Close to Breakout?

In my July 8^th Energy Alert, I said the secular bear market bottom reached in the spring of 2012 will likely hold for years to come, and with rates near a three year low Commercial Hedgers are holding near record long (BUY) positions anticipating higher rates, and with rates compressing with decreasing volatility, the next major move for rates is likely higher with a minimum objective to fill the gap left behind on 12/22/14.

As you can see in the chart below rates increased slightly since my last report:

As shown by the green line, the nearby contract of Natural Gas climbed from $2.685 per MMbtu on July 8^th to $2.835 per MMbtu at the opening today. As shown in the table below, over the last month supplies continued to increase versus the 5 year average moving average:

Date Released       This Year           5 Yr. Avg

   July 30th                 52 Bcf                 45 Bcf

   July 23^rd                 61 Bcf                 57 Bcf

   July 16^th                 99 Bcf                 77 Bcf

   July 09^th                  91 Bcf                 75 Bcf                    

Over the last 4 weeks our storage level increased to 2,880 Bcf and it is now 3% higher than the 5 year moving average. As I have stated in previous reports how a market responds to news is more important to me than the news itself. When a market does not decline with negative news it is signaling the path of least resistance is for higher prices, which is what we are experiencing at the present time.

We have traded within a very tight range since the beginning of the year. The question is, how much longer should we anticipate remaining within this tight trading range before breaking out?

Last month I said rates were compressing with decreasing volatility. The chart below shows rates appear to be nearing a breakout point.

The chart shows we are forming a symmetric triangle, which develops when a pattern has 2 distinct converging trend lines. As you can see we have been forming this pattern over the last 3 months and we are in the later stages of the pattern.

Theoretically we could remain in this pattern into mid-September, but as time passes the convergent lines draw closer to each other and the probability of a breakout increases. What is important to note is this type of pattern forms prior to increased volatility; therefore, we are likely near a period of sharp rate changes in Electricity and Natural Gas.

Based on the factors I discussed in my reports over the last few months, I believe the breakout will likely be to the upside, but if we experience a downside breakout instead I believe it will be sharp and quickly reversed. Historically this type of pattern is resolved with a false breakout approximately 1/3 of the time, which sets up an even more explosive move in the opposite direction.

Therefore, if you have not already secured a fixed rate for Electricity or Natural Gas, I recommend you consider doing so in the near future. Remember, over the last 13 years, Natural Gas, which is highly correlated to the cost of Electricity has been higher 95% of the time. Although it is possible this could be one of the times when we experience a false downside breakout prior to rallying, I do not recommend trying to catch the exact bottom.

The purpose of hedging your cost of Natural Gas and Electricity is to reduce risk, while the role of speculators is to assume the risk hedgers are unwilling to be exposed to. Speculators have the luxury of trying to catch the exact bottom because if they miss the bottom all it costs them is opportunity cost, and opportunity cost is not as expensive as lost capital. But hedgers don’t have the luxury trying to catch the exact bottom because if a hedger misses the exact bottom it always results in lost capital.

As a hedger do you really want to be at risk when a market has been higher 95% of the time over the last 13 years? If your answer is, “No”, then you understand why we recommend hedging your cost of Natural Gas and Electricity at today’s low historical price levels.

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 at this time. I invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Senior Commodity Analyst