the news did not really change the overall supply and demand picture, it did send traders scrambling to buy back previously sold positions.

However, according to industry insiders, the "smaller-than-expected" increase in gas storage was largely due to what the pipeline industry called Operation Flow Orders (OFOs). Pipelines may issue OFOs in the event of high or low pipeline inventory. OFOs require shippers/producers to balance their gas supply with their customers' usage on a daily basis, within a specified tolerance band. Shippers may deliver additional supply or limit their supply in order to match customers’ usage. If the supply isn’t balanced, shippers may incur noncompliance charges.

In other words, when OFO's are issued in an oversupply environment like we are in right now, shippers/producers either comply, i.e., sending less gas to pipelines & storages, or pay a penalty. As most shippers logically chose to comply with the OFOs, the volume that normally goes to storage ended up overflowing to the spot market pressuring prices to around $1.84/mmbtu on Friday, 9/4/09, just before Labor Day.

Storage facilities and pipelines typically raise their tolerance band after Labor Day to prepare for the higher winter usage season. So, the lift after Labor Day normalized the market and is a major contributing factor in the 60% rise of natural gas prices since Labor Day.

Although some producers already shut down production in response to the current OFOs, more production shut-in is expected as pipelines continue issuing new OFO's.

The Trader's Perspective

One alternative explanation, from a trader’s perspective, is that a large natural gas player saw the opportunity to make a huge profit by blowing out the stops of the large contingent of traders who were short the natgas market. For example, someone like John D. Arnold, the former Enron trader who is one of the large players in the natural gas market. To the point, the move in natural gas form $3.00 to $3.30 during late day trading on Thursday was strictly due to the pre-configured stop orders being hit.

Still a Very Short and Decoupled Market

Based on a Bloomberg report, although the number of shorts did decline 3.9% from a week earlier, speculative short positions still outnumbered long positions by 169,846 contracts on Nymex for the week ending September 1st, 2009, according to the Commodity Futures Trading Commission (CFTC). In a short market, things can get extremely volatile and completely decoupled from any fundamental or technical indications.

Crude oil and equities markets, which traditionally have a negative correlation, have moved in tandem for the most part of this year. The upward momentum has some investors chasing natural gas, which theoretically should have a fair amount of correlation with oil.


However, as discussed in Oil and Natural Gas: Ratio Explodes in 2009, natural gas tends to be regional, while crude is more globally driven. If we look at the price movement of crude oil, natural gas and the S&P 500 (SPX), it is evident natural gas has completely decoupled and gone off on its own downward spiral (Fig. 2, click to enlarge). This suggests in general that commodity and equities markets will likely be irrelevant to natural gas in the near to medium term, given the fact that there is no fundamental U.S. demand.

Heading for a Sub-Zero Price Zone?

Despite the signals given by Thursday's spike, U.S. natural gas storage currently stands at 3.392 bcf, 17% higher year-over-year, and fast approaching the maximum storage capacity of about 3,900 bcf. The September 2009 EIA Short-term Energy Outlook now expects another 12% build in working natural gas inventories reaching 3,840 Bcf at the end of the 2009 injection season, i.e., October 31st (Fig. 3).

So, there will likely be a painfully lower gas price on hand in the next 6 to 10 weeks or so until winter withdrawals begin. During this period, we could have a short and sharp collapse in the spot price in the sub $2.00 range.


A colder than usual winter season as currently forecast by weather bugs is likely to boost natural gas prices higher; however, if this weather pattern fails to materialize leading to a max-out storage capacity, then we could be looking at a brief sub zero price scenario similar to one the UK experienced in 2006.

Crystal Ball into 2010 & Beyond

Natural gas prices are down about 42% so far this year as demand has been sluggish during the economic downturn, while production from onshore gas fields has remained robust. The EIA now estimates that total domestic natural gas consumption will likely decline by 2.4% in 2009 and remain flat in 2010. As the economy starts to recover and production cuts kick in on a larger scale, natural gas prices should rebound averaging close to the $5.00-$6.00 range in 2010 and gradually ramp up from there. Investors and traders should brace themselves for quite possibly the darkest days in the next 2 months for the natural gas market in over a decade before the dawn finally breaks.

