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Why Has Natural Gas Spiked 60% Since Labor Day?
By Dian L. chu, Economic Forecasts & Opinions
As reported by Zero Hedge on Thursday, September 10, 2009, natural gas was up by about 16% on no real change in the fundamentals of the commodity. By the end of the trading day, natural gas saw its biggest one-day gain of 15% in almost five years (Fig. 1). Natural gas price has spiked almost 60 % since Labor Day and prompted investors to believe a V-shape recovery might be near for the brutally battered U.S. natural gas market. However, don’t break out the champagne just yet until you learn more about two of the major factor driving this latest spike, Operation Flow Orders, the trader's perspective and the UNG factor .
| Fig. 1 |
| Chart Source: ZeroHedge.com |
Operation Flow Orders (OFOs)...What?
On the surface, the Thursday gain was sparked mainly by the Energy Department’s weekly data that showed a “smaller-than-forecast” increase in U.S. stockpiles. Though the news did not really change the overall supply and demand picture, it did send traders scrambling to buy back previously sold positions.
However, according to industry insiders, the "smaller-than-expected" increase in gas storage was largely due to what the pipeline industry called Operation Flow Orders (OFOs). Pipelines may issue OFOs in the event of high or low pipeline inventory. OFOs require shippers/producers to balance their gas supply with their customers' usage on a daily basis, within a specified tolerance band. Shippers may deliver additional supply or limit their supply in order to match customers’ usage. If the supply isn’t balanced, shippers may incur noncompliance charges.
In other words, when OFOs are issued in an oversupply environment like we are in right now, shippers/producers either comply, i.e., sending less gas to pipelines & storages, or pay a penalty. As most shippers logically chose to comply with the OFOs, the volume that normally goes to storage ended up overflowing to the spot market pressuring prices to around $1.84/mmbtu on the Friday just before Labor Day.
Storage facilities and pipelines typically raise their tolerance band after Labor Day to prepare for the higher winter usage season. So, the lift after Labor Day normalized the market and is a major contributing factor in the 60% rise of natural gas prices since Labor Day.
Although some producers already shut down production in response to the current OFOs, more production shut-in is expected as pipelines continue issuing new OFOs.
The Trader's Perspective
One alternative explanation, from a trader’s perspective, is that a large natural gas player saw the opportunity to make a huge profit by blowing out the stops of the large contingent of traders who were short the natgas market. For example, someone like John D. Arnold, the former Enron trader who is one of the large players in the natural gas market. To the point, the move in natural gas from $3.00 to $3.30 during late day trading on Thursday was strictly due to the pre-configured stop orders being hit.
Still a Very Short and Decoupled Market
Based on a Bloomberg report, although the number of shorts did decline 3.9% from a week earlier, speculative short positions still outnumbered long positions by 169,846 contracts on Nymex for the week ending September 1st, 2009, according to the Commodity Futures Trading Commission (CFTC). In a short market, things can get extremely volatile and completely decoupled from any fundamental or technical indications.
Crude oil and equities markets, which traditionally have a negative correlation, have moved in tandem for the most part of this year. The upward momentum has some investors chasing natural gas, which theoretically should have a fair amount of correlation with oil.
However, as discussed in Oil and Natural Gas: Ratio Explodes in 2009, natural gas tends to be regional, while crude is more globally driven. If we look at the price movement of crude oil, natural gas and the S&P 500 (SPX), it is evident natural gas has completely decoupled and gone off on its own downward spiral (Fig. 2). This suggests in general that commodity and equities markets will likely be irrelevant to natural gas in the near to medium term, given the fact that there is no fundamental U.S. demand.
Heading for a Sub-Zero Price Zone?
Despite the signals given by Thursday's spike, U.S. natural gas storage currently stands at 3.392 bcf, 17% higher year-over-year, and fastly approaching the maximum storage capacity of about 3,900 bcf. The September 2009 EIA Short-term Energy Outlook now expects another 12% build in working natural gas inventories reaching 3,840 Bcf at the end of the 2009 injection season, i.e., October 31st (Fig. 3).
So, there will likely be a painfully lower gas price on hand in the next 6 to 10 weeks or so until winter withdrawals begin. During this period, we could have a short and sharp collapse in the spot price in the sub $2.00 range.
A colder than usual winter season as currently forecasted by weather bugs is likely to boost natural gas prices higher; however, if this weather pattern fails to materialize leading to a max-out storage capacity, then we could be looking at a brief sub-zero price scenario similar to one the UK experienced in 2006.
Crystal Ball into 2010 & Beyond
Natural gas prices are down about 42% so far this year as demand has been sluggish during the economic downturn, while production from onshore gas fields has remained robust. The EIA now estimates that total domestic natural gas consumption will likely decline by 2.4% in 2009 and remain flat in 2010. As the economy starts to recover and production cuts kick in on a larger scale, natural gas prices should rebound averaging close to the $5.00-$6.00 range in 2010 and gradually ramp up from there. Investors and traders should brace themselves for quite possibly the darkest days in the next 2 month for the natural gas market in over a decade before the dawn finally breaks.
Dian L. Chu, Economic Forecasts & Opinions
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60%. Not sure where that number is coming from. If you are looking at different months for delivery then you are a moron. Also look at spot prices, they have rallied also and this is real product for delivery next day (went up 40% in a week). Anyone ever think that speculation pushed it down to 2.14 (U9) and that at least part of this move is an adjustment back to reality (not saying all, just it seems people like to say speculation on upside and never on downside). Again the last month each EIA number has been smaller build then expected and it has still fallen.
How about the price had been sinking for so long and so many days in a row that only a few % of traders were bullish? At that point, there was almost nobody left to sell. A slight change in sentiment caused a scramble, and there was no resistance for 75 cents upwards. This was a very simple trade for patient longs who waited until the trend was exhausting on very low sentiment readings -- no supply/demand mumbo jumbo required.
