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For Natural Gas, Price Risk Is Impending
Any shortfall by local natural gas utilities in rebuilding inventories will lead to substantial price spikes next winter.
Howard L. Simons     

This past winter will be the gift that keeps on giving, especially when it comes to natural gas. Inventories in what the Department of Energy classifies as the Eastern Consuming region are 52.2% below last year's levels. Declines in the Western Consuming and Producing regions have been substantial as well -- 46.7% and 45.0%, respectively.
 

 
Now as we all know given the fracking boom, the US is not short on natural gas as a producible resource. The constraints are production rates and pipeline capacity. Gas trapped in shale and sitting hundreds of miles away from its final market and having to compete for limited pipeline capacity may not be available for consumption next winter. 
 
The Forward Curve
 
This means large natural gas buyers are going to have to raise their bids for delivery during the summer months to rebuild their depleted supplies with negative consequences for the forward curve.  The typical seasonal pattern for natural gas futures at this time of year is for the May-October contracts to be discounted relative to those for November-March. As demand falls seasonally, producers have to compete on the basis of a lower price to move the gas through their systems; buyers in turn can buy the gas, put it in storage, and sell winter contracts as a hedge.
 
This is hardly a clockwork trade. Rising use of natural gas as fuel for electric utilities has dampened some of the seasonality of demand, and this increasingly will be the case as everyone who puts solar cells on top of windmills finds they have to have a gas-fired micro-turbine as well for those days when the wind does not blow and the sun does not shine.
 
If the forward curve is not in its typical summertime carry, gas buyers will have to pay more for pre-winter supplies and will not be able to hedge their costs profitably by selling winter-month futures.  As both the supply and demand curves for natural gas are very price-inelastic -- a small change in quantity leads to a large change in price -- any shortfall by local natural gas utilities in rebuilding inventories can and will lead to substantial price spikes next winter, subject to two weather-related conditions. The first will be this summer's peak-load electrical generating demand and the second will be next winter's heating demand.
 
We can see the risk already in comparative forward curves for natural gas for 2007-2014, inclusive. In the graph below, five years of seasonally adjusted futures prices are presented as a percentage of the first year's May contract to emphasize the shape of the forward curve independent of the price level. The results illustrate how unusual this year is.
 

 
The forward curves for both 2007 and 2008 were both in greater backwardation after their first winter but retained their pre-first winter carry.  The forward curves for 2009, 2010,and 2012 all had pronounced carries associated with natural gas' multi-year bear market as well as the seasonal cycle. This is the only year after 2007 where the forward curve is not in a pre-winter carry.
 
What does it mean to you? Quite simply, if you liked last winter's heating bills, you just might be head over heels in love with next winter's.
 
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No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

More From Howard L. Simons
For Natural Gas, Price Risk Is Impending
Any shortfall by local natural gas utilities in rebuilding inventories will lead to substantial price spikes next winter.
Howard L. Simons     

This past winter will be the gift that keeps on giving, especially when it comes to natural gas. Inventories in what the Department of Energy classifies as the Eastern Consuming region are 52.2% below last year's levels. Declines in the Western Consuming and Producing regions have been substantial as well -- 46.7% and 45.0%, respectively.
 

 
Now as we all know given the fracking boom, the US is not short on natural gas as a producible resource. The constraints are production rates and pipeline capacity. Gas trapped in shale and sitting hundreds of miles away from its final market and having to compete for limited pipeline capacity may not be available for consumption next winter. 
 
The Forward Curve
 
This means large natural gas buyers are going to have to raise their bids for delivery during the summer months to rebuild their depleted supplies with negative consequences for the forward curve.  The typical seasonal pattern for natural gas futures at this time of year is for the May-October contracts to be discounted relative to those for November-March. As demand falls seasonally, producers have to compete on the basis of a lower price to move the gas through their systems; buyers in turn can buy the gas, put it in storage, and sell winter contracts as a hedge.
 
This is hardly a clockwork trade. Rising use of natural gas as fuel for electric utilities has dampened some of the seasonality of demand, and this increasingly will be the case as everyone who puts solar cells on top of windmills finds they have to have a gas-fired micro-turbine as well for those days when the wind does not blow and the sun does not shine.
 
