Potential of a Large Decline in Natural Gas Supplies Supporting Rally?

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

Starting with my March 7th Energy Alert, I warned Natural Gas was forming a similar pattern to the spring of 2012, which led to much higher prices by the winter of 2014. The pattern continues to hold, and as I explained in my Nov 2nd Energy Alert, the most common long-term moving average used by technical traders to determine long-term trends is the 200-day Moving Average. I pointed out Natural Gas remained below the 200-day moving average from the middle of 2014 until 5/31/16, when prices moved decisively above the 200-day.

As you can see in the chart below, after breaking through the 200-Day Moving Average on May 31^st, Natural Gas surged higher reaching a high of $3.366 MMbtu on Oct 13th. But very mild fall weather led to a test of the 200-Day Moving Average on Oct 26^th, which inilally held, but fear the mild weather might continue into late November led to a second test of the 200-Day Moving Average on Nov 10^th.

But as you can see in the above chart, after briefly trading below the 200-Day Moving Average, Natural Gas prices have again surged higher and we are close to retesting the Oct 13^th high.

The question is what triggered this latest rally?

Part of the reason can be explained by cooler weather finally arriving in the Mid-Western and North-Eastern states with some areas receiving substantial snow. The demand for heating increased and last week the EIA reported the first decline of Natural Gas storage since the week ending April 8^th. But the decline of 2 Bcf was not very impressive relative to the average decline of 45 Bcf for the same week over the last 5 years.

Also, considering we presently have 4,045 Bcf in storage, which is a new record for this time of the year, a decline of 2 Bcf was probably not the primary impetus for the rally. Therefore, I believe the rally is based on more than a short blast of cold air, and should be seen as a warning that higher prices are likely on the horizon.

I believe this latest rally is based on 3 factors:

1. As I wrote in my March 7^th Energy Alert, over the last 20 years prices fell 7 times to near where they were in March 2016, and rates were always higher on average the following 12, 24 & 36 months. Large hedgers are aware of this tendency and consider pullbacks as buying opportunities.

2. As previously discussed, Natural Gas is following a similar pattern to the spring of 2012, which led to much higher prices by the winter of 2014. As you can see in the chart below if this pattern continues to hold, prices have much further to go in this price cycle.

It is important to note, cycles normally do not end until an event leads to the culmination of the cycle. For example, the cycle beginning in the spring of 2012 was not completed until we experienced the brutally cold winter of 2013/14, which led to the final highs of that cycle.

But prices in this cycle are likely in their early stages and we have not yet experienced an event to justify a final surge to complete the present cycle.

The winter demand season is just starting and if demand is greater than supply, as measured by the EIA weekly storage report released on Thursdays, then prices would have a reason to move higher.

3. Present storage estimates for the next 4 weeks are calling for much higher than normal draws of Natural Gas, and if these estimates are correct, storage levels will quickly approach the 5-year moving average by the end of December. The strength of the rally since Nov 10^th indicates large traders believe this is a real possibility.

No one knows what event will lead to the culmination of this price cycle, but clearly, I do not believe that event has taken place yet; therefore, the risk of higher prices continues to be high, and hedging your cost of Natural Gas and Electricity is prudent considering the upside risk.

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
Senior Commodity Analyst
727-400-3170