Disclosure: No Positions

Comments

[fanning:]

It is informative articles and comments, Thanks.

Sep 15 11:53 AM

[Dryspell:]

If only this were true. There are currently producers drilling wells that are not economic hoping for a recovery in the gas price and to hold leasehold. It is possible in the short term for gas to trade below its marginal cost and producers to supply at a loss. They are doing it right now. This situation could take several years to correct without a return to strong demand.


On Sep 14 10:19 PM Mark Anthony wrote:

> The Author:
>
> The subtitle in your article reads "Heading for a Sub-Zero Price
> Zone?" Amazing any one can make that statement with a long face.
> I would love to be able to use as much natural gas as I want, and
> get paid to do so as well!
>
> The fact of the matter is fundamentals here support a much higher
> natural gas price. According to your quote number, EIA reports natural
> gas consumption is down only 2.4% in 2009. Is 2.4% down a collapse
> of demand. Let's say the demand is down 99%, the 1% of customers
> who still use natural gas still have to pay a fair price, otherwise
> not a single new natural gas well will be drilled and the supply
> will drop to zero%. This is the true fundamental, any commodity must
> be traded above fair cost, price below fair cost is unsustainable,
> reardless of supply/demand.
>
> The widely quoted number 3889 BCF is NOT the maximum storage capacity,
> it is the conservation LOW BOUND of the capacity estimate. The more
> optimistic upper bound of storage capacity is 4313 BCF. We are still
> far below that limit:
>
> www.eia.doe.gov/pub/oi...

Sep 15 12:33 PM

[Dryspell:]

Ariel,

I participate in this industry and I believe you have summed up the current situation better than I could have. There are many risks to increased prices and I believe the gas heavy US Independent E&Ps are a dangerous buy here. I am contemplating adding some puts to my portfolio today. Thank you for the post.


On Sep 15 04:22 AM Aricool wrote:

