Out of (Natural) Gas

By James Cordier and Michael Gross

The short and abrupt rally in natural gas prices off of multi-year lows appears to be coming to an end.

Natural Gas prices have been severely depressed in 2009, as a combination of slack industrial demand and burgeoning supplies drove prices to 7 year lows last month.

While the September rally to $5.75 per mbtu may have caught some traders off guard, those familiar with seasonal tendencies are more than likely shaking their heads in recognition.

September is a pivotal month of the year in the demand cycle for natural gas. By late summer, distributors begin accumulating inventories of natural gas in order to have enough supply on hand to meet winter supply needs. This can often result in price strength in natural gas as demand increases at the wholesale level.

The combination of this demand build and a falling dollar has supported higher prices in natural gas through most of September. A quick look at the chart, however, shows that as prices climbed, volume and open interest declined. This indicates that the rally was not fueled by investors taking new long positions. It was fueled primarily by traders, most likely funds, covering short positions – typically not a recipe for a healthy bull market.

Natural gas may have a bright future in the US and global energy picture. But in the near term, fundamentals are poor. While inventory accumulation may have supported demand, natural gas supplies are near record highs for this time of year. This should begin to weaken seasonal price support as distributor inventory building will be less aggressive with burdensome supplies in storage. Wholesalers, well aware of the supply picture, may be willing to wait for lower prices to secure inventory through the autumn months.

Chart courtesy of Hightower Research

Prices in natural gas can often peak in October or November as desired inventory levels are attained and new buying dries up. However, with inventory levels likely achieved early this year in many areas while others await lower prices, we may have already seen a seasonal top.

We would recommend selling call options instead of shorting the futures, just in case the highs are still ahead of us. However, natural gas prices have several bearish forces aligning them as October begins:

· Fund short covering appears to have run its course

· The market is extremely overbought

· Hurricane season is drawing to a close

· The cash market is burdened with excess supply

· A potentially strengthening US dollar

This is not a bullish set up. Natural gas prices will have an uphill battle if they want to achieve higher ground in October. Look for the path of least resistance to be lower.

An extreme cold snap or a sharp collapse of the dollar are two factors that could spur prices to new highs. However, selling options at strikes nearly double the current price of the commodity should go a long way towards insulating portfolios against such an occurrence.

Remember, as an option seller, you only have to pick where the market is not going to go. You don’t have to predict what will happen to price. Only what won’t.

We will look for isolated periods of price strength as opportunities for selling call options and collecting premiums for strikes nearly 100% out of the money. You can’t do this with stocks but you can with commodities.

And you won’t have to worry about a boardroom decision or lackluster earnings wrecking your trade.

Comments

[nctbadri:]

any advise to people holding UNG? or GAZ?

Oct 03 02:56 AM

[Freya:]

Thanks for the December Chart, I was almost spooked into buying more CQP on friday, I now look forward to seeing whether the right shoulder of the postulated H&S bottom can hold...a drop in the futures to just under $5.

If it does, I might be able to buy more CQP in the mid $8's.

Oct 03 05:32 AM

[jarco:]

A useful short term view. But longer term, where's the bottom?

With Mexico (our 2nd largest import source) crude production and findings falling off the cliff, demand for the cleaner NG will receive an added boost.

Oct 03 08:19 AM

[The Economi...:]

Not anytime soon.


On Oct 03 08:19 AM jarco wrote:

> A useful short term view. But longer term, where's the bottom? <br/>
>
> With Mexico (our 2nd largest import source) crude production and
> findings falling off the cliff, demand for the cleaner NG will receive
> an added boost.

Oct 03 09:17 AM

[Canuck Econ...:]

Thanks for the analysis and the info. Would have been good to know what positions you have.

I am long on gas because of exactly what you wrote. Everyone knows that news could not be worse. The farmers almanac has forecast colder than normal weather and the economy is picking up. My gas furnace started kicking in at night in September! The price of gas is at a point where running gas plants for electricity generation is extremely attractive. Industry output is picking up (production not employment drive the gas consumption numbers). Against the very high seasonal stocks are ridiculously low prices. Producers have shut down wells because these levels do no pay and it is not a simple matter to flick wells back on to get the gas to market. I believe that the least supply disruption will take this market to significantly higher levels because those high stock numbers could easily be taken down, in which case the price becomes an allocative mechanism once again. I do no want to miss the big upside opportunity for small profits on daily trading, which is what I think you are looking at, and on that you may be right.

Thanks for the info and the analysis.

Oct 03 09:22 AM

[Steven Ward:]

I don't see NG going to 7 to 8 bucks without a government boost of some sort. Without sizeable carbon credits for NG the product will have to wait for NG conversion to liquid transportation fuel and conversion to LNG to export to Europe. And who knows howlong that is going to take.

Oct 03 09:47 AM

[jerrydd:]

Cunnuck,
Could you state why NG can't be flicked on in an existing well that has been capped? I'd think it would be better as the gas would have moved into areas closer to the well that had been depleted by earlier pumping, so more available rather than less.

Or is it pipeline constrained?

It would seem with such large new NG source rock now available due to new tech, NG will stay rather low priced relative to oil as production cost is rather low, around $1/mmbtu I've heard. Is this true?

If it is that large as some say, Semi's would be first along with other trucks to switch as payback would be rather quick, under 1 yr and new semi's should cost less built new for NG because the engines are far cheaper, weigh less.

More electric plants will be converted from coal to cogen NG upping their eff from 35-40% to 60%, 70% if low temp Rankine generators like used in Geothermal are put between the steam turbines and condensers. Cars can use NG this way to charge EV's going 5-6x's as far on the same NG a ICE would use.

