Energy Update | July 29, 2019

Natural Gas Below $2.50 Per MMBtu Triggers Surge in Commercial Hedging. (My reports focus on Natural Gas as it is

Natural Gas Below $2.50 Per MMBtu Triggers Surge in Commercial Hedging.

(My reports focus on Natural Gas as it is the largest energy source for the generation of Electricity; therefore, Natural Gas and Electricity are highly correlated.)

In my July 1st Energy Update, I said Natural Gas prices below $2.50 per MMBtu were a rare occurrence and although it was possible prices could decline slightly from present levels, the longer they stay low, the higher prices will go long-term. 

Natural Gas prices have declined slightly and based on the 4 fundamental facts, I summarized in my last report the risk of higher prices long-term continues to increase.

My premise was largely based on the fact low Natural Gas prices are a disincentive to Exploration & Production companies (E&P) maintaining the growth of production necessary to keep up with the inevitable demand increases low prices support. The chart below clearly shows this phenomenon is beginning to take place, see graph to the right: 

(Graph source: PointLogic, HFI Research)

Over the last 3 months Natural Gas production has stalled, and the year over year rate of production increases have declined since Oct 2018. I predicted this would take place based on the factors discussed in my Oct 31st, 2018 Energy Update, which you can access by clicking on the hyperlink.  

In today’s report, I discuss another factor pointing to higher prices. Commercial hedgers are beginning to build long-term positions. Over the years, I have found it is wise to follow the lead of Commercial Hedgers. They are risk averse and have much more capital than speculative traders. Therefore, they have a vested interest and buying power to move markets based on their capitalization. It is important to note, when Natural Gas declined below key support near $2.50 per MMBtu on May 31st, Commercial hedgers began buying long-term positions.  

No one knows how much longer Commercial Hedgers will build their long positions prior to the market moving higher, but certainly it is in their vested interest for prices to move higher at some point in time.  

 

Although as previously stated it is possible rates can go slightly lower in the short-term, I don’t recommend trying to catch the exact bottom. This is the role of a speculator. If a speculator misses the exact bottom it does not cost them anything other than opportunity cost, and opportunity cost is not as expensive as lost capital. But hedgers don’t have that luxury. If hedgers miss the bottom they are inherently short the market, and it is not a good idea to be short a market when since 2000, there were only 3 previous periods when Natural Gas traded below $2.50 per MMBtu, and it always preceded much higher prices for an extended period. 

Conclusions:

When Natural Gas declined below $2.50 per MMBtu, Commercial hedgers began buying Natural Gas futures. Over the years, I have found it is wise to follow the lead of Commercial Hedgers. They are risk averse and have more capital than speculative traders to move markets. Commercial hedgers are aware there were only 3 previous periods since 2000 when Natural Gas traded below $2.50 per MMBtu, and it always preceded much higher prices for an extended period. Although no one knows how much longer Commercial hedgers will build their long positions prior to the market moving higher, the empirical evidence continues to point to higher prices. Therefore, we recommend anyone with agreements expiring within the next 18-months reserve energy at today’s very low prices to be available when their present agreements expire. The upside risk is too great to justify waiting 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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