> Mistrofan,
>
> We're already past the peak of Huricane season, and zero activity.
> Each day that goes by exponentially drops the risk b/c the chances
> are already slim that a given huricane would make a hole in one and
> hit the TX/LA Gulf coast. The last one got completely deflected northward.
>
>
> Also, I think your they are dangerously over simplistic and not at
> all rigourous enough to even be taken seriously.
>
> The current pop up is just massive short covering and rabid bull
> sector rotation desperation. Why can't Nat Gas (seekingalpha.com/symbo...)
> go under $2? The factors I talk about below are not priced in now
> b/c market is controlled now by V-shape recovervy bulls expecting
> industrial production to go up enough in Q3 (w/ the higher PMI) to
> avoid over filling storage.
>
> It is a matter of when, not if. If most of the producers are 100%
> hedged for '09 (hence likely why their stock prices are not in the
> toilet w/ NG price) and they have to produce to keep their valuable
> leases and we have a 100 year supply, then why stop production at
> any price when you're getting top (hedged) $ any how??? Someone needs
> to explain to me why will they given these (and many other simar)
> factors.
>
> Besides, did you notice that rig counts bottomed in early June and
> actually started to uptick in July-Aug. Also, day rates never came
> down enough. Not a good sign if you believe in major production cuts.
>
>
> Also, if you look at the last recessions NG droped to around $2.5-2.7
> in real terms (adjusting for inflation); however, that was when US
> NG production was believed to have peaked, which is why we later
> created infrastructure for LNG imports- and those lows were before
> we became the Saudi-Arabia of NG with massive supplies. So, it would
> stand to reason that we'll see below $2 easy; esp. since we got so
> quickly to $2.5 w/o resistance.
>
> Moreover, I'm very concerned about the long term pricing of NG. I'm
> trying to see it as bullish as you do, but many long-term factors
> seem like it might keep it very low- not the least of which is LNG
> imports from Russia and Arabs when NG gets back over $4.
>
> Have a look at the LNG import spike between end '06 and early '07
> and it tracks *exactly* with a step down of NG price from 7 to 5.
> This is insane that LNG could crush prices during a robust US economy.
> I'm very scared now that with the paltry 2% trend growth expected
> for the US (and EU?) going forward that they'll dump excess Euro
> LNG onto the US and repeat that '06/'07 event. This would almost
> certainly keep NG prices under $4 in the expected weak situation
> for '10. This is a huge uncertainty in playing '09 weakness esp.
> if buying into NG driller/services securities to play the "perfect
> storm" against NG. That is, the LNG would dump just enough supply
> to easily keep the storage full, thus keeping NG exploration and
> cap ex down to a minimum, and b/c most NG producers are only partially
> hedged for 2010 (maybe 30% or less?) then they would get killed in
> 2010 making there hedged supported stock prices 2009 quite high.
> This uncertainty really sucks! Can you discount this scenario?<br/>
>
> the EU is expected to recover more slowly than the US so why won't
> the LNG plays dump what ever they can on the US. As I analyze the
> charts, the LNG chart tells me a very bad story. That is, the June
> '09 LNG was sold at only ~ $4.3 while volumes where a little above
> that just before the '06 event (see above) when NG price in '06 was
> ~7, and then dumped 2X the volume for 6 months and were more than
> happy to collect only $5 in that time. Again, this was when the EU
> and US were heading into a peak earning cycle. This tells me that
> the LNG players will keep US NG prices in the toilet (<$4) until
> the US (and EU?) are in a full recovery. Very, very bad for NG sector
> stocks for 2010. Please debunk this gloom and doom scenario! It seems
> all too possible if the magal V-shape recovery does not materialize
> in early 2010. Hence, why with a weak EU they'll dump there LNG at
> a (double? june '09) high rate and keep the US storage near max,
> thus NG prices in the toilet.
>
> I'd really hate to additionally bet on a V-shape recovery on top
> of the structural NG risks I've discussed. There are much more (risk
> adjusted) profitable bets on a V-shape recovery in the market.<br/>
>
> Betting on a V-shape recover is over the top for a NG bet at this
> point. Also, how can you be so sure that that '06/'07 event (see
> above) won't repeat in 2010?
>
> In summary, NG prices seem destined to go well under $2 well into
> November, and while it may rebound next year LNG will keep it near
> $4 and kill/hurt most US NG producers until the economy fully recovers
> (1-2 years) and get NG price in the $5-6 range.
>
> So, you can try catching a falling knife or put your money in soaring
> NG stocks which will collapse next year when there hedges are gone
> and NG is kept too low b/c of LNG. Seems like NG is a bad bet until
> at least Nov.
>
> Cheers,
> Ariel-
>

Sep 15 12:39 PM

[Dryspell:]

Dian,

Excellent article. Thank you.

Sep 15 12:41 PM

[Steven Vincent:]

I think the bump in NG price is really an oversold bounce. It's pretty simple. Price will revisit the recent bottom and when it does we will see how it acts at that time. It may be a buy then.

Sep 15 12:48 PM

[Steven Vincent:]

Also we should all note the bearish chart of the CRB and WTIC. Is NG going to buck the overall bearish trend in commodities?


On Sep 15 12:48 PM Steven Vincent wrote:

> I think the bump in NG price is really an oversold bounce. It's
> pretty simple. Price will revisit the recent bottom and when it
> does we will see how it acts at that time. It may be a buy then.

Sep 15 12:49 PM

[wobatus:]

What i found interesting is that, despite the call for near term dark days on prices, the article projects $5-6 in 2010. Which doesn't sound bad for CHK, ERF or RDC, 3 of my holdings. So if a near term slump is expected, intermediate term gains are as well.

Good luck to all.

Sep 15 01:32 PM

[Dian L. Chu:]

Thank you. Please do visit often.


