Mild October a Buying Opportunity for Natural Gas?

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

In today’s report, I discuss why a warmer than normal October is presenting hedgers with an excellent buying opportunity prior to the winter heating season. My September 28^th Energy Alert explained why the inverted head & shoulders pattern Natural Gas formed over the last 4-months increased the risk of higher prices.

It is important to note, very mild weather forecasted throughout October lowered Natural Gas’s demand with heating degree days far below normal, but as you can see in the chart below, the inverted head & shoulders pattern continues to hold:

In my last report, I explained that when a market did not decline despite negative news, it is signaling the path of least resistance is for higher prices, and holding the inverted head and shoulders pattern over the last 2 weeks despite decreased demand indicates Natural Gas prices will likely move higher from present levels.

The question is why are Natural Gas prices holding despite negative short-term news? There are multiple reasons, but I summarize the 2 main ones below:

1. Last week, the EIA announced Natural Gas supplies are now below the 5-year moving average as we approach the winter heating season. This is important because:

a. At the start of the Natural Gas injection season on Apr 1^st, Natural Gas supplies were 14.8 % above the 5-year moving average. The supply surplus evaporated largely due to increases in LNG exports overseas along with exports to Mexico also increasing substantially after the completion of new pipelines.

b. The structural imbalances due to increased exports are expected to continue for the foreseeable future.

c. Starting the winter heating season with relatively low supplies increases risk of higher prices if we experience a colder than normal winter, and with structural imbalances still in place even an average winter will likely lead to higher prices.

2. Although long-term forecasts are not always accurate, several highly respected sources listed below are predicting an increase in heating demand this winter:

a. AccuWeather is forecasting a cold winter for the Northeast and mid-Atlantic, with January being the coldest of the winter season, and those low temperatures may be surpassed in the northern Plains where temperatures could drop to minus 30 degrees Fahrenheit at times. Below are the highlights of AccuWeather’s Winter Outlook:

If AccuWeather’s forecast proves correct, Natural Gas and Electricity prices will likely skyrocket like the winter of 2013/14, when prices doubled due to Polar Vortexes, after beginning the winter heating season with inventory levels very close to where they are today.

b. The Farmer’s Almanac on the other hand is predicting generally colder temperatures than last winter for the U.S. and Canada, but not colder than a typical winter, based on historical averages.

c. In their Short-Term Energy Outlook, released yesterday, the EIA, similar to the Farmer’s Almanac, is forecasting temperatures across the United States are expected to be 13% colder than last winter, but despite the expectation of colder temperatures compared to last winter, temperatures across the eastern United States are expected to be comparable to the average of the previous five winters, and in the West, temperatures are forecasted to be only slightly colder than the previous five-winter average.

Conclusions:

We are entering the winter heating season with relatively tight supplies; therefore, prices could skyrocket if we experience a colder than normal winter, and with the structural imbalances still in place an average winter will likely lead to somewhat higher prices.

Also, in the scenario of another warmer than normal winter, prices would probably not drop below this year’s low near $2.50 per MMbtu. As I pointed out in the August 28^th Energy Alert, after reaching a Bear Market low in the Spring of 2016 at $1.61 per MMbtu, Natural Gas quickly rallied to near $3.00 per MMbtu, and to date has not traded below $2.50. Bull Markets typically trade in a sequence of higher highs and higher lows; therefore, Natural Gas will likely not decline below $2.50 prior to trading much higher than its present price near $3.00 per MMbtu.

Based on the above, I believe, the risk versus reward ratio favors hedging the cost of Natural Gas and Electricity now, and the warmer than normal October is presenting hedgers with a good buying opportunity prior to the winter heating season.

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

Ray Franklin
North American Energy Advisory
Senior Commodity Analyst