By Sumit Roy
Read Part I of this interview here.
Dennis Gartman is the man behind The Gartman Letter, a daily newsletter discussing global capital markets. For more than 20 years, The Gartman Letter has tackled the political, economic and social trends shaping the world's markets, and Gartman himself is a frequent guest on CNBC, Bloomberg and other financial media outlets. Hard Assets Investor Managing Editor Sumit Roy recently caught up with Gartman to discuss the latest developments in the energy markets.
Hard Assets Investor: What's your view on the recent surge in natural gas above $5/mmbtu?
Dennis Gartman: There's two things problematic with the natural gas market. But first, let's applaud the advent and the burgeoning of fracking here in North America. It is making the United States energy-independent faster than anybody might have ever dreamed. It is one of the great benefits to our country, and it will be benefiting us for decades into the future.
That said, one of the problems is that the natural gas futures market has gone into backwardation, with front month priced well above the deferred months. I think that's predicated upon the fact that the Commodities Futures Trading Commission (CFTC) has made it relatively impossible to hold large enough positions on the part of the long-only funds who used to be wonderful buyers in the deferred contracts, both in crude oil and in natural gas. And they used to bid the back months up, which made a wonderful mechanism for hedgers.
It used to be that, several years ago, if front-month natural gas contracts were at $5, contracts two years forward would probably have been at $7. In that instance, drillers would have said, "I'll drill and I'll sell forward to lock in wonderful gains." You can't do that now. Because now the front month is at $5 and the deferreds are $4 and $3. It's taken the ability to hedge properly away. That's going to make drilling far more problematic than it has in the past.
The same can be said for what's going on in crude oil with WTI and Brent backwardated. Part of the backwardation that has occurred is because there are no more bidders from the long only funds bidding the back months up and keeping the market in contango. That's disturbing.
All of that said, if the term structure of natural gas futures was $5 across the board, people would be hedging like mad men. Drilling would be going on like nobody's business. The country would be awash in gas.
HAI: Given that the deferred months aren't trading at $5, presumably we're not going to see the hedging and we're not going to see the huge growth in production. That leaves the market in a really uncertain place...
Gartman: It does, especially as we get to the summer months. It's interesting, natural gas used to be a winter play; now it's an all-year play because of air conditioning. You could end up getting really spiky prices during periods. You could consistently see front month natural gas easily trading at $7, $8, $9, or $10, and deferred natural gas staying at $3 and $4.
HAI: What about propane? That's even more incredible. I've read they're rationing supplies in the East Coast.
Gartman: They forgot to take into consideration we have a 15-billion-bushel corn crop this year. This is one of those things that I like to think I do well, is to explain to energy people what's going on in agriculture, and explain to people in agriculture what's going on in the bond market. The propane dealers and energy traders across the board didn't pay much attention to the fact that we had a 15-billion-bushel corn crop, 2.5 billion bushels more than last year, all of which has to be dried. And the only way you dry it is with propane. There's the real problem in the propane market. At the margin, the marginal taker of propane this year was the corn market.
HAI: Then adding the heating demand on top of that was a perfect storm.
Gartman: Yes, a perfect storm.