Natural Gas: Big Supply, Getting Bigger

Natural Gas: Big Supply, Getting Bigger
Oct

27

2014

Natural Gas: Big Supply, Getting Bigger

Natural Gas traders should look to take Call premium when Supplies are building. That means Now.

I once heard a statistic that up to 80% of traders who “try” commodities lose money. Judging from the way most individual investors approach this unique asset class, it does not surprise me. For most investors who start out in buying or selling commodities contracts are simply stock traders acting on a hot “tip” – either something they read online or in the newspaper. They often don’t understand how leverage works in futures contracts. More importantly, they don’t understand how to properly research a commodity. The result of this is that many of them fall victim to relying on “pop analysis” of commodities markets.

A prime example of this is the old wives tail that you buy heating oil or natural gas in the fall because demand for these products goes up in the winter. It stands to reason then that prices should go up too, right?

Wrong.

At least, not when you think they should.

The Misunderstood Seasonal Tendency

Prices of certain commodities moving a certain direction during a certain time of year are called seasonal tendencies. And while these can indeed be powerful price projectors in certain markets, most neophytes fail to understand how to use them properly.

As autumn 2014 fast approaches, the Natural Gas market gives us a perfect opportunity to explore and possibly exploit a seasonal tendency.

In commodities, supply and demand will almost always be the key to ultimate price direction of any market. The mistake many make is that it is not supply and demand on the retail market that is exerting the most immediate force on prices. It is supply and demand on the wholesale market.

Figure 1 below shows historical highs and lows of natural gas in storage facilities around the country throughout the year. This chart tracks wholesale supply. Note that supplies tend to be lowest in the Spring months (April, May and June). This is because supplies have been drawn on all winter to meet heating demand. By the end of winter, supply levels are at their lowest.

Figure 1: Energy Information Agency Natural Gas Storage Levels

Figure 1: Energy Information Agency Natural Gas Storage Levels


Note supplies lowest at end of winter and highest right before winter.


Figure 2 is what is known as a seasonal chart. This is an average (and only an average) of price direction over a 5, 15 and 24 year period.

Figure 2: March Natural Gas 5, 15, 24 year Seasonal Price Tendency

Figure 1: Energy Information Agency Natural Gas Storage Levels

Average price highs tend to occur after winter ends and price lows tend to occur as winter begins in earnest.


If you compare these two charts, you will notice two key correlations.

  1. Prices (at least the averages) tend to be highest during the spring months – right about the time storage supplies are at their lowest
  2. Average price also tends to be at it’s lowest near the end of the year – right about the time storage supplies are at their highest.

Note to new commodities traders: This is not a coincidence.

Supply and Demand really are the keys to the castle when it comes to trading commodities. But it’s wholesale supply and demand – which often runs contrary to the retail side (so often reported in the media) that steers the cart.

How to Target Profits Trading Natural Gas this Fall

Seasonal Averages and price tendencies are not, of course, an exact science. “Buy this day and sell that day” nonsense is a good way to lose money. Instead, you are better served by taking a broader view.

Seasonal charts and storage levels would seem to suggest it’s a good time to be short natural gas. While this may be true, it might not be the perfect time to get short natural gas.

A look at March 2015 Natural Gas (See Figure 3) shows prices currently near their lows for the year.

Figure 3: March 2015 Natural Gas

Figure 1: Energy Information Agency Natural Gas Storage Levels

Average price highs tend to occur after winter ends and price lows tend to occur as winter begins in earnest.

In addition, seasonal tendencies (Figure 2) suggest that an October rally in Natural gas prices is hardly unprecedented. This countertrend within a trend is more likely due to the Gulf of Mexico reaching the peak of hurricane season and speculators buying nat gas contracts for the “winter play” – pop analysis – remember? Figure 2 would suggest this is not a good idea.

Instead, the better play may be to look for October rallies as opportunities to begin establishing short positions in the natural gas markets.

Conclusion and Recommendation

With 2.891 trillion cubic feet of gas currently in storage, inventory gains topping 5-year weekly averages for 20 straight weeks, and stricter new regulations starting this month that will limit the amount of gas that can be “flared” off of US wells, storage supplies should be more than ample for the start of the 2014 winter.

This will be a drag on prices through the remainder of 2014.

We will look for rallies above the 4.00 level over the next 4-6 weeks as opportunities for selling call options in the natural gas market. Solid premium is available at strikes high above this market and we intend to take advantage of this on behalf of our clients.

Remember that as a commodities trader, you’re best served by looking behind the headlines and studying the fundamentals that really move prices.


Price Chart Courtesy of CQG, Inc.
Seasonal Charts Courtesy of Moore Research Center, Inc
Fundamental Charts Courtesy of Hightower Research, Inc

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***The information in this article has been carefully compiled from sources believed to be reliable, but it’s accuracy is not guaranteed. Use it at your own risk. There is risk of loss in all trading. Past performance is not necessarily indicative of future results. Traders should read The Option Disclosure Statement before trading options and should understand the risks in option trading, including the fact that any time an option is sold, there is an unlimited risk of loss, and when an option is purchased, the entire premium is at risk. In addition, any time an option is purchased or sold, transaction costs including brokerage and exchange fees are at risk. No representation is made that any account is likely to achieve profits or losses similar to those shown, or in any amount. An account may experience different results depending on factors such as timing of trades and account size. Before trading, one should be aware that with the potential for profits, there is also potential for losses, which may be very large. All opinions expressed are current opinions and are subject to change without notice.

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