Finally, someone writing on ZeroHedge that actually understands that the fundamentals of Nat Gas are completely irrelevant.
The Nat Gas market can be traded just like any other market - there is no need to look for rationalizations after a large move.
LNG is irrelevant to US markets, now that shale has happened, North America is a potential exporter not importer
A big problem is amateurs who don't understand gas as a commodity, and certainly don't understand how all bets are off since the shale plays. Looking at charts and bands, and bells and whistles won't work. It's all about supply and demand and keeping the system in balance.
You do well to to explain about sub zero pricing, because thats an operational constraint you don't find in pork bellies. Think about, not only do you lose money going down, it doesn't even stop at zero! If more people knew about that possibility (and if we have a mild winter, it could be a certainty), they'd go and speculate in something safer for them and less dangerous to any one who pays a utility bill!
Iran is not a player in the LNG markets. Their supply does not count other than inside Iran mostly. The Qatari's are a big LNG supplier to Europe and a bit to Asia. They matter. Lately we have seen a lot of LNG spot supply on the markets due to the slowdown in Economies plus the added new supply from LNG Trains coming on-line. We are seeing natural gas spreads in Europe and Asia converging in price to the US due to this new spot supply.
What's all the fuss about? This was just a bounce, plain and simple. When even the dumbest of dumb money are talking about front-running UNGs roll as 'the easiest trade in the book' then you know it's time to take profits and play for a bounce.
Contango still in place, UNG still in trouble, storage still at capacity, production still cranking. I'm playing this as a standard dead-cat bounce and sticking with the trend.
that downdraft wed/thurs was too steep- started looking like that 'v-shaped bottom' recently made so famous.
bought thurs, sold thurs, made a quick scalp, then watched it keep going! oh well. like you said, made the commission back....
everyone's getting too glib about shorting natgas. it could go either way from here. long run, it could be a 'fuel of the future' being clean and domestically produced. if i were a conspiracy theorist i'd say it was run into the ground so the big boys can buy the next 50 years worth of production.
interesting, that bit about iran.
it'll fluctuate in the near term, but med and long-term the bias will be upward- after the big boys have had their fill. long-dated far OTM calls are gonna buy more than their usual share of luxury goods.
autumn is coming and obama hasn't announced his energy 'policy' yet, but i think it's reasonable to assume it's going to include some nat gas buses and fleet cars, 'clean and abandunt' gas-fired power plants, etc.
unless a (temporary) 2.5% reduction in demand + new shale production = free energy forever.
Yeah... the low tick is about 2.40 for the October contract and the high tick is about 3.42... Really, where did the 60% come from? Natural Gas Index?
Don't hate the rally, make up your own trade.
I do not understand where 60% spike come from.
$2.14 to $3.42 doesn't sound like much but it's 60%.
hope you enjoyed the rally
Maybe a better explanation is that nothing in the markets moves in a straight line and natgas was poised for viscious rally.
If you are a trader this should have been quite apparent for no other reason than it was moving straight down for an extended period of time.
Shit...just look at the stock market.
well, it is certainly a good analysis. However, how many times do these well design plans work out the way you planned? If the demand is low, will the Nat gas be free to everyone? If history ever teaches us anything, and if oil is 30 bucks, will Nat gas be 1? the ratio still 30 to 1? how can someone see Nat gas in 1 handle? is this the same kind of reasoning when average house on the block is 1 mil, and analysis shows 1.5 m? what the hell happened to buy low and sell high? can anyone take a look at historic price for Nat Gas and show me where it was 1?
good luck with the trade.
Lizzy
Interesting stuff. I can almost assure you he was not sending this higher on Thursday, at least initally. He may very well have been the icing on the cake towards close.
This article is interesting and exactly why we had no problem loading on new puts.
What about the number two supplier of natural gas?
Iran?
What would a supply disruption stemming from geopolitical tensions do to the regional pricing of natural gas?
Excellently written and documented like a true investor.
However, because of the dip that preceded this run up, the day trade chat rooms have been filled with pumpers for weeks leading up to this and only dupes are left to hold the bag when it corrects, while the herd moves on to the next best bollinger band.
You see volume but not the incremental trade amounts as "they" (an ever larger pack of day traders, heat-seekers and computerized algorithms) get in and out and in and out every time they can cover the commission while maintaining their core positions until the music ends and it's time to move on. C traded a billion+ shares for how long?
Talk about your up-tick rule!
"On a large enough scale any stock can get dumped/pumped."
From the rumors i heard JA was a massive seller of oct/nov puts until wednesday.
He got worked over in the spring and now it is pay back time.
He is one of the best nattie traders out there.
And fundamentally (for whatever that is worth these days) this market should have a $1 handle on it before this is all over.
From the rumors i heard JA was a massive seller of oct/nov puts until wednesday.
He got worked over in the spring and now it is pay back time.
He is one of the best nattie traders out there.
And fundamentally (for whatever that is worth these days) this market should have a $1 handle on it before this is all over.
Oct Jan
you mean ng at $1 something again? producers would simply cap the wells imo.
but with contango going up $2 in 2 months contracts forward, there's room for the shorts still. don't honestly believe that ng will trade at $5 in November, do you?
Nice article. I folllow the weekly nat gas inventory reports and last weeks report was inline with other reports. In fact in previous weeks where the build was much lower than the consensus nat gas still sold off. I've heard from a few sources that this was a pure short squeeze play. Nat gas fundamentals have not changed and is headed for some dark days ahead like you suggest. Most players are predicting prices will recover though next year so this will make a great investment once we do see the bottom.