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Martin Tillier

Martin Tillier

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Don’t Trust The Bounce In Natural Gas

As I write on Friday, natural gas is having one of its best days for months and is trading well over six percent above yesterday’s close. That and the fact that yesterday also was a day of gains in gas futures makes it tempting to view this as the start of a long-awaited recovery in a commodity that has lost over half its value since the end of last year. That, however, would be a mistake.

Martin

The bounce that we have seen over the last few days also looks sustainable based on the chart. After hitting a low of 2.1590 a couple of weeks ago, nat gas looked like testing that level again before the last two days of gains, and the “higher low” pattern that has come from that is usually seen as a bullish sign. The problem is that technical analysis can only take you so far, and the fundamental conditions that have dragged natural gas down all this year are still there.

That is a systemic, chronic supply problem, while the cause of this jump is a temporary, supply related issue.

To really appreciate the nature of the problem, it is best to take a step back and look at the historical context. As you can see from the EIA chart below, U.S. natural gas marketed production has been increasing sharply since the middle of 2005.

Martin

There are two main reasons for that. Fracking has increased the accessibility of natural gas, and infrastructure improvements mean that more of it actually gets to market than was the case in the recent past. Yes, demand has also increased in a meaningful way as increasing numbers of power plants have turned to what is seen as a “clean” fossil fuel, but that growth driver has a natural limit, and the rate of demand increase is slowing down considerably.

Supply, on the other hand, keeps growing, in part because of a battle going on in oil. The OPEC+ cuts to oil production have resulted in a step up in U.S. shale production to fill the gap, and that means more natural gas as well. The infrastructure improvements mentioned above and the localized nature of the natural gas market with wide spreads between different countries have led to that increase having an outsized effect on prices.

That hasn’t changed. If anything, the extension to the oil production cuts announced after this week’s OPEC meeting has made it worse, making another nine months of imbalance in the domestic natural gas market look far more likely than it would otherwise have been.

The demand factor that is causing this pop, however, is much more short-lived in nature.

One of the biggest influences on natural gas prices is the weather. Periods of cold in the winter and heat in the summer both increase demand for the fuel, pushing prices up. That is the cause of this move too. The hot weather that has crept up the East coast is now more widespread and expected to last longer.

The resulting expectations for increased demand have pushed prices higher, and that has had the effect of squeezing out some short positions, exaggerating the move. There are, however, only so many shorts that can be squeezed, and, climate change notwithstanding, the weather is hardly known for its consistency and predictability. At some point, both things will fade away and when they do, we will be back to a market with a longstanding issue of oversupply that is, if anything, getting worse.

Momentum is often a wonderful thing, but in this case, don’t trust it. As Friday’s trading wore on, a top was formed in nat gas futures at 2.445, and using that as a basis for a short position in futures looks like a far better trade than following this short-term trend.



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