On Sep 15 12:41 PM Dryspell wrote:

> Dian,
>
> Excellent article. Thank you.

Sep 15 01:35 PM

[Dian L. Chu:]

Thanks you as well.

On Sep 15 11:53 AM fanning wrote:

> It is informative articles and comments, Thanks.

Sep 15 01:39 PM

[Dian L. Chu:]

Thank you and good luck to you guys as well.


On Sep 14 10:45 PM JuniorEnergyFund wrote:

> Dian,
>
> Thank you for a very timely article. I was in Houston this morning
> asking our bank to open us a line of credit. If we see “under $2”,
> or better yet the 1998 low of $1.78, we are going to borrow money
> for the first time in our history to get “leveraged long”.
>
> Not to fond of ETF’s. Too many contango problems! We’ll probably
> use the money to buy weak/bankrupt reserves. At under $2 there will
> be plenty to choose from.
>
> However you play it, good luck! And, thanks again for a great article.

Sep 15 01:45 PM

[Joe Duggins:]

Natural gas commodities offer unique opportunities to invest and receive favorable returns, according to several commodities experts. In terms of energy commodities, natural gas has been a sort of sleeper and is poised to take off very soon. There are several reasons for this.

Surprisingly, one of the first reasons is the merging demand for ethanol production as represented by the Obama Administration's call for more reliance on alternative fuels. Writing for Commodity Newscenter, Devin Brady writes that there are 116 ethanol distilleries in the USA and seven of those are expanding. In addition, there are another 78 facilities under construction. These ethanol producing plants rely upon natural gas as their energy source. Thus, as ethanol production increases, so too does demand for this commodity.

One factor not discussed by Brady is the potential impact China will have on global energy commodities prices. As most of us are aware, China is one of the most polluted places on earth (a factor which almost derailed its Olympics bid) and this is due to its dependence on coal which is in abundant supply and is inexpensive. However, China has announced in recent years its desire to shift to other forms of energy in an attempt to redress China's pollution problems. Our commodity under discussion is one of those fuels which can provide China with the energy it needs while at the same time cutting back on pollutants since the main byproducts of natural gas are carbon dioxide and water vapor.

It is no wonder then that China Natural Gas announced recently that its profits for the first quarter of 2009 were up a little over 32% and it announced further a reverse stock split of two for one. The actions by one of China's largest natural gas producers may very well signal that China is serious in moving away from coal and this bodes well for investors in energy related commodities.
----------------------

Money without intelligence is like a car without a road.
www.intelligentinvesti...

Sep 15 03:07 PM

[Dian L. Chu:]

Please note that this is $UNG rollover week, and $UNG has reportedly just become an active buyer of fresh futures again, which probably has to do with the planned new shares issuance the end of this month.
This at least is one of the major contributors to the 16% natgas gain in the past 2 days. Nothing has really changed from a market fundamental perspective regarding storage, demand & supply.

ftalphaville.ft.com/bl.../
ftalphaville.ft.com/bl.../

Sep 15 05:33 PM

[Supplyguy:]

I agree with the bearish sentiment. Too much gas behind pipe, too much LNG ready to come here. If NG does move over the winter due to large drawdowns in storage, there is enough spare supply to keep the market down.

The big question mark is conventional NG declines. Vertical rigs have dropped way off, and horizontals have stayed about the same, even though the Shale Gas wells they drill don't account for much of US/Can production. When we get an actual handle on natural declines, we'll have a good idea of the supply side, and how fast we can chew through the storage overhang. Demand may pick up slightly, but alot of demand in 09 is fuel switching from coal, which will evaporate once NG heads above $4/mmcf. My sense is we are heading down again, and we may see some 'no-bid' on the spot market, but it is unlikely. Capital budgets are being set as we speak, the next 6 weeks will tell the tale...

Sep 15 05:55 PM

[ManAboutDallas:]

Why is everyone so mystified by this? This is how a bear market in ANY commodity ALWAYS ends... with a sudden, mysterious, where-did-this-come-from? rally.

