Energy Update | 25 January 2021
Is Natural Gas Backwardation Offering Hedgers an Opportunity to Protect Themselves Against the EIA’s Forecast of Higher Rates? In my
Is Natural Gas Backwardation Offering Hedgers an Opportunity to Protect Themselves Against the EIA’s Forecast of Higher Rates? In my
In my Jan 18th Energy Update, I said the EIA’s most recent Short Term Energy Outlook (STEO) increased the probability Natural Gas will experience structural imbalances, which greatly increases the probability of higher prices in 2021 and 2022. I also pointed out in the last 20 years, Natural Gas only traded below $2.50 per MMBtu three times, 2001, 2012 and 2016, and it always preceded higher prices for at least three years.
Given the EIA’s forecast of higher prices in 2021 and 2022, and empirical evidence that in the last 20 years when Natural Gas prices were this low it always preceded higher prices for at least three years, it is wise to consider ways to protect yourself against the high probability of higher prices the next three years. The question is this, is Natural Gas’s forward market offering effective hedging opportunities to protect against the probability of higher prices?
In today’s report, I will address this question and why Backwardation is offering hedgers an excellent opportunity to protect themselves against the probability of higher prices.
Natural Gas is presently experiencing a market phenomenon called “Backwardation”; therefore, hedgers can secure rates far below the EIA’s forecasted 2021 average rate of $3.01 per MMBtu and 2022 average rate of $3.28 per MMBtu. Backwardation occurs when nearby contracts sell at a higher price than contracts further out, and at the present time, Natural Gas’s average price is lower the further you go out in the forward market, and far below the EIA’s forecasted rates for all periods of time.
Natural Gas Average MMBtu Price in the Forward Markets:
2021 – $2.68
2022 – $2.66
2023 – $2.55
2024 – $2.53
In the forward market, the price of Natural Gas is much lower than the EIA’s forecasted rates for 2021 & 2022, and as I have pointed out based on pricing since 2000, the above prices are below where they likely will be for at least three years.
Astute hedgers understand the old proverb, “A Bird in the Hand is Worth Two in the Bush” is as true today as in the 16th century and will benefit by reserving rates longer-term while they are far below the EIA’s forecasted rate, and not delay hoping for lower rates in the future.
Natural Gas’s forward market backwardation is an excellent opportunity for hedgers to secure rates far below the EIA’s forecasted rates for the next two years. Weather factors as always will influence the direction of energy prices near-term but based on the EIA’s supply/demand estimates and Natural Gas’s historical pricing over the last 20 years, the downside reward potential of lower prices short-term is minimal versus the upside risk of higher prices long-term.
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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