Natural Gas Outlook and Strategies

By Matt Krupski

Natural gas prices have seen a sharp correction in the past few months amid a slowdown in the economy. However, natural gas is influenced by seasonal fluctuations, and winter tends to see a boost in demand for heating. Let’s take a look at where storage levels at right now as we head into the heating season, and some possible trading strategies to consider.

The graph below is taken from the Energy Information Administration Web site, and shows current storage levels versus the five-year average. The gray area represents the five-year high and low natural gas storage levels, and the red line is where the market is currently at. These are based the October 24, 2008 storage report. You can see natural gas is right in the middle of the range in terms of the five-year average, and you can see the cyclicality of the market here. Natural gas supplies typically build up during the warmer summer months and then we draw down upon those the stocks as natural gas is used for heating during winter.

Here are some numbers comparing the October 14 and October 24 storage reports.

EIA Natural Gas Storage

Total 10/24/08: 3,393 bcf

Total 10/17/08: 3,347 bcf

Change: 46 bcf

Year-ago stocks 3,490 bcf

Year-over-year change -2.8%

Five-Year average stocks: 3,296

Current versus five-year average 2.9%

Natural gas saw a build in stockpiles reflected in the October 24 data, compared with the prior week. Given the build, the market is still reaching the top of the upswing of prior graph. Stocks are a little below last year’s levels, but a little above average, so you would expect based on this kind of fundamental information that natural gas prices would not be at either extreme. If we look at closing prices from Friday, October 31, 2008, you can see market prices moving with the seasonal trend in 2009.

Natural Gas Contract Term Structure 10/31/08 closing values ($/mmBtu)

December 2008: 6.783, January 2009: 7.053, February 2009: 7.114, March 2009: 7.051, April: 2009: 6.981, May 2009: 7.046, June 2009: 7.158, July 2009: 7.281, August 2009: 7.366, September 2009: 7.396, October 2009: 7.476, November 2009: 7.816, December 2009: 8.191, December 2010: 8.586

As we get further into the winter, people anticipate natural gas will cost more, and we can see how market prices reflect a peak in February as stockpiles are drawn down. The market has already priced in higher prices heading into the coldest part of the winter; then there’s a small drop in the April contract as peak heating season ends. However, as we move further into 2009 and 2010, we see a steady increase in prices. People may be thinking natural gas is cheap on a long-term basis, and when crude oil prices surged to record highs this year, the idea of tapping into more natural gas to serve our energy needs got more attention.

The “Pickens Plan” and Proposition 10 in California may also be getting the market’s attention. T. Boone Pickens, a former oil man, is now positioning himself as a maverick in the new alternative energy race. Among other ideas to end our dependence on foreign crude oil, he’s pushing for the transition of all of our nation’s trucks to run on compressed natural gas. If natural gas does become a more widespread fuel source, of course demand will increase. Proposition 10 in California involves giving rebates to consumers who purchase alternative fuel cars, including those that run on natural gas. I don’t claim to know the future of any of this, but perhaps some market participants are speculating these types of initiatives are likely to be successful.

Right now the economy is slow and that’s dampening commodity prices, but once we start coming out of our recession/depression (whatever it turns out to be), industrial demand should increase. That also may be fueling natural gas prices as we go out into the price term structure to late 2009 and 2010. In addition, there is an idea that what we are extracting in terms of natural gas has peaked—and we may not be able to produce much more to meet increased demand. What’s coming out of new wells is not enough to replace production from lost old wells.

Now let’s pull up some price charts for natural gas futures. We know the market is in the average range in terms of storage for the past five years. Looking at a monthly chart going back to 1996, we can see in the late 1990s natural gas was trading around $2 - $3 mmBtu, and we can see the seasonal spikes. As the world economy started improving, we saw more demand and a steady uptrend.

The weekly chart shows the fall off in natural gas since July 2008 that has mirrored that of crude oil. Natural gas has lost about the same percentage as crude oil; it’s fallen over 50 percent off its highs. The market seems to have found support near $6 and I think people will be leery about getting short heading into the winter, and the chance it might be severe.

The daily chart shows congestion in the $6 - $7 range. While I don’t expect a big drop heading into the winter season, we could certainly see a correction. That would depend on how severe the economic slowdown is, and how much industrial demand slows. It is possible prices could pull back to $5.

I would be careful about getting long due to the weakening economy, but if you are bullish natural gas, you can consider selling calls against a long futures position near $12 - $13. Another strategy would be a spread based on seasonal factors, such as a March 2009/April 2009 call spread. March had as much as $2.80 premium over April at the market’s highs this year, and now there’s only about an 8-cent premium. If we get a prolonged winter or severe cold snap and draw down stocks more than expected, that could put more pressure on March. In that case, we’d likely see a greater premium, possibly an increase of 50 cents to $1 March over April. That would be a way to get a bullish position with a little less risk than an outright futures position. Of course, anything could happen with the economy and the weather, but this is just one idea that I think is viable at this time. Feel free to call me with any questions you have, and to tailor a specific strategy in this or other markets for your particular goals and risk tolerance.

Matt Krupski is a Senior Market Strategist with Lind Plus, Lind-Waldock’s broker-assisted division. He can be reached at 877-847-3034 or via email at mkrupski@lind-waldock.com

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

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