If the forward curve is not in its typical summertime carry, gas buyers will have to pay more for pre-winter supplies and will not be able to hedge their costs profitably by selling winter-month futures.  As both the supply and demand curves for natural gas are very price-inelastic -- a small change in quantity leads to a large change in price -- any shortfall by local natural gas utilities in rebuilding inventories can and will lead to substantial price spikes next winter, subject to two weather-related conditions. The first will be this summer's peak-load electrical generating demand and the second will be next winter's heating demand.
 
We can see the risk already in comparative forward curves for natural gas for 2007-2014, inclusive. In the graph below, five years of seasonally adjusted futures prices are presented as a percentage of the first year's May contract to emphasize the shape of the forward curve independent of the price level. The results illustrate how unusual this year is.
 

 
The forward curves for both 2007 and 2008 were both in greater backwardation after their first winter but retained their pre-first winter carry.  The forward curves for 2009, 2010,and 2012 all had pronounced carries associated with natural gas' multi-year bear market as well as the seasonal cycle. This is the only year after 2007 where the forward curve is not in a pre-winter carry.
 
What does it mean to you? Quite simply, if you liked last winter's heating bills, you just might be head over heels in love with next winter's.
 
< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

More From Howard L. Simons
Daily Recap
For Natural Gas, Price Risk Is Impending
Any shortfall by local natural gas utilities in rebuilding inventories will lead to substantial price spikes next winter.
Howard L. Simons     

This past winter will be the gift that keeps on giving, especially when it comes to natural gas. Inventories in what the Department of Energy classifies as the Eastern Consuming region are 52.2% below last year's levels. Declines in the Western Consuming and Producing regions have been substantial as well -- 46.7% and 45.0%, respectively.
 

 
Now as we all know given the fracking boom, the US is not short on natural gas as a producible resource. The constraints are production rates and pipeline capacity. Gas trapped in shale and sitting hundreds of miles away from its final market and having to compete for limited pipeline capacity may not be available for consumption next winter. 
 
The Forward Curve
 
This means large natural gas buyers are going to have to raise their bids for delivery during the summer months to rebuild their depleted supplies with negative consequences for the forward curve.  The typical seasonal pattern for natural gas futures at this time of year is for the May-October contracts to be discounted relative to those for November-March. As demand falls seasonally, producers have to compete on the basis of a lower price to move the gas through their systems; buyers in turn can buy the gas, put it in storage, and sell winter contracts as a hedge.
 
This is hardly a clockwork trade. Rising use of natural gas as fuel for electric utilities has dampened some of the seasonality of demand, and this increasingly will be the case as everyone who puts solar cells on top of windmills finds they have to have a gas-fired micro-turbine as well for those days when the wind does not blow and the sun does not shine.
 
If the forward curve is not in its typical summertime carry, gas buyers will have to pay more for pre-winter supplies and will not be able to hedge their costs profitably by selling winter-month futures.  As both the supply and demand curves for natural gas are very price-inelastic -- a small change in quantity leads to a large change in price -- any shortfall by local natural gas utilities in rebuilding inventories can and will lead to substantial price spikes next winter, subject to two weather-related conditions. The first will be this summer's peak-load electrical generating demand and the second will be next winter's heating demand.
 
We can see the risk already in comparative forward curves for natural gas for 2007-2014, inclusive. In the graph below, five years of seasonally adjusted futures prices are presented as a percentage of the first year's May contract to emphasize the shape of the forward curve independent of the price level. The results illustrate how unusual this year is.
 

 
The forward curves for both 2007 and 2008 were both in greater backwardation after their first winter but retained their pre-first winter carry.  The forward curves for 2009, 2010,and 2012 all had pronounced carries associated with natural gas' multi-year bear market as well as the seasonal cycle. This is the only year after 2007 where the forward curve is not in a pre-winter carry.
 
What does it mean to you? Quite simply, if you liked last winter's heating bills, you just might be head over heels in love with next winter's.
 
< Previous
  • 1
Next >
No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

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