The Day Backwardation Died

by: Five Thousand Over Libor

A little less than a year ago, Feb 19, 2010, the prompt NG contract on NYMEX fell into contango against the next-to-prompt for the first time in 34 straight trading days. The prompt settle that night was $5.044. We wouldn’t see that price in the prompt contract again for 81 straight trading days. We’ve only seen it higher twice through Thursday’s settle.The prompt contract would go on to lose 24% over the next 27 trading days, with 19 of the 26 daily changes negative. 3 in 4.

Interesting then that the prompt spread closed Thursday evening for the first time in contango since Dec 31.

Furthermore, backwardation was lost in the balance-of-January physical strip against FEB futures Thursday – going out trading -4 cents to a February contract that had already lost 10 cents on its own. This balance-of-January strip traded as high at +8cents against FEB on Monday morning. So, during the likely peak demand days of the year, the market is quickly beginning to encourage taking gas delivered through the rest of January into February (only 3 of the past 10 Februarys have seen an average demand higher than January, and not once following a cold January). That speaks some volumes.

These are pricing signals that are thrown off by a market that is fantastically well-supplied. To wit: Atlanta has been in an ice box for the past 3 days – an event difficult to match in modern memory. New Orleans has averaged a daily temperature 13 degrees under seasonal norms for the past 4 days – during the coldest period of the year - and Henry Hub cash for next-day delivery in central Louisiana, and the major hub for the southeast (and marker price for the nation) hasn’t been able to price above $4.58, averaging $4.47 the past 4 days.

I don’t expect a similar 24% loss in prompt gas price this year as we welcome back the contango regime. Price is already, and has been, pretty low for this time of year (set a 9-year low for JAN contract expiries last month and on par to do the same for the FEB contract). A further illustration of this: Last year, this date, the JUN 2010 contract settled $5.78 per MMBtu. Thursday the JUN 2011 contract settled $4.51 – 22% lower. At Thursday's settle, $5.78 doesn’t show on the forward curve until DEC 2014 – at a settle of $5.76. Last year, $5.78 was available 5 months out. This year…47 months out, with a 2-cent discount.

Price is low and spreads are tight – so the prospect for a 25% haircut from here to $3.30 is remote. But the prospects for price gains in gas from here through the next two months are bleak to quite bleak and the chance for gas to lose 10% over the next couple of weeks looks real.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.