A Bird in the Hand is Worth Two in the Bush!

(My reports focus on Natural Gas as it is now the largest energy source for the generation of Electricity; therefore, Natural Gas and Electricity are highly correlated.)

The 16th century proverb in today’s heading is one of the oldest and best-known. It warns against taking unnecessary risks – it is better to keep what you have (a bird) than risk getting more and ending with nothing (two birds out of your reach).

In today’s report, I explain how this old proverb applies to securing Natural Gas and Electricity hedges now, and not delaying hoping for a better opportunity in the future. In my Apr 26^th Energy Alert, I explained why from a cyclical perspective, Natural Gas’s April decline was a buying opportunity, and longer-term hedges was prudent for those who are risk averse.

As you can see in the chart below, since my last report, Natural Gas’s decline ceased, and prices have been range bound between $3.14 and $3.43 per MMbtu:

Natural Gas prices have consolidated above the April 25^th low of $3.02 per MMbtu, and consolidation patterns often precede sharp price movements. The question is, what direction is Natural Gas preparing to sharply move?

The answer is that due to conflicting fundamental and technical factors an argument can be made to support both possibilities.

Fundaments are based on supply/demand and due to the structural deficit, I discussed in my Feb 9^th Energy Alert, the fundamentals continue to favor higher prices. But a counter technical argument can be made due to a high level of speculative long positions (speculators betting on higher prices), a sharp correction may occur to shake out speculators prior to a longer-term move higher.

Therefore; technical factors are warning a near-term decline is possible, and fundamental factors favor higher-prices long-term. On the surface, the risk of a correction would seem to favor delaying hedging hoping prices will be lower later, but this is where the old proverb “A Bird in the Hand is Worth Two in the Bush” comes into play.

When considering the market phenomenon backwardation, which I discuss in my Oct 6th Energy Alert, rates in the forward markets are much lower than near-term rates. Remember, Backwardation occurs when nearby contracts are sold at a higher price than contracts further out. And, even if prices decline near-term, prices in the forward markets may not decline. In the past, I have observed many instances when large hedgers sold their high priced near-term positions to force out speculative traders, while simultaneously purchasing lower priced long-term positions.

Below are examples of the present backwardation in Natural Gas’s April Contracts:

• Present – $3.22 per MMbtu
• Apr 2018 – $2.94 per MMbtu
• Apr 2019 – $2.72 per MMbtu
• Apr 2020 – $2.68 per MMbtu

 Conclusions

The price of Natural Gas is lower in the forward markets, and astute hedgers understand the old proverb, “A Bird in the Hand is Worth Two in the Bush” is as true today as in the 16^th century, and will benefit by reserving rates longer-term while they are below nearby rates, and not delay hoping for lower rates in the future.

Not every client’s risk tolerance and hedging strategy is the same, but we trust the above report will help you put into perspective the risk/reward opportunities now. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
North American Energy Advisory
Senior Commodity Analyst
727-400-3170