Unlike oil, which can be transported and traded around the world, natural gas (not in the liquid form) is tough to transport, and thus boxed in within the producing continent. The inventory glut due to diminishing demand since the recession hit in the 4th quarter of 2008 has been pressuring U.S. natural gas prices. As a result, on Sept. 4, the NYMEX October futures contract for natural gas closed at
$2.73/mmbtu, a 7-year low, as the ratio of oil to natural gas prices
exploded to 25-to-1, compared to its energy conversion ratio of 6-to-1.
Now, just one month later, natural gas has rebounded 75% to close at $4.77/mmbtu for NYMEX November delivery last Friday on record high levels of natural gas in storage, leaving investors to wonder if prices have bottomed out and it's time to jump back into the market, or if the sector is dead.
During the past month, several factors have emerged to spur enthusiasm in the futures market, though spot gas continues to suffer in price.
- Generally, macroeconomic forecasts have been upgraded for 2010 on the back of Federal Reserve Chairman Ben Bernanke stating that the recession was "very likely over." This lends itself to a bullish demand outlook for natural gas from the industrial sector.
- The presence of colder weather in early October, notably in the Rockies Mountain region, helped support natural gas prices. The National Weather Service forecast for Oct. 16-22 calls for below-normal temperatures across the Midwest, the mid-Atlantic and parts of the Northeast. The cold temperatures are expected to spur some early heating demand for natural gas.
- Natural gas rig count has dropped more than half from its historical high of 1,606 reached in Sep 2008, implying an improved supply picture fueling bullish price anticipation.
- The rally was also helped by traders and speculators who had sold positions expecting natural gas price to decline, and speculators who were betting against United States Natural Gas Fund LP (UNG). When those bets failed, speculators and traders canceled positions by buying back futures, sending the contract higher.
With the
2010 strip priced around
$6.00 on NYMEX, traders clearly are betting that the recent supply/demand trend will lead to falling inventory levels. Is the futures market right about this? Let's review some of the key trends in the U.S. natural gas sector.
No Help from the Fundamentals
During injection season, producers store natural gas to ensure ample supply for the winter when high demand typically normalizes inventory levels. This winter, however, may be difficult as storage levels were at all time highs going into the injection period, production from new shale gas fields still continues to flow (albeit at a slower rate), and a dismal economy dented end user demand, particularly in the industrial and electric power sectors. (
Fig.