Update on the FEB 16th Alert “Buying Opportunity For Hedgers?”

(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 my Feb 16^th Energy Alert, the question posed was “is a very mild February an excellent long-term buying opportunity for hedgers?”, and then I explained based on 2 lessons I learned over the last 40 years, the answer was a resounding yes! To recap, the 2 reasons I gave were:

1. Plan entry points in advance based on long-term fundamentals such as structural supply/demand imbalances, which will support higher prices.
2. Short-term, buy when news is at its worse, and sell when news is at its best.

As mentioned, the structural deficit supporting higher prices remains in place and is expected to increase in the months ahead with further growth anticipated in Mexico gas and international LNG exports, and the structural imbalances will support higher prices long-term. Therefore, I believe the very mild February has provided hedgers with an excellent long-term buying opportunity. But the present structural deficit, which helped accelerate storage draws this winter versus last winter was not enough to counter the continued bearish heating demand, and short-term, prices have continued to decline.

Since writing my last report, unseasonably mild weather continued as forecasted in the high usage gas regions of the United States through the end of February, and the latest forecasts are indicating that the unseasonably mild weather will continue into mid-March. When I wrote that short-term, buy when the news is at its worst, I did not anticipate the weather news would worsen and prices would break below potential long-term support. No one can predict exactly the depth of market corrections, but my role as an analyst is to identify long-term trends, and point out tendencies and potential support areas.

In today’s report, I address where we may be cyclically, potential near-term support levels, and where prices will tend to go long-term.

1. Cyclical Perspective: From a cyclical perspective, we have not completed the move higher from the March 2016 cycle low, and prices are destined to go much higher before this cycle is completed sometime in the future. The final highs in the present cycle will likely be attained due to a weather event such as a warmer than normal summer, a colder than normal winter, or a geo-political event, and corrections in the cycle will occur due to weather events.

The chart below shows where we may be from a cyclical perspective:

The 6-year chart above shows the full cycle of Natural Gas after reaching its spring 2012 low. The present cycle since the spring 2016 low is very similar, and if the present pattern holds Natural Gas is likely close to a short-term low, and we will trade higher from present levels.

1. Potential Near-Term Support Levels: If you look closely at the chart below you will notice 4 red circles. The first 2 red circles occurred after the spring 2012 low and were caused by mild weather. The first red circle occurred after a mild winter and the second after a mild summer. And what is important to note is the second correction held near the low of the previous correction.

As you can see in the above chart, history may be repeating itself. The second 2 red circles have occurred after the spring 2016 low and represent corrections caused by mild weather. The first red circle occurred after a mild fall and the second after our present mild winter. We are near completion of one of the mildest winters in history, and Natural Gas is testing the previous seasonal low. If we hold above the fall 2016 low over the next week, prices will likely move higher from here. The winter heating season is nearly over, near-term weather surprises will cease to be a factor, and the focus will soon turn from weather concerns to the structural supply/demand imbalances presently in place long-term. Therefore, from a fundamental perspective, the odds favor prices moving higher from present levels.

But there is one caveat to consider. Natural Gas could experience one last sharp decline due to technical characteristics of the commodity. This market has a very large open interest at present, and open interest is a measurement of the number of buyers and sellers. Commodity markets are referred to as “Zero Sum Games”, which means for every buyer there must be a seller. High open interest breeds volatility.

The sharp decline that broke through support was triggered by unanticipated weak demand caused by an extended period of mild weather, which surprised traders like myself, who purchased Natural Gas based on strong long-term fundamentals. The nearby contract expired on Friday, Feb 24^th, and traders who purchased nearby Natural Gas contracts had to sell their positions prior to expiration, which added additional selling pressure.

The open interest of Natural Gas continues to climb, and is now the highest it has been since Dec 2013. We are likely entering a period of high volatility, which is.an exciting period for traders, but not an ideal environment for hedgers who should be risk averse. The next move could be an explosive short-covering rally, or one final downside plunge to facilitate large long-term hedges positioning themselves. Personally, I am hoping for one final downside plunge so I can repurchase positions I sold after Natural Gas broke through support after my Feb 16^th report, but I believe with the winter heating season ending, a short covering rally is the more likely scenario.

• Where prices will tend to go long-term: The answer to this question is much easier to answer, then where we may go short-term. Since structural deficits remain in place and are expected to increase in the months ahead with further growth anticipated in Mexico gas and international LNG exports, the structural imbalances will support higher prices long-term.

The extremely mild winter we have experienced has weakened winter demand to such a large extent that it superseded the structural imbalances and has presented us with a sharp short-term correction. But it is important to note, the structural imbalances not only remain in place, but are expected to worsen in the months ahead. Therefore, if you have not already hedged Natural gas and Electricity, I strongly recommend you do not delay and do so now! As the winter heating season ends, structural imbalances will again become the focus and support higher prices.

Conclusions

Extremely mild weather in January was followed by another extraordinarily mild February, the mildest since 1970, which led to a short-term break in prices. The combination of structural supply/demand imbalances in conjunction with a sharp correction caused by unexpected prolonged mild weather is presenting hedgers with an excellent buying opportunity. Although it is possible prices could decline briefly, I believe, the evidence favors higher prices long-term.

No one can precisely predict where Natural Gas will go short-term, but I can say with confidence long-term prices will be higher than where they are today. In 2000, my loving wife was concerned that I had moved all our stock assets into cash and many of her work associates were still profiting from the market’s rally. What I said to her at that time was although I believed the market could go marginally higher short-term there was one thing I was certain of; there would be a time in the future when it would be MUCH LOWER than today. I feel the same way about Natural Gas today. Although I believe Natural Gas could trade marginally lower short-term there is one thing I am certain of, there will be a time in the future when Natural Gas and Electricity will be MUCH HIGHER than it is today.

As I have stated many times hedgers should not try to catch the exact bottom, which is the role of a speculator. If a speculator misses the exact bottom it does not cost them anything except opportunity cost, and opportunity cost is not as expensive as lost capital. But hedgers don’t have that luxury, since if they miss the bottom they are inherently short the market.

  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,

NAEA Senior Commodity Analyst