How Low Can Natural Gas Go?
Fundamentals
If one were to look up a textbook definition of a bear market, this year's natural gas market would be it. Yesterday, lead month Natural Gas futures fell to lows not seen since March of 2002, as the EIA weekly storage report showed 65 billion cubic feet (bcf) of gas was placed into storage last week. Although this figure was in-line with expectations and well below the 95 bcf injected into storage this time last year, traders continued to focus on weak industrial demand as well as burdensome supplies. Including last week's build, U.S. supplies of Gas in storage now total 3.323 trillion cubic feet (tcf), which is 18% above the 5-year average. It was a perfect storm for gas bulls this year, with industrial demand expected to be down just over 8.5% this year and summer cooling demand which never really materialized due to relatively cool summer weather in the Midwest and on the east coast. The market psychology is so bearish that traders have not been able to build a "weather premium" into prices, despite entering the peak Atlantic hurricane season during the month of September. Should the storm season spare the Gas infrastructure in the Gulf of Mexico this year, it is possible we may see a record amount of Gas in storage going into the winter. November 1st is considered the "official" start of the heating season in the U.S., in which energy producers begin to draw Gas out of storing to meet heating demand. Some traders believe we may reach maximum storage capacity of just under 3.9 tcf before this occurs. The previous record was 3.545 tcf of gas in storage in 2007. Large speculators are holding a large net short position in Natural Gas futures according to the most recent Commitment of Traders report (COT). According to the COT, large non-commercial traders were net short 89,239 contracts as of August 25th. Small speculative traders were net long 49,161 contracts. This information really highlights the trading styles of large and small speculators, as large speculators have historically been trend followers who will add to wining trades as the market moves in their direction. Small speculators like to try to pick tops and bottoms in a market, which is a difficult task for those lacking the funds to hold a position in the midst of a strong trending market.
Trading Ideas
Given the current weak fundamentals in the Natural Gas market as well as the upcoming rolling of long positions by the widely popular Natural Gas ETF the United States Natural Gas fund (UNG), which are expected to start on September 14th, some traders may wish to investigate bear spreads in Natural Gas futures. An example of such a trade would be buying November Natural Gas and selling October Natural Gas. As of this writing, November Gas is trading at a 1.130 premium to the October futures. A trader who chooses to hold a bear spread would want to see the November premium increase. Though the exchanges usually have a lower margin requirement for intra-commodity spreads, this trade is not without risk. Any production disruption in the Gulf of Mexico due to hurricanes or tropical storm threats could cause the front month futures to gain sharply on the deferred months. Additionally, the large short position by large speculators could cause sharp run-in prices should the market's fundamentals change dramatically as these large traders possibly attempt to exit the market all at once. As always, traders should closely monitor their positions
Technicals
Looking at the daily chart for October Natural Gas, we notice prices accelerated to the downside once the July 13th low of 3.584 was taken out. This was the bottom of a two-month long consolidation pattern that gave way in the direction of the major trend. The 14-day RSI is currently reading an extremely oversold 18.24, but has not yet shown any signs of reversing. 2.250 is seen as the next psychological support point for the October futures, with the 20-day moving average, currently near the 3.325 area, acting as resistance.
Mike Zarembski, Senior Commodity Analyst
