After a Long Period of Complacency Natural Gas Supplies Continue to Deteriorate and Prices Breaks Out of Trading Range!
(My reports focus on Natural Gas as it is the largest energy source for the generation of Electricity; therefore, Natural Gas and Electricity are highly correlated.)
In my Sep 19th Energy Update, I warned not to be complacent and count on increased production being sufficient to meet demand this year with supplies at the start of the winter heating season at the lowest level in 10 years. After writing this report as you can see below Natural Gas prices rallied 17% going from $288 to $336 per MMbtu:
The rally was based on an already dire supply situation deteriorating further with forecasts for colder than normal weather starting in mid-October causing supplies to fall further below the 5 Yr. Avg. by Oct 26th. Below is a summary of supply estimates for the weeks ending Oct 5th thru Oct 26th compared to the 5-Yr. Avg. based on NOAA’s present weather forecasts:
Week Ending 2018 Net Change 5 Yr. Avg. Deficit to 5 Yr. Avg. % Below 5-Yr.
Oct 05 2956 +90 3563 607 17.0%
Oct 12 3039 +83 3642 603 16.6%
Oct 19 3101 +62 3719 618 16.6%
Oct 26 3151 +50 3781 630 16.7%
Natural Gas supplies normally increase from April thru October to prepare for the winter heating season and with supplies projected to be 630 Bcf below the 5 Yr. Avg. near the end of October, it is not surprising Natural Gas prices broke out of the stable trading range it has been in all year.
The question is if you did not heed my warning about complacency and have not hedged your cost of Natural Gas and Electricity is it too late now? Absolutely not!
As I stated earlier, since Sept 19th, the nearby contract of Natural Gas increased from $2.88 to $3.36 per MMbtu and based on present weather forecasts supplies are now expected to remain 630 Bcf below the 5 Yr. Avg. near the end of October; therefore, the risk of higher prices continues to increase. But the good news is as I explained in several earlier reports due to the market phenomenon called “Backwardation”, hedgers can still secure rates below present levels in the forward market.
Below is a summary of Backwardation for Natural Gas:
Present – $3.36 per MMbtu
Apr 2019 – $2.74 per MMbtu
Apr 2020 – $2.55 per MMbtu
Apr 2021 – $2.48 per MMbtu
The price of Natural Gas is lower in the forward markets, and although since Sept 19th, the nearby contract increased 17%, rates in the forward markets remain very attractive. This is especially true when you consider the chart below:
Anytime you can purchase a commodity near the lower end of its 20-year trading range while supplies are below the 5 Yr. Avg., it is prudent to do so, but this is especially true when a commodity such as Natural Gas has supplies starting its high demand winter heating season at the lowest level in 10 years.
As I wrote in the Sep 19th Energy Update, if we experience a normal winter, increased production should be enough resulting in stable prices, while a warmer than normal winter could lead to lower prices. But it is important to understand that since we are at the lower end of the 20-year trading range, the downside reward potential for lower prices is minimal.
But if we experienced a colder than normal winter since much more Natural Gas is used in the winter than summer, and with supplies over 600 Bcf below the 5 Yr. Avg. as we are start the winter heating season, we would likely experience a dangerous shortfall in supplies and much higher prices; therefore, the risk versus reward ratio clearly favors hedging Natural Gas and Electricity now, and not delay hoping for lower prices.
The recent rally of Natural Gas was due to an already dire supply situation continuing to deteriorate with forecasts for colder than normal weather starting in mid-October causing supplies to fall further below the 5 Yr. Avg. by Oct 26th. But the good news is the market phenomenon called “Backwardation”, allows hedgers to secure rates below present levels in the forward market. This is especially beneficial when you can purchase Natural Gas near the lower end of its 20-year trading range with supplies significantly below the 5 Yr. Avg.; therefore, the risk versus reward ratio clearly favors hedging Natural Gas and Electricity now, and not delay hoping for lower prices.
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.
North American Energy Advisory
Senior Commodity Analyst