Gas Prices Remain Elevated Despite Excess Supplies

In 2006, working natural gas supplies in underground storage reached record levels. In fact, for the week ending March 23 2006, natural gas in underground storage was 67% above its 5 year average according to the Energy Information Administration. The glut in natural gas last year drove spot prices down to 4.05 by Sept 2006. For the week ending Dec 20 2007 the total working gas in underground storage still remains 9% above the 5 year average, indicating ample supplies.

This excess supplies no doubt contributes to the “speculative short positions outnumbering long positions by 96,357 contracts and net-short positions rising 3,476 contracts or 3.7% this past week from a week earlier” according to the Commitment of Traders [COT] report. No doubt, spec shorts are being emboldened by weather forecasts expecting unusually warm temperatures between now and March 2008 in both the East and the West regions.

However, what may be most important dictating the future direction of Natural Gas prices in 2008 and beyond is the rate at which demand is absorbing the excess supplies in the past. In fact, demand curve for natural gas may no longer be subject to seasonal weather patterns to the extent it has been in the past. Biofuel plants today are using clean burning natural gas to produce ethanol. As demand for biofuels increase, so will demand for natural gas increase. This will naturally increase the demand curve for natural gas and smooth out the volatility of the natural gas demand curve associated with weather related factors.

US Senate Mandates a Positive Shift in Natural Gas Demand Curve

Just this past month, the US Senate approved legislation to quadruple the use of biofuels over the next 15 years from 7.5 billion gallons this year to 36 billion in 2022. Moreover, the measure, which passed 86-8, mandates a 20% year over year increase in usage from 7.5 billion gallons in 2007 to 9.0 billion gallons in 2008 according to the Renewable Fuels Association in Washington.

Given the positive shift to the natural gas demand curve that will evolve as a result of this mandated legislation in 2008 and beyond, the path of least resistance for natural gas prices should on balance be upwards. In short, the spec shorts are apt to be driven out of their positions as 2008 year unfolds.

Seasonal Considerations

Seasonally speaking over the past ten years, there has been a strong tendency for natural gas prices to set seasonal lows in late August or September, then move sharply higher. Excepting the spike low in September 2006, we see natural gas has set a gently rising price base from $4.36 in Sept 2003 to $5.39 in August 2007.

Bull Flag in 2H 2007

The sharp move to $8.66 by November 1 2007 has taken on the appearance of a bull flagpole. This is a bullish pattern that usually is followed by a consolidation pattern known as a bull flag. These bull flag patterns frequently retrace 50%. Bull flags that retrace around 50% are said to consolidate at “Half Mast.” The recent pullback to $6.86, is just above the 50% Half Mast Target at $6.75.

Bullish Ascending Triangle of 2006-2007

Not only is a bull flag at half mast forming in the second half of 2007, but there is also a bullish ascending triangle that has been forming since bottoming at $4.07 in September 2006. This pattern is recognized as forming a flat top and a rising bottom. As long as the bottoms keep rising, the resolution of the pattern should be to the upside. The double top at $9.05 in November 2006 and $8.66 in November 2007 constitutes the flat top of the ascending triangle. The seasonal lows set at $4.07 in September 2006 and $5.23 in August 2007 constitutes the rising bottom. As long as the August 2007 low holds, the resolution should be to the upside taking natural gas prices well above $9.00. And given the bull flag setup in 2H 2007, it would not surprise to see that price breakout at some point in the first half of 2008.

Investors should note that the positively sloped 5 year moving average on the weekly chart sits at $6.95 today. The recent dip to $6.86 in Dec 2007 in natural gas prices tested this moving average. Historically, since 2000, natural gas prices tend to trade at prices well above this key moving average, only spiking below it twice – once in 2001-2002 and again 2006-2007. We would expect that as working gas in underground storage continues drifting towards or even below its 5 year average that this will put upward pressure on natural gas prices in the coming quarters and years.

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Disclosure: none

Comments

[calvino]

Good analysis. Another factor adding to the gas bull is the imminent decomissioning of many diesel utility plants that are coming to their 50 yr end of life cycle. Here in the Nutmeg State, 90 gigs of diesel capacity is going offline within 4 years, according to the state DPUC. Undoubtedly, the Utilities will delay the cap ex as much as possible , however the pattern is there. Additionally, the diesel capacity will be replaced by nat gas - cleaner and domestic. The short interest on the futures may be tradable in the near term.

[Charlie Peters]

Will corn fuel ethanol policy increase oil use and oil profit?

* Some folks think so

* Clean Air Performance Professionals