Risk of Higher Prices Long-Term Increasing!

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 explain why the risk for higher prices long-term is increasing, and the age-old proverb “A Bird in the Hand is Worth Two in the Bush”, referred to in my May 24^th Energy Alert, should be heeded now.

1. Why is the risk of higher prices increasing Long-Term?

 The structural imbalance in supply/demand, discussed in my Feb 9^th Energy Alert, has improved slightly, but is not resolved. Production is increasing slowly, but Mexico and LNG exports continue to increase; therefore, supplies are expected to end this year’s injection season below the 5-year Moving Average. The injection season for Natural Gas (building supplies to prepare for the winter heating season), runs from April thru October, and as of last week’s EIA Storage Report, supplies are 11.2% below last year. The concern is unless production increases significantly in the second half of 2017, the risk of higher prices will increase long-term.

But it is important to note, if Natural Gas’s near-term prices were increasing, suppliers would have an incentive to increase production, and the structural imbalance would continue to diminish along with the risk of higher prices. The problem is near-term prices are not increasing.

In my May 24^th Energy Alert, I explained due to a high level of speculative long positions (speculators betting on higher prices), a sharp correction may occur to shake out speculators prior to a long-term move higher. Unfortunately, this is precisely what is happening. Natural Gas prices declined over the last month, and as explained in my report, I have observed many instances when large hedgers sold their high priced near-term positions to force out speculative traders, while simultaneously purchasing lower priced long-term positions, as protection against the likelihood of higher prices later.

The chart below, shows Natural Gas’s decline over the last month:

While the fundamentals continue to favor higher prices, a sharp correction has occurred to shake out speculators prior to prices likely moving higher long-term, and the longer near-term prices stay low now, the greater the risk for higher prices from Apr 2018 thru Apr 2020.

1. Why should the age-old proverb “A Bird in the hand is worth Two in the Bush”, be heeded now?

In my May 24^th Energy Alert, I said, when Natural Gas is lower in the forward markets, astute hedgers understand the old proverb, “A Bird in the Hand is Worth Two in the Bush”, and benefited by reserving rates long-term when they were below near-term rates. Although Natural Gas’s nearby contracts declined over the last month, as you can see below prices did not decrease in the forward markets:

Conclusions

Although prices declined in the present contract, prices from Apr 2018 thru Apr 2020 remained essentially unchanged, and if prices stay low near-term, producers will have no incentive to increase production and the risk of higher prices long-term will continue to increase. Natural Gas’s decline over the last month is a disincentive for suppliers to increase production, and astute hedgers will heed the old proverb, “A Bird in the Hand is Worth Two in the Bush”, and reserve rates long-term while they are below nearby rates, and not delay hoping for lower rates in the future.

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