Natural-gas futures prices through mid-2017 have rallied significantly since bottoming in early March; however, the futures curves for late 2017 and beyond haven’t changed very much at all.
The calendar strip, or the average price of natural-gas futures over the next 12 months, provides superior insight into producers’ average price realizations over the coming year, assuming they lock in a portion of their expected output via hedging transactions.
The calendar strip price for natural gas has surged by 46 percent since its springtime low—an impressive rally, albeit less dramatic than the improvement in front-month prices. At these levels, the 12-month strip price hovers near the top of its two-year range.
Much of the recent upside in natural-gas prices reflects the unusually hot summer weather, expectations for a cold winter and modest supply growth, as oil and gas producers have curbed their drilling and completion activity in prolific US shale plays.
However, our intermediate- to long-term outlooks for gas supply and demand remain unchanged.
In April, the volume of natural gas stored in the US reached a record seasonal high that exceeded the five-year average by about 879 billion cubic feet.
An extraordinarily warm 2015-16 winter reduced heating demand and swelled natural-gas inventories heading into the spring, depressing the price of this commodity to an 18-year low.
However, a hot summer prompted US households and businesses to run their air conditioners longer; this uptick in electricity demand helped to alleviate the supply overhang.
In a year with typical weather patterns, US natural-gas inventories build at a pace of about 65 billion cubic feet per week from late March until late September. This year, stockpiles grew at about 40 billion cubic feet per week—down 38 percent from the seasonal norm. As a result, the volume of natural gas in storage stands just 163 billion cubic feet above the five-year seasonal average. If recent trends continue, the US market could enter the winter heating season with normal inventory levels.
These improvements have prompted hedge funds to shift their positioning in natural-gas futures traded on the New York Mercantile Exchange.
At the end of 2015, hedge funds had built up a sizable short position in natural-gas futures (bets on a decline in prices), while these institutional investors’ aggregate reported long positions shrank to an almost five-year low. These bets panned out, with natural-gas prices falling to an 18-year low in spring 2016.
However, the speculative landscape has shifted dramatically. Hedge funds’ aggregate reported short positions in natural-gas futures have plummeted to an almost six-year low, while their long bets have surged by roughly 70 percent since January 2016.
The bars at the bottom of the graph show the ratio of hedge funds’ gross long positions to their gross short positions; a higher ratio indicates that portfolio managers have bet heavily on an improvement in natural-gas prices.
Over the past six years, hedge funds bet more heavily on upside in natural-gas prices on only one occasion: early 2014, when the polar vortex fueled robust demand for heating and natural gas.
Hedge funds often bet correctly on the market’s short-term direction. However, a lopsided short or long position in natural gas often serves as a warning sign of a potential shift in the trend.
For example, on Feb. 18, 2014, hedge funds’ aggregate long positions in natural-gas futures stood at 2.44 times their short positions. Front-month gas prices closed the trading session at $5.55 per MMBtu that same day and peaked at $6.49 per MMBtu less than a week later.
Thereafter, natural-gas prices trended lower, tumbling to $4.22 per MMBtu by early April and ending 2014 at $2.89 per MMBtu.
In other words, the hefty aggregate long position served as a contrary signal that sentiment had become too bullish and that the risk-reward balance had shifted to the downside.
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Elliott and Roger on Jan. 30, 2020
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