Energy Alert: Mild Weather Forecast for First Half of February Leads to Break of 50-day and Possible Test of 200-day Moving Average

As usual since the use of coal has diminished, my reports focus on Natural Gas because it is now the largest energy source for the generation of Electricity; therefore, Natural Gas and Electricity rates are highly correlated.

My Jan 25^th Energy Alert stated “Natural Gas was valiantly holding near the 50-day Moving Average in the face of a substantial decrease in the estimated draw in supplies. But if warmer than normal weather persisted into February, and storage declines remained below average, it was likely the 50-day Moving Average would not hold, and the next price objective could be the 200-day Moving Average.”

 As you can see below NOAA’s latest 8 to 14 day forecast is calling for milder than normal weather for virtually all of the United States until Feb 14^th:

The forecasted mild weather will decrease demand, and continue to slow the draw of Natural Gas supplies. Natural Gas supplies will rise above the closely watched 5-year Moving Average in tomorrow’s EIA weekly Storage report, and if NOAA’s 8 to 14 day forecast is correct, will remain above this important Moving Average into the middle of February;

Therefore, as you can see in the chart below, Natural Gas did break through the 50-day Moving Average and could test the 200-day Moving Average.

My Nov 2^nd Energy Alert, explained that technical traders follow a variety of moving averages, but the most common moving average used to define a long-term trend was the 200-day Moving Average, and Natural Gas remained below the 200-day moving average from the middle of 2014 until 5/31/16, when prices moved decisively above the 200-day.

The 200-day Moving Average will likely hold in the near-term, although prices could briefly drop below the 200-day Moving Average to fill the gap, shown by the green circle, left behind on Monday, Nov 21^st.

The questions is, should hedgers secure rates now, or wait, for a possible test of the 200-day Moving Average?

 To answer this question, you need to consider the 2 factors summarized below:

1. The near-term, bearish, weather dynamics have been mitigated by structural imbalances in supply and demand. On the supply side, US Natural Gas production is presently averaging 70 Bcf/d, and although it is expected to rebound this year to an average of 74 Bcf/d, this is still lower than 2016. On the demand side, increases in LNG exports and new pipelines to Mexico have increased Natural Gas exports and they are compensating for decreased demand due to mild weather. Therefore, further price decreases will be limited by structural imbalances in supply and demand.
2. But if mild weather continues into the second half of February, the nearby active Natural Gas contract will remain under pressure and we could test the 200-day Moving Average. But from a hedging perspective, lower prices near-term may not result in lower prices in the forward markets. My Oct 6^th Energy Alert pointed out that Natural Gas, and in most regions Electricity, are experiencing backwardation. Backwardation occurs when nearby contracts are sold at a higher price than contracts further out.

When prices decrease in the nearby month, prices further out will not always decrease. My Jan 4^th Energy Alert pointed out that, although the nearby contract declined sharply due to NOAA changing their 8 to 14 day forecast over the Holiday weekend, prices did not decrease further out in the forward market, as you can see in the summary of rates below, priced in $ per MMbtu:

                               Dec 28^th           Jan 4^th             Difference

 Nearest           $3.74              $3.28                – 46

Apr 2017         $3.53              $3.22                – 31

Apr 2018         $2.97              $2.90                – 07

Apr 2019         $2.70              $2.71                +01

Apr 2020         $2.70              $2.71                +01

And as you can see below, from Jan 4^th to Jan 31^st, this pattern remains in place:

                           Jan 4^th           Jan 31^st         Difference

 Nearest           $3.28              $3.12              – 16

Apr 2017         $3.22              $3.17              – 05

Apr 2018         $2.90              $2.92              +02

Apr 2019         $2.71              $2.72               +01

Apr 2020         $2.71              $2.71                n/c

Although since Dec 28^th, the nearby contract decreased from $3.74 to $3.12 after yesterday’s close on Jan 31^st, the forward contracts from 2018 thru 2020 were little changed. Therefore, to delay hedging hoping nearby rates decline may not be in your best interest for longer-term contracts.

Based on the 2 above factors, I believe it is prudent to reserve rates in the forward markets near present levels and not wait hoping nearby rates test the 200-day Moving Average, but if you decide to wait and rates decline to the 200-day Moving Average, be thankful for your good fortune and act.

 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
Senior Commodity Analyst
727-400-3170