NatGas emerging from hibernation

The US natural gas future (NGZ8) is about to finish a quarter that yielded the lowest trading range since Q2 of 1995. In percentage terms, the $0.407/therm range was the lowest since 1990 when the contract was launched. During this time we have seen record production off-set by rising exports and consumption. 

This week, natural gas broke back above $3/therm after once again finding strong support below. A weekly close above $3.053 could signal some additional demand from momentum traders looking for an extension towards $3.50/therm. 

As we approach the winter months one piece of data has begun to show support. During the summer months between April and October, natural gas is being injected into underground storage facilities only to be extracted during the winter months when the need for heating raises demand from utilities, especially across the US Northeast. The current supply-demand balance is therefore used to estimate whether enough gas will be injected into storage by the end of October to meet winter demand or withdrawn from storage by the end of April to meet storage restrictions during the build-up phase.

On Thursdays, the US Energy Information Administration publishes its Weekly Natural Gas Storage Report which shows the amount of gas that goes in and out of storage. What we have seen during the past few months are lower than normal injections into storage, as consumption and exports have stayed strong relative to production.

As of last week, following another lower than expected injection, the total amount of gas in storage reached 2,768 billion cubic feet (Bcf) which is some 18.3% below the five-year average of 3389 bcf. With time running out to replenish stocks before November, we could see a market increasingly being left exposed should the US winter prove to be colder than expected.

From having been a horrendously expensive investment for passive long investors for years due to the structure of the futures curve, there are now emerging signs that a change is on the way, not least due to the ever-increasing amount of Liquified Natural Gas exports. The emerging tightness has seen the one year futures spread (1st minus 13th futures contract) move into a solid backwardation of 10% compared to a contango which at it worst point back in 2015 went above 50%.

In other words, an investor back then would need a 50% return on a one-year horizon before making any money.

Short to long-term weather forecasts hold a major sway on the market given the limited amount of time left to see an acceleration in storage injections. While high oil prices may provide natural gas some tailwinds, it also must be remembered that high prices attract higher shale oil production, thereby supporting a continued increase in natural gas given that some US natural gas is produced as a byproduct from shale oil.