Natural gas - Permanent recovery or barely short correction?

Summary:

• Natural gas prices are once again on the rise

• Weather forecasts indicating possible heat waves stand for recent surge

• Fundamentals are not necessarily the reason for solid gains

2020 is tough for societies and businesses due to obvious reasons. However, the pandemic does not influence weather factors and these are crucial not only for agricultural commodities, but also for energy commodities (American natural gas in particular). Natural gas is being used as power supply in most power plants in the U.S. Due to increased demand for electric energy (caused by common AC usage), demand for natural gas is on the rise as well. This factor is indeed the main reason for recent natural gas price surge. 

Another dimension is the recovery of the demand for LNG, even though the nominal demand is still rather minor and many deliveries from the U.S. are being cancelled. According to EIA’s data, 46 deliveries were cancelled in June, in July the number stood at 50. So far clients have decided to cancel 46 deliveries in August and 30 deliveries in September. As one can notice, even increased demand associated with AC usage does not recoup subdued industrial activity in the United States and lower exports. 

The forward curve analysis is also worth mentioning. As noted at the beginning, natural gas is heavily connected with seasonality and currently one can notice this seasonality on the chart. The September’s contract is seen slightly below 2.4 USD MMBTU while October’s contract fluctuates around 2.5 USD MMBTU. Still, the further contango tends to rise even more. In November it amounts to 2.80 USD while the January’s one reaches 3.2 USD. Therefore, investors looking for long-term profits (for instance until November) would need to see the price above 2.80 USD. 

The forward curve looks pretty steep. Strong contango might prevent further rally. Source: Bloomberg

Moreover, fundamentals related to inventories do not seem favorable in terms of further price recovery (at least middle-term one). Total inventories have already exceeded the highest point in the last 5 year-period. Apart from that, drilling activity in the U.S. tends to recover, which also leads to increased production. Inventories change alone is positive as well and we might look for some changes in the heating season (prices are most volatile since late-September when seasonal inventories start declining as well). 

Total inventories have exceeded the highest point in the last 5 year-period. Moreover, inventories build-up period continues. Source: Bloomberg

In our view natural gas markets deal with speculative moves these days. In fact, one can notice positioning change too - there are significantly less short positions. Nevertheless net positioning has been approaching crucial point. It might turn out that one day natural gas will become too overbought and markets will be forced to deal with rapid declines after rollovers. 

Positioning supports recent gains, but it is slowly approaching dangerously high levels. Source: Bloomberg

The seasonality index shows that gains are still ahead of us. The highest volatility starts in late-September. Current market conditions are abnormal though. Therefore, we believe that the correction might start before the heating season. Source: xStation5