How to Respond to Near-Term Correction in Natural Gas Price

In our last alert on 4/6/13, we stated that in the next 30-45 days a window of opportunity might present itself in which our clients could capitalize on a short-term pullback. We also stated that it would be important to take advantage of this buying opportunity because we believe energy supply rates are poised to go much higher in the second half of 2013.

On 5/2/13, 26 days after our last alert the forecasted pullback of Natural Gas and electricity prices began. The question before us now is how deep and long will this correction be. No one knows for sure, but today’s alert will cover the 3 most likely scenarios. Our hope is that this discussion will help you to effectively take advantage of this pullback and implement your hedging strategies.

The correction that began after the 5/2/13 Natural Gas storage report has been sustained and very sharp; therefore, we are likely nearing the completion of a 3rd wave down. The chart below shows the 3 wave pattern formed over the last 3 weeks:

May 18, 2013

Corrections normally are completed in either 3 or 5 wave patterns; therefore, we believe one of the following 3 scenarios will most likely take place:

1. The correction we were anticipating could be a 3 wave correction in which case we reached an important low after yesterday’s storage report and it would be in your best interest to lock in a fixed rate immediately.
2. The correction could be a 5 wave correction in which case there will be a 4th wave rally after yesterday’s storage report followed by a 5th wave decline towards the lower daily Bollinger band, which will be marginally lower than the low reached after yesterday’s storage report. Although I believe this scenario is more likely than scenario 1, the risk/reward benefit of waiting for a 5th wave down may not justify the risk.
3. Due to slowing demand between the winter heating and summer cooling seasons the correction that began on 5/2/13 could last longer and be more complex, leading to a test of long-term support near the 200-day moving average, in late May or early June. As seen in the 1 year chart of Natural Gas below, we believe this is the most likely scenario:

May 9 Natural Gas Chart
The chart above shows the 200-day moving average in green.

Scenario 3 is based on slowing demand in the spring, and an eventual test of the 200-day MA is the most likely scenario, but the risk/reward benefit of trying to nail the bottom of the correction that began on 5/2/13 is not favorable as reflected in the 15 year chart of Natural Gas contained in our 4/6/13 alert.

No one knows precisely when the energy markets will again spike upward, but obviously the upside risk is substantial.

In our 4/6/13 alert, we advised clients to anticipate a correction in Natural Gas and Electricity within 30-45 days and that, based on the above 15 year chart, it was important for you to take advantage of the buying opportunity.

The correction has begun as anticipated and Natural Gas has declined approximately 50 basis points, and we believe a test of the 200-day MA is very possible. The 200-day moving average is just 40 basis points below yesterday’s low, and based on the above chart, the risk/reward ratio does not favor trying to catch the exact bottom of this correction. I leave that for the speculators who can stand aside and hope to nail the exact bottom. If they miss the bottom it does not cost them anything except opportunity cost, and opportunity cost is not as expensive as lost capital. But hedgers do not have that luxury, since if they miss the bottom and they are not hedged they are inherently short the market.

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. We invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

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. We invite you to call one of our energy analysts to help you plan a hedging strategy appropriate for your situation.

Ray Franklin
Senior Energy Analyst