Never Sell a Quiet Market

In my June 9th Energy Alert, I summarized the changing dynamics in production and consumption that have not been fully factored into pricing. If you have not read this report I encourage you do so, that way you can fully appreciate what I am writing today.

In today’s report, I explain further why I believe Natural Gas and Electricity, which are highly correlated are in a transition period, and the relatively quiet period we experienced in the first half of 2015 will likely come to an end soon.

In this report, I focus on 4 points:

• Secular bear market bottom reached in Apr 2012.
• Large commercial hedgers remain buyers at present levels.
• Never sell a quiet market.
• Upside gap to be filled.

I will refer to the chart below as I develop each point.

• The secular bear market bottom for Natural Gas was reached in April 2012, and it is highly unlikely those lows will be reached again in this market cycle. The spring lows of 2012 of $1.902 per MMBtu were the byproduct of the warmest winter in 100 years in conjunction with a large year over year increase in production due to new fracking technology. The energy markets are highly cyclical and self-adjusting as producers’ incentive to maintain production is diminished by low prices while demand increases when prices are low. We have been in a transitional period over the last 3 years, but based on the factors summarized in my last 2 reports production now appears to be declining year over year while demand is expected to continue to increase.

• As you can see in the above chart Commercial Hedgers continue to hold near record long (BUY) positions and I believe it is not a question of if the market will go higher, it is only a question of when. In my March 4^th Energy Alert, I said over the years, I have found it wise to follow the lead of Commercial Hedgers. They are more highly capitalized than traders and have a vested interest in moving the market higher based on their capitalization. No one knows how long Commercial Hedgers will hold their positions prior to the market moving higher, but it is important to note Commercial Hedgers are the Natural Gas and Electricity Supply Companies (ESCOs) commercial accounts purchase energy from, and they literally control the market.

• In the above chart note rates remained in a relatively tight trading range in the first half of 2015 well above the spring 2012 lows despite ongoing bearish EIA storage reports. The consensus at the beginning of the injection period in April was rates were destined to test the spring 2012 lows as production overwhelmed demand and storage levels reached record levels. In my May 5^th Energy Alert, I said how a market reacts to news is more important than the news itself. If a market does not decline with bearish news it is signaling the path of least resistance is higher prices. This market has been compressing just above $2.50 per MMBtu with decreasing volatility. There is an old trading adage “never sell a quiet market”. Why is it wise to heed this adage? Simply stated because quiet markets are a byproduct of complacency, and market bottoms are formed when traders do not fear prices going higher and they become complacent.

• Finally, if the market rallies as expected what is a reasonable first objective for the Commercial Hedgers. Traders often set an objective of filling a gap in the chart. Gaps are created when a market opens sharply higher or lower and does not return to the previous close for an extended period. A gap was created on 12/22/14, when the market opened sharply lower on a forecast of very mild weather and left an area unfilled from $3.35 to $3.44 MMBtu. I believe this gap is an initial objective for Commercial Hedgers, and after filling this gap they will reevaluate their positions based on the prevailing fundamentals at that time.

In summary, the secular bear market bottom reached in the spring of 2012 will likely hold for years to come. Commercial Hedgers are holding near record long (BUY) positions in anticipation of higher rates, and with rates compressing with decreasing volatility, the next major move for rates is likely higher with a minimum object to fill the gap left behind on 12/22/14.

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