Winter Update

In this Energy Alert I will review Natural Gas and Electricity rates in 2014 and discuss what we will likely be exposed to in 2015 and beyond.

In my January 30^th, 2014 Energy Alert I said we were heading into a period of high volatility in Natural Gas and Electricity rates similar to 2000 through 2009. The volatility would be caused by an ongoing struggle to maintain a balance in the increases in the supply and demand of Natural Gas, which is highly correlated to the cost of Electricity.

The chart below shows Natural Gas pricing over the last 25 years:

The period of high volatility from 2000 through 2009 was primarily caused by the struggle to balance supply and demand factors in an industry with limited storage capacity. Each year April through November is the injection period for Natural Gas in which supplies are built prior to the winter heating season, and then from December through March, Natural Gas supplies are drawn down. Prices are susceptible to high volatility during the winter and summer seasons because supplies cannot quickly adjust to increases or decreases in demand created by weather extremes.

Prior to 2000 the storage capacity of Natural Gas was sufficient to handle the demand for Natural Gas; therefore the price of Natural Gas remained relatively stable. But demand for Natural Gas has steadily increased for residential and commercial applications along with increased usage as an energy source for the generation of Electricity; therefore, as you can see in the above chart volatility increased dramatically from 2000 thru 2009.

But from 2010 thru 2013 we experienced a transitional period in which the production of Natural Gas increased dramatically due to new fracking technology leading to a period of relatively low and stable pricing, but as I warned in my January 2014 Energy Alert we are now returning to a period of high volatility similar to 2000 through 2009. The price of Natural Gas ranged from $2.88 to $6.49 per MMBtu in 2014. The high of $6.49 was reached on February 24th due to a colder than normal 2013/14 winter and the low of $2.88 was reached on December 31^st due to an unexpectedly mild start to the 2014/15 winter heating season. These types of wild swings in pricing should be anticipated for the foreseeable future as dramatic increases in production and demand continue to vie for control of a commodity with limited storage capacity.

This brings us to where we are at the present time. The chart below shows Natural Gas pricing since 2002.

The above chart shows after a period of high volatility Natural Gas prices plunged due to the worldwide financial crisis of 2008/09. But since the fall of 2009 Natural Gas has been tracing out a potential inverted Head and Shoulders bottom. This type of pattern is often seen at major market tops and bottoms. The pattern is defined as having 2 shoulders on each side of a head. At major tops the head is higher than the 2 shoulders and at bottoms the pattern inverts and the head is lower than the 2 shoulders.

In the above chart the left shoulder was reached due to the financial collapse of 2008/09 and the head was reached during very warm winter in 2011/12. The right shoulder appears to be forming due to the warmer than anticipated start to this year’s winter heating season. The left shoulder’s low in the fall of 2009 was $2.40 per MMBtu; therefore, with Natural Gas trading near $2.80 today it is possible Natural Gas could trade a little lower before completing its right shoulder.

But I do not recommend trying to catch the exact bottom at this time. I believe the downside reward potential is minimal while the upside risk is extraordinary. If we are in the process of forming an inverted Head and Shoulders bottom, then this formation is predicting the next rally will take prices much higher than last winter’s high of $6.49 per MMBtu. Therefore, I do not advocate trying to catch the exact bottom at this time. As I have stated in previous reports this 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 as a hedger you don’t have that luxury, since if you miss the bottom you are inherently short the market, and it is never a good idea to be short a market while it is in the process of potentially completing an inverted Head and Shoulders bottom.

In summary, I believe we are entering an extended period of high volatility in which the timing of entering hedges is extremely important. When prices decline during periods of lower than expected demand it should be used as an opportunity to lock in a fixed rate. If you have not already hedged your cost of Natural Gas or Electricity, I recommend you do so at this time. Although it is possible rates could go slightly lower in the short-term, I am confident in stating there will be a time in 2015 when rates will be significantly higher than where they are as I write this report.

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 Energy Analyst