Natural Gas: Injection Season Spells Opportunity for Put Sellers
With Heating Season all but over and Summer Cooling Season Around the Corner, Nat Gas Distributors are Getting Busy Rebuilding Inventories. Here’s How to Capitalize.
Natural Gas can be a great market to trade this time of year. Hurricane season is still months away. With US gas demand met almost entirely from domestic production, the market is somewhat insulated from geopolitical events. This allows the market to take price direction almost exclusively from core supply demand fundamentals.
There is no shortage of natural gas at the retail level right now. In fact, natural gas prices plunging by 40% since December highs indicate one thing: The market believes supplies are more that adequate to meet demand needs for the rest of heating season.
MAY 2015 NATURAL GAS
Natural Gas prices have plunged by 40% since December. However the demand cycle for gas changes in the Spring.
Yet, investors not familiar with the demand cycles of energies may find it curious that supplies are now at their lowest levels of the year.
How can this be? Doesn’t low supply mean higher prices?
The answer is, yes and no. For low supply means little if demand is lower.
The Natural Gas Demand Cycle
In the futures markets, commodities take their price cues from demand at the wholesale level. And while retail demand for natural gas may be highest in winter, March wholesale demand is virtually nil.
….“heating season” as it is known amongst gas traders, ends this month. And April gives way to “injection” season.
This is because wholesalers (or distributors), spend the months leading up to demand season building their inventories. This means buying it from producers. Socking away inventories means rising demand at the wholesale level. This often serves as a bullish influence to prices.
NATURAL GAS SEASONAL CHART
The heating season for gas runs November-March. After winter, distributors begin rebuilding their stocks. Because this causes an increase in demand at the wholesale level, price strength is often the result. (Past performance is not indicative of future results. There is no guarantee a rise in prices will occur this year.)
Once supplies are deemed adequate, the wholesalers spend their time selling their gas to retail gas distributors. During this time, there is little demand at the wholesale level. That’s where we are now.
Knowing these seasonal tendencies in the energy and other commodities markets can be a powerful tool for option sellers. (Seasonal tendencies and how to use them are discussed thoroughly in the new 3rd Edition of The Complete Guide to Option Selling).
But “heating season” as it is known amongst gas traders, ends this month. And April gives way to “injection” season.
During injection season, the cycle begins anew as wholesalers once again begin injecting gas into storage. This means increased demand from producers at the wholesale level and can often correspond with higher prices in the natural gas market during the spring. This is evidenced in the previous chart.
While there is no guarantee that higher prices will occur this year, we feel the fundamental supply draw appears to be occurring in line with past years (see chart below).
Natural Gas inventories tend to hit a low at the end of winter as stockpiles have been consumed to meet winter heating needs. However, by late March, distributors begin rebuilding inventories to meet summer demand needs.
Now for some interesting correlations:
- Notice how inventory builds starting in the March/April time periods have correlated with average price moves in the past by comparing the chart above to the May Natural Gas Seasonal Chart.
- Compare the price pattern of May 2015 Natural Gas to date (top of article) with the May Natural Gas Seasonal chart.
You may draw what conclusions you want from those. However, our outlook and plan of action are summarized below:
Outlook and Strategy Suggestion
In the accounts we manage for investors, we don’t try and pick highs and lows in the market – at least not as a trading strategy. Instead, we try and pick points far above or below potential highs and lows and take premium there. I recommend using this approach if you are a self directed commodity trader.
As of the latest report available at time of writing, there are 2.268 Trillion Cubic Feet (tcf) of natural gas in storage – close to the 10 year average for this time of year.
After the 40% correction, natural gas prices currently stand at $2.75per mbtu, close to multi year lows.
With injection season beginning this month, OptionSellers.com projects a low in the natural gas market at some point over the next 30-45 days.
Does that mean you need to pick the low to take money out of this market? Does it mean we need a wild rally in prices this spring to make a good return? Does it mean we need natural gas prices to follow the averages for normal seasonal tendencies to profit?
No, no and no.
What it does mean is that now might be a good time to go shopping for put premium. The cyclical influence of increased demand in this market can be strong. Thus, with prices at an already low level, the market will have a harder time pushing substantially lower (in our opinion) once injections begin in earnest.
Thus selling put options seems to be a high percentage strategy for taking money out of this market without betting on a rocket surge in prices (although getting one would benefit you just the same.)
We advise using additional weakness in natural gas prices this month to begin taking premium in July and/or August puts.
Aggressive premium sellers can look at the July 2.00 put while more conservative investors may consider the August 1.75 puts. We’d like premiums in at least the $500 area which could come available on additional price weakness in March.
Speculators are still heavily short this market which means signs of bottoming action could bring fast short covering action should they become spooked. Don’t be afraid to sell premium on a big day down this month off of a “warmer weather” report. Weather means little on the wholesale demand front this time of year. Focus on the big picture fundamentals to take premium this time of year.
We’ll be working with clients this month in the timing of selling natural gas premium. If you’d like more information on how to participate, be sure to request your Investor Discovery Kit at www.OptionSellers.com/Discovery or see the announcement on the back page