Natural Gas Prices Buoyed by Petroleum Strength, Hurricane Concerns
Despite natural gas storage levels sitting near record highs, natural gas futures prices remain lofty compared to past years, likely due to elevated petroleum prices and fear-based premiums attached to the upcoming hurricane season.
"I think the market is in a sense trading in conflict with the fundamentals," said John D'Agostino, a founding partner and COO of MotherRock LP, an energy hedge fund. "We obviously have a ton of gas in the ground, which everyone is well aware of. That fact has already been priced into the market."
D'Agostino, as one of many speakers at GasMart 2006, May 3-5 in Denver, will share his views on market liquidity, volatility, and how to manage gas price risk.
With the traditional natural gas heating season officially ending with a 10 Bcf weekly net withdrawal, as reported by the Energy Information Administration (EIA) on Thursday, the focus in the natural gas futures industry now turns to the potential for summer heat and the upcoming 2006 Atlantic hurricane season, which after 2005's destruction is being monitored closer than ever.
The overactive 2005 season saw hurricanes Katrina and Rita shut in more than 711 Bcf of natural gas in the Gulf of Mexico, which is equivalent to 19.5% of the annual production from the Gulf (about 3.65 Tcf), according to the Minerals Management Service. The shut-in amount is still growing by about 1.36 Bcf/d, MMS said on April 5.
Havoc caused by the hurricanes sent natural gas futures to a new all-time high in December of $15.780/MMBtu. However, a significantly milder-than-normal winter saw levels of gas in storage stay robust.
With 1,695 Bcf of working gas left in storage, the 2006 withdrawal season-ending level goes down in the books as the second largest amount since natural gas futures began trading on the New York Mercantile Exchange in 1990-91. Only in 1991 was more gas left in storage (1,912 Bcf) at the end of March, according to EIA's Natural Gas Monthly.
However, despite the significant storage surplus, natural gas front-month futures are now trading in the $6.500 to $7.500/MMBtu area, far less than December's $15.780, but significantly higher than past years with ample storage. In the closest storage comparison in recent years, the 2002 withdrawal season ended with 1,518 Bcf still in underground stores. For the week ended April 5, 2002, front month natural gas futures closed at $3.275/MMBtu, or $3.697 less than Thursday's close at $6.972.
D'Agostino said last year's hurricane season really left an indelible mark on the trading community. "Not only did you have the vision of the Henry Hub buried underwater and the lack of information coming out of the Gulf of Mexico, the trading community itself was uprooted when Houston was evacuated," he said. "A lot of liquidity was gone. Obviously the big volatility swings hurt, but they can be dealt with as long as the liquidity is there. What threw everyone off guard was that the market kind of shut down for three and half weeks."
Looking at this year's hurricane season, D'Agostino said traders are definitely concerned. However, he warned of fear mongers. "We had really bad luck last year, and you have to hope people will be better prepared for it this year."
D'Agostino also pointed out that strength in the petroleum sector is also helping to buoy natural gas prices, despite the lack of a direct relationship. He said that as heating oil futures continue to go up, natural gas will continue to be propped up due to the switchability of those two fuels. "In addition, the political tension surrounding crude doesn't seem to be going away," he said. "It really is a conflicting factor to the overwhelming fundamentals."
While some discount the switchability factor between heating oil and natural gas as marginal, D'Agostino said the relationship between natural gas and petroleum is very real. "I have seen reports that say there is a lot of switchability and others that say 'not as much as you think.' It doesn't really matter. The trading community definitely believes that there is a relationship and the contracts are clearly trading that way."
As for natural gas price movement predictions for the next couple of weeks, D'Agostino said it is a dangerous time in the market. "Any time the market is trading like it has been recently, you are setting yourself up to be a fool by trying to predict," he said. "If I had to, I would say we should be in the middle of a bearish trend, but I wouldn't put my money towards it. This market right now is a very tough market to call. For a while it seemed like it was just reacting to weather. You wake up and it was cold, prices would go up. You wake up and it was warm, prices would go the other way."
D'Agostino said you have to "grind it out" in periods like this. "In terms of a speculative trading strategy, you just don't pile into big bets right now. Not that you ever should, but especially not now. The guys who make their money by plowing into a big bet are finding that there are not many opportunities. Now they are just grinding it out. You look for little inefficiencies, little market-making opportunities. You kind of earn your living by working really hard when the market is trading this way."
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