Tuesday, November 10, 2009

The Important Holidays

Different cultures have different days that are important to them. The Europeans don’t care about our Columbus Day, nor does the typical American even pause to think about Canadian Boxing Day. That’s easily understandable, as different world groups have unique reasons to remember special days.

But what about us? Collectively, we might be called the “Loosely Affiliated Group of Natural Gas Market Participants, Florida Chapter.” What holiday should we remember? Easy. We should care about Veterans Day. It is the number one holiday on our calendar.

On this holiday, it is important to remember the many folks that have protected our country through the years, sacrificing so much. But Veterans Day also roughly coincides with the last weekly natural gas storage build of the annual inventory season. Each week of the year, on Thursday, the EIA reports inventory builds and draws in the natural gas market. And, since the typical demand profile for natural gas is winter heavy and summer light, inventories build through the summer. If we were to look at a seasonal price chart of the natural gas market, we would find a rough correlation to the storage season – low prices in the summer as inventories build followed by higher prices during the winter as the market experiences periods of peak demand. (There are things that from year-to-year can disturb this seasonal pattern – hurricanes or economic “meltdowns”, for example – but the seasonal is still generally representative of the overall balance of gas supply and gas demand in the market.)

On this Veterans Day, the natural gas market finds itself at a bit of a crossroads. For months, the broad news media has been reporting on the development of unconventional supply sources – “shale plays” – in a broad swath of the midcontinent from Texas and Arkansas through to Pennsylvania and New York. New technologies have unlocked vast amounts of previously unavailable natural gas, causing a supply glut this year and drastically affecting the future supply-demand balance. Proven domestic reserves of natural gas have increased by 50% in the last two years.

These changes to the market have impacted price dramatically, pushing the price of cash natural gas in Louisiana to below $2.00/dekatherm in early September. But at that time, the curve of forward prices reflected a huge carry to the winter-time, typical of an over-supplied market. So although price was dirt cheap in the spot market, gas really couldn’t be bought in the forward market at a similar low price. But things change. Markets change. And now here we are….Veterans Day.

Since that point in September, the market has moved around a bunch. It rallied by almost $3.00, only to set back again under the pressure of mild weather and lack of early season heating demand. Now January gas is trading for $4.86/dekatherm on the NYMEX – on its face this looks to be around $3 dollars higher than that September low. But it is not. Because at the time that cash gas was below $2.00, the January NYMEX was trading for $5.00-5.25. So right now, the January market is at parity with its previous 2009 low.

Where it goes from here I guess no one knows. I have been watching, trading, and studying commodity markets for 15 years, and “no one knows” is one of the only things I know for certain. But let’s think briefly about the range of possible outcomes that the market could present to us. In the face of remarkably bearish fundamentals, the market remains around $5.00. Consider that until now the market has been presented with mild weather and building storages (remember Veterans Day?). But with the onset of more robust cold fronts and growing degree day counts, the market has the potential to rally. As I wrote in my last commentary, the two previous times this decade that the front month hit $2.75, within 12 months the market traded at above $9.00. The market will do whatever it has to in order to fool the majority.
Locking in a piece of fixed price at this level, one risks the chance that the market will fall to the sub-$3 level. But not locking in at this level is the equivalent to a bet that price WILL go down as we proceed into the winter supply drawing season. With Veteran’s Day upon us and the storage draws beginning, I don’t like the odds on that bet.