"Should we talk about the weather? Should we talk about the government?"
- R.E.M., "Pop Song 89"
Dear natural gas (the United States Natural Gas ETF (NYSEARCA:UNG)) traders, the answer is NOT "the weather."
Bloomberg published an article the other day, titled "Gas Traders Are Giving Up On U.S. Winter Before It's Begun." The upshot of the article is that traders and analysts are stunned by the sudden drop in natural gas prices over the past couple weeks:
"It is really ridiculous," said Teri Viswanath, managing director for natural gas at PIRA Energy Group. Gas prices have "just fallen out of bed in the last week and half. Someone, about a week ago, decided to cancel winter."
Um, no. Natural gas prices over the past few weeks have simply followed the oil price (the United States Oil ETF (NYSEARCA:USO)), which peaked as high as $52 on October 19, but has fallen all the way down to $44 since then. This chart of the UNG natural gas fund and the USO oil fund shows how gas has moved together with oil:
Sure, nat gas has dropped a little more than oil, but not so much as to blame the whole thing on warmer weather and winter forecasts!
The Bloomberg article focused heavily on the plummeting spread between the March and April 2017 natural gas futures prices. This spread is a popular trade: a cold winter is supposed to mean greater heating demand through March, driving up the nat gas price, until warmer weather in April slashes heating demand and drives down gas prices.
I don't know how much actual truth there is to this trading thesis. A look at the monthly seasonality chart of the natural gas price over the last 27 years shows that the price rises an average of 2.5% in April, not much different from the average 2.9% increase in March.
The biggest trend that jumps out from the chart is a big average gain in September and October, followed by declines in November, December, and January. I suspect this indicates traders buying the rumors of a cold winter in the fall, and then selling the actual winter facts.
But the gas price drop the past couple weeks, I believe, has very little to do with the weather. It has to do with the falling oil price, and in particular, with the collapse of the speculation that the oil price was going to rise from $50 to $60 or higher on an OPEC deal at the end of November.
Until 2-3 weeks ago, this speculation was very popular in the oil trading market. What does this have to do with the March-April nat gas futures spread? Here's what I think.
Traders who were betting on this spread - long March gas and short April gas - were counting on a general rise in all energy prices heading into the whole season. If an effective OPEC deal would drive oil to $60 or higher, nat gas would likely also be riding higher on oil's momentum into winter. That would provide a good trading environment for cold weather to encourage speculators to bid up the gas price even higher through the winter. Then, indeed, there would be a good set-up for gas to rise into March and then fall in April.
But without the whole backdrop of oil and all energy prices rising into December on an OPEC deal, the trade just doesn't make as much sense. If energy prices in general are trending down heading into the winter, gas is less likely to find momentum for a big peak in March, so the long March and short April trade is a lot less appealing of a bet.
That's what I think is the real story behind the collapse in the premium for March gas futures to April.
The Bloomberg article also mentions another example: "A wrong-way wager on the March-April spread contributed to the collapse of hedge fund Amaranth Advisors in 2006." In fact, as a New York Times article at the time explained in detail, Amaranth was mainly betting on the March-April 2007 spread back in August and September of 2006, and lost big when the spread collapsed over the course of September.
But the simple context was, the natural gas price itself crashed in September 2006, from $7.50 on August 25 to $4.30 on September 26. And yes, the oil price was falling steeply then too, from $73 to $60. Just like in the past couple weeks, when the current oil and gas prices fell, so did the March-April gas futures spread.
My advice to natural gas traders is to look at the context of all energy price trends, not just the weather forecast for the coming winter.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.