Why Natural Gas ETFs Should See Big Gains This Week

Natural gas futures and the ETFs that track them are set to make their largest weekly gains since May as signs of a recovery in the economy continue to emerge.

An uptick in demand for industrial fuels is helping natural gas futures regain the ground they lost this summer. Reg Curren for Bloomberg reports that confidence among U.S. consumers increased in September for the first time in three months as the pace of job losses slowed and the economy showed signs of pulling out of the recession.

A smaller-than-expected increase in U.S. stockpiles also contributed to the spike, and demand is also expected to increase as other power generators such as coal and nuclear plants shut down for maintenance.

Natural gas for October delivery was trading at $3.234 per million British thermal units. UNG ETF advanced $1.08, or 11%, to $11.18, down 52% this year. The fund owns futures and swaps and tries to track price changes in the fuel.

• United States Natural Gas (NYSEArca: UNG): down 51.8% year-to-date

• First Trust ISE/Revere Natural Gas Index Fund (NYSEArca: FCG): up 35.6% year-to-date

Comments

[tuj:]

No discussion of the massive oversupply of NG in the US. Why not?

Sep 14 08:15 AM

[tripleblack:]

LOL, because it would have made the article a lot longer?

Yes, a very incomplete analysis there. Very shallow. Though I am long NG, and own FCG, this does us no favors. Personally I am still looking for words from someone who has been talking to the owners of the remaining storage capacity as to THEIR plans... Or the producers, for that matter. Over the next 3 months, it will be this group that makes decisions and takes actions which will be the foundation for prices, regardless of history or trends.

Sep 14 08:34 AM

[BPYHO:]

Keep smoking that crack pipe of hope for NG. It will be a big week for NG, making it's way back to 7 year lows.

Sep 14 09:27 AM

[richpee:]

article is good makes sense but did you also see this one?
Natural Gas Has Spiked 60% Since Labor Day. Why? 5 comments
by: Dian L. Chu September 14, 2009 | about: UNG
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Font Size: PrintEmail TweetThis 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

Sep 14 09:29 AM

[Mad Hedge F...:]

ffcf Since I have had such a hot hand in natural gas (see my call to sell at $4.30 in June by clicking here ), many have asked me to comment on yesterday’s surprise announcement that the ETF, UNG, finally got permission to issue new shares. The easy answer here is that UNG will crater. There is no reason for the fund to trade at a premium, whatsoever, which at one point traded as high as 20%, an overvaluation you normally only see in closed end funds at bear market bottoms. These ETF’s are simply pass through vehicles which make it easier for investors to own NG in stock form when they are legally unable, or too lazy to open a futures trading account. They should never trade more than 1% out of line with the underlying to account for the admin and execution costs of running such an instrument. The people who made the killing here were the handful of hedge funds that were able to borrow UNG shares, sell them short, and go long the futures, locking in a guaranteed 20% spread. They will cash in their profit next week. Something similar is still going on where smart industry players have locked up salt caverns to store gas, buy it cheaply on the spot market, and sell it forward. This is possible because yesterday you could buy October at $3.25/MCF and sell it for April delivery at $5.32, giving you an annualized return of 127%. Leverage that, and you are talking about some serious money. If you were wondering where the money was coming from to buy those G5’s, this is it. The fundamentals for the industry are still terrible, and there is a risk that the market could completely grind to a halt when the country runs out of storage, so the volatility will remain huge. This week’s explosive 44% move from $2.40 to $3.44 was nothing more than pure short covering. I expect a quick double in NG once the storage issue is resolved, and the cheapest, cleanest, and most liquid way to participate is through the futures. If you need help in how to

Sep 14 09:58 AM

[Sinoman:]

I guess you forgot about the need to cover the premium before UNG can move. . . . . .

Sep 14 10:32 AM

[maelstrom:]

Forget the facts ..buy the tout

Sep 14 01:29 PM

[Semi-Contra...:]

I bought UNG at $11.40, that's about a 70% discount from it's 52 week high of $37.41... The spread between Natural Gas and Oil prices are completely out of whack, with Natural Gas the laggard. While I'm no meteorologist, it's been reported that the El Nino is going to make this a cold winter in the densely populated Northeastern U.S., which should create adequate demand to drive prices higher. The 20% premium is an issue, but when you're down 70% in one year, it seems like you can easily make that up on the rebound in supply.

Sep 14 03:35 PM

[Semi-Contra...:]

I bought UNG at $11.40, that's about a 70% discount from it's 52 week high of $37.41... The spread between Natural Gas and Oil prices are completely out of whack, with Natural Gas the laggard. While I'm no meteorologist, it's been reported that the El Nino is going to make this a cold winter in the densely populated Northeastern U.S., which should create adequate demand to drive prices higher. The 20% premium is an issue, but when you're down 70% in one year, it seems like you can easily make that up on a strong rebound in demand, which is sure to happen in the next few months to few years... I don't mind holding onto this, hey it's probably going to fare better than the dollar, right?

Sep 14 03:51 PM

[squark62:]

not much trades on fundamentals (or technicals for that matter) in U.S. markets these days. natural gas is a short squeeze play right now. i'm long PBT with a big fat juicy dividend. ;-)

Sep 15 09:43 AM

[bobbobwhite:]

Not one word from Rhet(rhetoric)Obama on the massive availability and low price of NG that could be used to bridge the huge and long gap between oil and green energy. It seems he wants to jump directly to green no matter how illogical and uneconomic it is. So, NG languishes while we all listen to the good Reverend Obama spout his wishes and dreams that mostly will never happen. Those that may happen will happen at our great expense in place of much more reasonable, expedient and practical solutions.

Sep 15 10:02 AM

[bricki:]

As the dollar fades domestically produced NG will increasingly be cheaper relative to oil encouraging substitution. Long term it will be a good thing we have lots of supply.

Sep 15 11:15 AM