The super contango that has plagued the natural gas market during most of its decline this past spring and summer is showing signs of falling apart with this most recent rally. For those unfamiliar with the futures market, natural gas is traded in “contracts,” which is the obligation to purchase a certain quantity of a commodity at a specific date. Contract expirations are in months. So, for example, holders of a “November ’09” contract are obligated to take delivery at the expiration of that contract, usually in the final week of the month. The Front Month contract is the next futures contract to expire and is usually the most actively traded. The price of the Front Month contract is closely related to the Spot Price, or the price that is most frequently quoted on CNBC or Yahoo Finance or wherever.
Contango is the situation that arises when each successive month’s contract is progressively more expensive than the Front Month Contract. This has been the situation in the natural gas space most of the summer. At the beginning of September, for example, the Front Month Oct ’09s were trading near $3.00/MMBTU while the Nov ’09 contract was near $4.00 and the Dec ’09 contract near $5.00. This marked the most extreme contango I’ve seen in the market, with the contract 2 months out trading at a 60% premium to the front month.
Throughout the summer, each time the front month contract expired, the quoted spot price would spike perhaps 10% due to rollover and Contango. This was met with immediate selling on concerns of both supply and demand, sending both the spot price right back down, and dragging the forward month contracts down with it. This has put a dent in many an attempted rally. I have been saying all summer that I didn’t believe NG could rally until the Contango broke down.
Well, my friends, that date may have finally arrived. Over the past two days, the front month has rallied substantially compared to the November and December contracts. The price gap between Oct ’09 and Nov ’09 has fallen from nearly 35% gap to 25%. Today’s trading illustrates this breakdown:
Table 1: NG Session Overview (1:30 pm, 9/15)
| Contract | Last Price | Today’s Change | Today’s % Change |
| Oct 2009 | 3.55 | +0.25 | +7.5% |
| Nov 2009 | 4.44 | +0.11 | +2.5% |
| Dec 2009 | 5.04 | +0.05 | +1.00% |
| Jan 2009 | 5.30 | +0.03 | +0.57% |
| Feb 2009 | 5.34 | +0.02 | +0.03% |
.
Obviously, a substantial contango still exists, but I believe that this is the beginning of a move towards a more stable futures market. Looking back, the collapse of Backwardation (the opposite of Contango, i.e. the forward months are less expensive than the front month) marked the beginning of the breakdown in oil last summer. Once oil fell all the way to $30/Barrel, the Backwardation had turned into Contango. The collapse of this new Contango marked the beginning of the oil rally late last winter. Basically, the breakdown of extreme Contango/Backwardation conditions has historically resulted in a long-term price reversal. Obviously, there are many more forces at work that simply Contango, but I appreciate it as a broad indicator of the market.
I believe that this situation bodes well for natural gas heading into what promises to be a cold winter. I believe NG may pull back quite a bit in the next few weeks, especially as we approach peak storage, but am confident we have now reached the bottom. I do, however, expect the Contango to continue to narrow.
In terms of investing, I have no desire to directly buy UNG, as that fund is completely broken. GAZ, a similiar fund, is marginally more attractive, but would still advise staying away.
The Fly’s calls with FTK, HERO, and GMXR looks to be right on. I own a small quantity of FTK from about $1.90.
My big positions in energy have been Chesapeake (CHK) and Southwestern (SWN). I own CHK from $21.50 and am enjoying a 30% gain in the position since early July.
I plan to hold all three of these positions. For those looking to get into the market, I would consider waiting for a pullback.
The Tropics
Still all quiet on the Eastern/Southern Front here. The remnants of Hurricane Fred are still hanging together and there is a small chance it could regenerate once it encounters more favorable conditions in a day or two. Several models have been consistently forecasting development of a wave between Africa and the Leeward Islands by the weekend. It is too early to tell if said wave will recurve or enter the Caribbean.
Note I: With the hurricane season heating up, Dr. Cane is now on Twitter as DrCane09 since this is often a faster way to provide updates as things quickly change. FOLLOW ME for regular updates regarding the Tropics, Trading, and misc other weather stuff.
Note II: The Hurricane Naming Contest is on the homestretch with the season finale coinciding with the end of the MLB season September 30. Current leaders are shown below. Everybody needs to put on their rally caps and get into gear…
Rankings 9/15/09
|
Points |
Points Back | Days to Elimination | |
|
1. DPeezy |
16 |
– |
– |
|
2. Wabisabi |
11 |
5.0 |
10 |
|
3. TraderCaddy |
4 |
12.0 |
3 |
|
4. Yogi & Boo Boo |
3 |
13.0 |
2 |
|
4. BuffaloUdders |
3 |
13.0 |
2 |
|
6. Jim |
1 |
15.0 |
Playing For Pride |
GAS on the tsx is a NG etf to have a look at.
DrCane,
Thanks for all you do – terrific analysis every time.
Q: If I were, say, a manufacturer, looking to lock in my electricity for a few years,
should this narrowing contango in natty concern me? If so, I should be looking to lock
in within the next few weeks (assuming the narrowing pattern continues)?
Will,
NG prices beyond 6 months have remained relatively stable and are comparatively typical of the NG market through 2014 (cheaper during the summer, more expensive during the winter) and will likely be unaffected should Contango continue to break down. Those who will be affected will be producers (as opposed to the consumers who use NG for electricity). The Contango has made it a good business decision for producers to store NG rather than immediately sell it on the open market since they can get a better price in the future due to Contango. This has likely contributed to our supply glut. If the price spread continues to break down, look for producers to begin selling more of their product, rather than pumping into storage.
Bret?
Not Brett…(similar strength, but Brett was further west in south Texas)
Alicia?
Good guess, but its not Alicia. Satellite technology in the early 1980s could not get this sort of resolution…
BTW – Im out of this hunt. With only a few days to go I dont wan to take points away from those who might catch DPZ
Hurricane Claudette, 2003?
Nope, not Claudette. Claudette didn’t get this strong and was further west. Damn, this one’s tough…
hmmm….isn’t there only like 1 more Texas hurricane from the last ~15 years??
Three potentially relevant questions in answer to your question:
1) Who said anything about Texas?
2) Who said anything about it being a hurricane at landfall?
3) Who said anything about it being in the last ~15 years?
Rita?
No! Not Rita. Have changed my mind. It is Andrew.
Bingo. Andrew it is and Jimmy Hill picks up a point. Damn, I was getting somewhat enthused about carrying the storm over to my next post. Oh well. Nicely done. Despite its intimidating appearance on satellite, Andrew’s second US landfall was far more benign than its first three days earlier in south Florida, striking a very unpopulated area west of Morgan City, Louisiana as a 115 mph Category 3 storm. Andrew did about 200 million in damage to Louisiana, just a shadow of the $26 it did in South Florida.
What just happened? The near month Nov 09 future is a buck higher than the spot on the first day. This is a super sized contango. What can we expect for Nov 09 contracts through the month of October as storage fills and the spot price goes down?