Another use could be converting NG to gasoline/diesel and electricity by GTL tech already in use.

If there is truly enough NG then it could cut our need for coal and imported oil, the most dangerous things to our future national economic and security problems along with RE, biomass. And nuke once they bring down the cost by new tech already here.

Oct 03 10:18 AM

[toobad41:]

Today's natural gas glut is more related to what happened a couple of years ago...operators began drilling and producing gas as fast as they could because the NG pricing was very, very good. Then all of a sudden the economy collapsed and demand went with it. Because there are very few places where you can store any significant amount of gas most wells are shut-in (for a better market), production is often constrained by pipeline pressure or capacity, etc. So those companies will not be inclined to spend money in the coming year until demand picks up, prices for natural gas goes back up or inventory is used up. So my take on this is that the cycle will bottom by the second quarter next year (2010) and the cycle will begin its upward journey in the third quarter next year. Drilling budgets are usually determined in the fall (2010) and drilling expenditures begin in January of the following year (2011).

Oct 03 01:50 PM

[Old Trader:]

I can't recall where I read it (probably Bloomberg, but it might have been Reuters), but NG storage is all filled up. At least the northern Midwest is unseasonably cold, so that might help a bit.

Oct 03 09:39 PM

[anarchist:]

GAZ is the only stock mentioned above and I can not find any options for it. If you look a NG or any of the gas-related stocks that I look at the premium for writing a call twice the price of the stock is a nickel or less, not much income there, maybe I don't understand what your doing.

Oct 03 10:29 PM

[Road Runner:]

El Nino has been declared for this winter, www.noaanews.noaa.gov/... and www.cpc.noaa.gov/produ....

El Nino usually brings above average temperatures in the northern US as is stated in this link, www.cpc.noaa.gov/produ... , "THE LIKELIHOOD OF ABOVE AVERAGE TEMPERATURES INCREASES IN THE NORTH-CENTRAL US FROM OND 2009 THROUGH FMA 2010. THOUGH MEAN WINTER TEMPERATURES IN THE NORTHERN PLAINS HAVE MOST OFTEN BEEN ABOVE AVERAGE IN THE LAST DECADE, THIS DECADAL TEMPERATURE SIGNAL IS EXPECTED TO BE ENHANCED BY THE DEVELOPING EL NINO, AS INDICATED BY SIGNIFICANTLY GREATER PROBABILITIES FOR BOTH THE NORTHERN PLAINS AND PACIFIC NORTHWEST. "

Note that the southern US will be cooler than normal with more rain.

Has anyone on this post factured in El Nino in their natural gas forecasts.

Oct 04 12:51 AM

[Road Runner:]

Wikipedia has a good explanation of how El Nino affects winter weather in North America, "In North America, El Niño creates warmer-than-average winters in the upper Midwest states and the Northeast. Meanwhile, central and southern California, northwest Mexico and the southwestern U.S. become significantly wetter while the northern Gulf of Mexico states and northeast Mexico are wetter and cooler than average during the El Niño phase of the oscillation".

en.wikipedia.org/wiki/...

Oct 04 12:58 AM

[Alan Young:]

You lost me when you attributed the rally to the "falling dollar." Hard assets are sometimes used as inflation hedges; and imported goods become more expensive as the dollar falls. But gas is neither of these.

Oct 04 01:21 AM

[User 422955:]

to jerrydd: Where are semis going to tank up if they were to run on NG?

To all you El Nin(y)o fans: I live in mid-MO. Our temps have been below average from early July to the present. People here (including me) expect a long, cold winter. I hope El Nino is correct and we turn out to be incorrect. Wait and see.

Oct 04 08:33 PM

[Ron2008:]

He is selling options on futures at NYMEX.


On Oct 03 10:29 PM anarchist wrote:

> GAZ is the only stock mentioned above and I can not find any options
> for it. If you look a NG or any of the gas-related stocks that I
> look at the premium for writing a call twice the price of the stock
> is a nickel or less, not much income there, maybe I don't understand
> what your doing.

Oct 04 11:39 PM

[Ron2008:]

Below normal summer temps have little correlation to below normal winter temps, lately. From 1979 to 2008 we have had 8 below normal temp summers. The next winter was below normal twice and above normal six times.


On Oct 04 08:33 PM User 422955 wrote:

> to jerrydd: Where are semis going to tank up if they were to run
> on NG?
>
> To all you El Nin(y)o fans: I live in mid-MO. Our temps have been
> below average from early July to the present. People here (including
> me) expect a long, cold winter. I hope El Nino is correct and we
> turn out to be incorrect. Wait and see.

Oct 05 12:03 AM

[tuj:]

"Could you state why NG can't be flicked on in an existing well that has been capped? I'd think it would be better as the gas would have moved into areas closer to the well that had been depleted by earlier pumping, so more available rather than less."

Capping shale wells for a prolonged period of time damages the frac'ing geology in the well.

Oct 05 07:56 AM

[aureus:]

About possible effects of El Ninõ : www.usatoday.com/weath...

Regards
Aureus


On Oct 05 12:03 AM Ron2008 wrote:

> Below normal summer temps have little correlation to below normal
> winter temps, lately. From 1979 to 2008 we have had 8 below normal
> temp summers. The next winter was below normal twice and above normal
> six times.

Oct 05 08:09 PM

[Robert D.:]

If you are long UNG, sell OTM calls and collect on a little premium to reduce your cost.

Oct 06 02:27 PM