Energy Update | January 8th, 2019

Long-Term Implications of Potential Double Bottom. In my December 2nd Energy Update, I said this year warmer than normal weather

Long-Term Implications of Potential Double Bottom.

In my December 2nd Energy Update, I said this year warmer than normal weather in November and early December resulted in prices again declining below $2.50 per MMBtu, but if we experience a colder than normal winter prices would likely rally far above $2.50 per MMBtu.

While this premise is still valid, warmer than normal weather continued from early November to the present time and as you can see in the chart below, we are now testing the lows from last summer:

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Warmer than normal weather over the last 2 months decreased heating demand and prices have fallen to their lowest level since Aug 5th. But we are holding just above the Aug 5th low and could be near completion of a double bottom. Double bottoms are very common near important support areas and since prices this low only occurred 3 times since 2001, we are likely at or close to a cyclical low.

 

This belief is supported by the fact that in the previous 3 instances when prices were this low, they were always on average significantly higher the following 36-months. When a pattern consistently repeats itself there must be a fundamental reason it is repeating. In this instance the fundamental factor is the cost of production of Natural Gas is higher than the present price; therefore, suppliers of Natural Gas will be forced to curtail their production.

 

This premise is supported by the latest Baker Hughes drilling data released Jan 3rd showing the number Natural Gas drilling rigs continue to decline and we now only have 125 active rigs down from 198 rigs a year ago, which is a decline 36.9% year-over-year.

 

The sharp decline in Natural Gas rigs will inevitably lead to decreased production in 2020 and since demand is expected to continue increasing due to the increased exports of Liquified Natural Gas, pipelines to Mexico and switching from Coal to Natural Gas for electric power generation, Natural Gas prices will likely repeat the pattern experienced over the last 20 years in which prices this low were always followed by significantly higher prices the following 36-months.

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Therefore, based on the empirical evidence reflected in the above chart, I recommend anyone with agreements expiring within the next 18-months not delay hoping for lower prices. The upside risk is too great to justify waiting hoping for slightly lower prices.

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

Ray Franklin
Energy Professionals
Senior Commodity Analyst                                                                                                                                                        

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