At its recent low, NG was below the cost of nearly every producer's cost of production.

Helloooooooooooooooooo... ???????????

Sep 15 07:45 PM

[Aricool:]

Dryspell, your feedback is much appreciate.

Re your puts on NG indep producers. I would wonder if that is wise. My thinking is that the market's "dash for trash" will continue until some v. bad macro econ. data comes out, which likely won't happen until Fed stimulous dries up or unemployment or ARM mortgage resets causes a wave of consumer spending cuts. This should not happen until next year. So, rabid bulls can keep trash stocks up for several months to come. Puts in the E&P sector going out a few months are probably too expensive and may even time out before price drops b/c of hedges and bull market blinders. My concern is that the E&P guys are hedged for '09 so they should make it through the storm and can survive on $4 NG next year. So, I ran away from that trade. Actually, for fear of missing the boat, I bought a few to hedge my bets. Namely, DBLE @ 4, PDS at ~5.7, PETD @ 16.8, and EXH @ 17.5. They've run up about 25% from by entry. I expect they will survive. The sector is priced for faliure so it might be more profitable to buy the survivors in the toilet than to pick the loser stock(s) and have to bet on a time of there decline.

Any feedback is much appreciated.

Cheers!
Ariel-


On Sep 15 12:39 PM Dryspell wrote:

> Ariel,
>
> I participate in this industry and I believe you have summed up the
> current situation better than I could have. There are many risks
> to increased prices and I believe the gas heavy US Independent E&amp;Ps
> are a dangerous buy here. I am contemplating adding some puts to
> my portfolio today. Thank you for the post.

Sep 16 04:36 AM

[HedgeFundBaby:]

Great too see all the bears sticking to their guns (being very emotional about their views too, the poor animals). I will be happy to take your furry dollars at $5.50, keep up the good work, hope you enjoyed another 14% short squeeze today, I could almost hear you squeal.

To the writer of this article: sub-zero prices? which planet are you from anyway?

Sep 16 04:18 PM

[Mistrofan:]

Well- I have to admit that during all the argumentation, sometimes not very friendly, I tried to keep a clear mind. And, in the end I agreed somehow with the arguments brought by Dian, Static Chaos and others. And - yes, indeed, I came to the conclusion that there is still more downside potential in Natural Gas for the coming weeks. Accordingly, this morning I sold 2/3 of my Natural Gas, being left with only an exposure of 5% of my total portfolio. I am not afraid with 5% as long as I found other plays and as long as I am still bullish over intermediate term.

Thank you all once again for the cold shower.

Sep 17 04:58 PM

[HedgeFundBaby:]

Covering is obviously the way to go in any market, especially as volatile as this.
I, myself, have covered about 1/4 of my long nat. gas position on thursday morning (europe) at about $3.75.

Great weekly close for bulls though, I think we'll see them stops above 4.10 next week on the frontal.

And by the way, for all the geniuses out there - this market has got nothing to do with fundamentals - it's a purely technical/stop-hunting kind of marketplace at the moment.


On Sep 17 04:58 PM Mistrofan wrote:

> Well- I have to admit that during all the argumentation, sometimes
> not very friendly, I tried to keep a clear mind. And, in the end
> I agreed somehow with the arguments brought by Dian, Static Chaos
> and others. And - yes, indeed, I came to the conclusion that there
> is still more downside potential in Natural Gas for the coming weeks.
> Accordingly, this morning I sold 2/3 of my Natural Gas, being left
> with only an exposure of 5% of my total portfolio. I am not afraid
> with 5% as long as I found other plays and as long as I am still
> bullish over intermediate term.
>
> Thank you all once again for the cold shower.

Sep 18 07:16 PM

[Commies are...:]

Excellent article...

Oct 16 08:51 AM

[Mistrofan:]

Where is everybody that I was fighting with when the NG was $2.50? Where are those short sellers? Hey! Anyone around? I made plenty of many in 8 weeks. From $2.50 to over $5. What happened with your theory Dian?

Oct 22 09:48 PM