Fall Update

My reports focus on Natural Gas rates because it is now the largest source of energy for the generation of Electricity in many regions; therefore, Natural Gas and Electricity rates are highly correlated.

In my September 1st Energy Alert, I said if the EIA continues to report larger than expected storage we could test the April 27^th spring low near $2.443 per MMbtu, which as you can see in the chart below is what has taken place:

Over the last month Natural Gas declined reaching a low last Friday at $2.403 per MMbtu. But this week Natural Gas firmed and is now trading above the $2.443 per MMbtu spring low. When a market trades briefly below a key support level and returns above that support level it is more often than not a buy signal. What it revealed is after hitting stops just below the support level and taking out previous buyers, stronger long-term buyers came into the market to scope up contracts at historically low price levels. As I will explain later in my report this is not surprising for this time of the year.

Notice in the above chart after reaching the spring low on April 27^th, Natural Gas experienced a sharp short covering rally as shown by the first red line and quickly reached a high of $3.105 per MMbtu by May 19^th. I believe we will likely experience a similar short covering rally as shown by the second red line in the above chart. 

The next chart clarifies why I believe this will happen:

In Feb 2014, Natural Gas surged to a high of $6.493 per MMbtu after a brutally cold winter before plunging to this year’s spring low of $2.443 per MMbtu on April 27^th, which occurred after last year’s warmer than normal winter. After experiencing the sharp short covering rally in May, which I discussed earlier, Natural Gas remained under pressure this summer due to relatively mild weather in the high usage areas and continued robust production.

As you can see the above chart, we appear to be completing a double bottom formation, which should support higher prices near term. I believe last week’s $2.403 per MMbtu low will likely hold. Spring and fall lows are attained at the end of low demand periods, and in most instances they precede higher prices in the higher demand periods. Therefore, I believe we will rally from present levels into November.

Where rates go from here will be determined by many factors, but the most important factor will be the severity of the coming winter.

The market is anticipating a milder than normal winter, which is already factored into the market and one of the primary reasons rates reached $2.403 per MMbtu last week. NOAA is forecasting a 95% probability we will experience an El Nino this winter, which historically is associated with cooler and wetter than normal winters for the Southwest and Southeast, but drier and warmer winters for the high usage energy users in the Midwest and Northeast, which could decrease demand for Natural Gas and Electricity. El Ninos occur when the water temperatures in the Pacific Ocean near the equator become abnormally warm. El Ninos tend to begin in the summer and usually peak in intensity during the following winter, which is the pattern we are presently forming. Therefore, after rallying into November, rates could turn back down to test the Bear Market low attained in April 2012 after one of the warmest winters in recorded history.

Given this possibility if you have not already hedged Natural Gas and Electricity for 2016 and beyond should you wait for possible lower rates in the spring of 2016?

Last month I asked the same question and said the answer is found by identifying the risk of not hedging at present price levels versus the potential reward of purchasing at a lower level. The chart below is an updated risk/reward chart of Natural Gas prices over the last four years.

Last month’s Energy Alert contained a similar chart, which showed the potential upside risk of testing the high reached during the cold winter of 2013/14 versus the reward potential of testing the low reached in April 2012 after the warmest winter in 100 years was 4.75 to 1.

But after the recent declines due to the combination of the EIA reporting larger than expected builds of supply over the last month and NOAA forecasting a 95% probability of an El Nino this winter the risk versus reward has risen to 6.5 to 1. As I stated in my last report anytime the Risk/Reward ratio is this highly skewed to the upside, I always recommend hedging your cost of Natural Gas and Electricity.

One last point, if we experience a very mild winter similar to 2011/12, and retest the spring 2012 low this would be long-term very bullish for Natural Gas and subsequently Electricity. The boom in drilling based on new fracking technology has been funded largely with debt, which many drillers are now struggling to pay due to low cash flow from low prices. A sustained drop below present rates would challenge the survival of many drillers and production levels would be adversely effected.

Summary

1. If you hedged your Natural Gas or Electricity earlier this year don’t be concerned rates are slightly lower now. Historically speaking over the last 13 years rates have been higher 95% of the time than where rates were over the last 9 months, and there is a high probability they will be higher on average over the next 12, 24 and 36 months.

2. If you have not already hedged your Natural Gas and Electricity be aware both markets will likely rally in the near term and securing hedges ASAP would be wise.

3. If you already have hedges in place and we experience a very mild winter similar to 2011/12, and retest the spring 2012 low, it would be an excellent opportunity to extend hedges for as long as possible. A retest of the spring 2012 low in the spring of 2016 would likely usher in much higher pricing for many years.

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
727-400-3170