Major Bottom Likely in Place – Higher Prices Ahead?

In my March 7^th Energy Alert, I said in 40 years of trading I seldom observed conditions more suitable for a major bottom in Natural Gas and Electricity than today. My report focused on Natural Gas, but my analysis also pertained to Electricity. Natural Gas is the largest source of energy for the generation of Electricity in many regions; therefore, Natural Gas and Electricity rates are highly correlated.

The 2 conditions I described in my March 7^th report were unsustainably low prices and a high level of negative news. Unsustainably low prices influence suppliers to decrease production, which leads to higher prices, and a high level of negative news is already factored into low prices and rates are primed to move higher!

As I wrote the March 7^th report, conditions supporting a major bottom in Natural Gas were in place, and supported my belief the average price of Natural Gas would be higher over the next 12, 24 & 36 months.

I based this observation on the empirical evidence contained in the 20-year chart of Natural Gas below:

When prices decline below $2.00 per MMBtu, rates were always higher on average the next 12, 24 & 36 months. Past performance does not guarantee future results, but if you don’t learn from history, you are doomed to make the same mistake in the future.

But as I wrote my March 7^th report, I didn’t realize Natural Gas would rally more than 25% starting that day! As you can see in the 12-month chart below, Natural Gas’s rally began on March 7^th, and continued through today:

The rally starting on March 7^th was not a surprise, although I must admit, I thought rates could go slightly lower short-term. But I learned over the years when the major factors described in last month’s report are in place, it is not prudent to delay hedging hoping for slightly lower rates.

The question is, if you delayed securing your hedge hoping for lower prices, should you continue to delay hoping rates will pullback? I believe it would be unwise for the following reasons:

1. No one can say with certainty that the lows in this market cycle are in place, but the conditions supporting a major bottom are in place, and the upside risk of higher prices for unhedged accounts far exceeds the potential downside reward of waiting for a lower entry point.

2. As discussed in my March 14^th report, the number of active U.S. rigs reached a record low of 480 early in March. The previous record was 488 in April 1999, which as you can see in the chart below preceded a major rally over the next 18-months:

Last week, the total number of active rigs fell to a new record low of 450 rigs, and will further exacerbate an already weakened production base!

3. In the near-term, the next 4 weekly EIA storage reports may signal we are in the midst of a major change in the supply/demand balance of Natural Gas. Last year, the EIA reported a total injection of 250 Bcf in the first 4 weekly storage reports for Natural Gas in April 2015. This year, over the next 4 weeks, the EIA may announce total Natural Gas storage is decreasing. It has been widely reported record high storage levels could lead to lower prices as inventories build during the injection season, which runs from April thru October. But a delay in building storage this year could support higher prices in April, and if this trend continued into May an explosive rally from present levels is possible. 

Therefore, based on the above 3 factors, if you have not already hedged your cost of Natural Gas and Electricity, I recommend doing so at this time. Although past performance does not guarantee future results, the evidence supporting Natural Gas and Electricity rates moving higher from present levels is increasing.

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