Pre-Winter Update

The purpose of this Energy Alert is threefold:

1. Discuss performance of Natural Gas and Electricity since our October 25th Energy Alert. We discuss the price action of Natural Gas and Electricity together because of their high price correlation.
2. Short-Term – Market Perspective
3. Long-Term – Market Perspective

1) Performance of Natural Gas and Electricity since our October 25th Energy Alert.

In our last Energy Alert I stated, The way 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 next major move is likely to the upside. I also explained how large hedges are built during a bull market, and pointed out Commercial Hedgers have been accumulating long positions since August and this was another factor indicating the next major move would be to the upside.

The 1 year chart below reflects Natural Gas trade action since our October 25th Energy Alert.

The week after our Oct 25th Energy Alert we experienced milder than normal weather in the high usage areas and Natural Gas declined until 11/05, but then reversed and rallied over the last 30 days. Clearly the overall trend since our last Energy Alert has been to the upside, which is what we anticipated would take place based on the market signals we were observing.

2) Short-Term – Market Perspective.

Natural Gas has rallied essentially in a straight line over the last 30 days without experiencing any corrections. This type of trade action indicates strong buying interest and is normally seen at the beginning of major moves. But straight line moves are always followed by a correction before continuing higher. The question is when will the correction begin and how deep the correction will be. The most likely scenario is the upward thrust will end abruptly and the correction will begin when the present colder than normal weather in the Midwest and Northeast eases a bit. The 2 year chart below of Natural Gas points out the most likely objective for the correction.

In previous Market Alerts I discussed the significance of the 200-day Moving Average as a long-term trend indicator. Since breaking below the 200-Day MA in August due to very mild weather in the high usage areas, Natural Gas has attempted to trade back above the 200-Day MA without success until trading decisively above this important trend indicator over the last 8 trading sessions.

As you can see in the above chart, the last time Natural Gas broke decisively above the 200-Day MA was in July 2012 and then experienced a correction in August 2012 to the 200-Day MA prior to moving higher. I believe we will likely experience a similar pullback to the 200-Day Moving Average prior to moving higher. The only caveat is if December remains colder than normal throughout the month, then the correction may not take place until a January thaw from a higher level. In either case, any pullback to the 200-Day MA should be considered a buying opportunity.

3) Long-Term – Market Perspective.

When considering your hedging strategy it is important to view the energy markets from a long-term perspective. Since our May 8, 2012 Energy Alert we have repeatedly recommended hedgers lock in rates longer-term. We explained that rates from a historical perspective were extraordinarily low and likely to move higher in the coming years. On our Historical Data page (click here), we discuss Natural Gas and Electricity prices from a cyclical and historical perspective. After reading this material you will understand present cyclical and historical price patterns support the premise that we are in the early stages of a long-term bull market and the upside risk in prices is substantial at this time. Our view over the last 18-months is the bear market low of 2012 will lead to a bull market similar to 2002-2008.

The 15 year chart below reflects today’s rates from a long-term perspective.

When you look at the above chart you will understand why I believe from a historical perspective the upside risk is far greater than the downside reward potential of not hedging your cost of Natural Gas and Electricity. Remember if you are not hedged you are speculating prices will go down, but you are exposing yourself to very high upside risk for a very small downside potential return.

The 5 year chart below will help further put into perspective where we are at the present time.

The above chart shows the lows reached during the 2008/09 financial collapse and in 2011/12 when we experienced the warmest winter in 100 years. In our last Energy Alert, I pointed out in more than 2 out of 3 instances the low reached during the fall shoulder was lower than the low reached in the following spring shoulder. The primary exception is when there are extenuating circumstances such as the 2 above examples, but historically the evidence favors higher prices next spring.

Before closing I would like you to consider what has taken place over the last 12-months. In the above chart I bracketed the price action over the last 12-months and titled this period “Accumulation Period”. When markets move forward from a bear market low they do so in steps. There are periods such as from Apr 2012 thru Dec 2012 when the market experienced an upward thrust followed by an accumulation period. Accumulation periods give market participants the time necessary to build long-term positions prior to the next upward thrust.

Accumulation periods are characterized by sideways trading even though the markets news is predominately bearish. Over the last year, supply levels remained high as we experienced a mild summer in high usage areas, and the weakest Atlantic storm season since 1982, but we still are closing 2013 at slightly higher price levels from the close of 2012. Remember as I stated in the introduction, over the years I learned that when a market does not go down on bearish news it is signaling the next move will be to the upside; therefore, we continue to recommend clients with hedges expiring within the next year consider extending their hedges at this time.

In future Market Alerts I will discuss the changing fundamentals which will support higher prices for 2014 through 2016.

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