Natural Gas Is Trading Around The $3 Pivot Point

In March 2016, the price of active month natural gas futures that trade on the New York Mercantile Exchange dropped to the lowest level since the late 1990s at $1.6110 per MMBtu. The market took the price down to close to the bottom end of its trading range that has been in place since 1990 when the NYMEX introduced futures contracts on the energy commodity. Over the past twenty-seven years, natural gas futures have traded between $1.02 and $15.65 per MMBtu.

The March 2016 lows were the result of massive discoveries of reserves of natural gas in the Marcellus and Utica shale regions of the United States. Technological advances in fracking caused a decline in production cost, and the price fell like a stone. At the same time, the price of another energy commodity, crude oil, declined to its lowest level since 2003 when nearby NYMEX oil futures hit $26.05 per barrel just one month before natural gas found its nadir. While increasing supplies of natural gas weighed on its price, new demand verticals caused a recovery in the months that followed. The demand for natural gas powered electricity generation grew as the energy commodity replaced coal in many power plants around the United States.

Moreover, liquefication of natural gas has caused an emerging export market for the commodity that previously was only able to travel domestically and to bordering countries by pipeline. These days, natural gas can travel around the world in liquid form by ocean vessels. By the final days of 2016, the price of natural gas had more than doubled compared to the March lows.

Lower highs since December 2016

In March 2016, it looked like the price of natural gas could fall to a new all-time low below $1.02 per MMBtu under the weight of large reserves in the United States. Source: CQG

At the end of the 2016 winter season, the price turned around rallying from $1.611 to highs of $3.994 by the end of the year. Natural gas has a long history of volatile price action, and the price moved almost 148% higher over a nine month period. Meanwhile, as the weekly chart highlights, the most recent high at $3.994 came at the beginning of the winter season which is the time of the year where demand tends to peak. Since then, the price of natural gas has moved to the downside.

The 2017 low came in February

A warm winter in 2016/2017 caused the price of the energy commodity to make lower highs and lower lows since last December, and natural gas fell to a low of $2.522 per MMBtu in February 2017 which has so far stood as the low for the year. The weekly chart shows that the price has made higher lows since last December, but the price is currently stuck in a range from $2.753 to $3.114 since early June on the active month September futures contract. Natural gas has been consolidating and has not challenged either the December 2016 highs or the February 2017 lows.

The inventory trickle continues

Each Thursday at 10:30 a.m. ET, the Energy Information Administration releases inventory data for natural gas as of the end of the previous week. The price of the energy commodity typically moves after the release of the weekly data.

In the world of natural gas, inventories tend to fall during the season of peak demand from November through March and rise from March through November. Since the winter is the warming season, each year natural gas producers typically stock up to satisfy demand requirements during the cold winter months. Over the course of the current injection season in natural gas, the energy commodity has not been flowing into storage at the rate seen over recent years for two reasons. First, the price at under $3 per MMBtu is not attractive for producers. Second, the two new demand verticals, LNG, and natural gas fired electricity production, have caused more demand for the energy commodity during what has historically been low usage months.

On Thursday, Aug. 24, the EIA told markets that inventories rose by 43 billion cubic feet for the week ending on Aug. 18, 2017. Total stocks now stand at 3.125 trillion cubic feet which is 6.7% below last year’s level at this time of the year and just 1.5% above the five-year average. The comparison to the five-year average has been falling steadily and in a few weeks, it is likely that there will be less gas in storage than the five-year average if the current trend continues.

Meanwhile, in 2015 the total amount of gas in storage going into the winter season rose to an all-time high of over four trillion cubic feet for the first time. In 2016, stocks rose to a new marginal high at 4.047 tcf. This year, it is starting to look like the four tcf level will be a wall too high to climb for the energy commodity. With twelve weeks left in the 2017 injection season, the average weekly injection will have to be 76.9 bcf to reach a new record high. To reach the four tcf mark for the third consecutive year, the average weekly build in stocks will have to be 73 bcf.

Both of these average levels seem unlikely given the fact that natural gas has been trickling into stockpiles over recent months. In 2013, stocks went into the 2014 winter season at 3.834 tcf, and a cold spell caused the price of the energy commodity to rise to just under $6.50 per MMBtu. To surpass the 2013 level, the average weekly increase in stocks will need to exceed 60 bcf for the next twelve weeks, which is a level we have not seen much this injection season.

Inventories have been trickling into storage since last March, and if the winter of 2017/2018 turns out to be colder than average, low stock levels could cause lots of upside price action in the natural gas futures market.

The weekly chart looks very bullish

The price of natural gas has been consolidating since March and has been trading around the $3 pivot point on the nearby NYMEX futures contract. Source: CQG

As the weekly chart shows, while the price had been making lower highs since last December, open interest has declined over recent months. In early May, the technical metric reached an all-time high at 1.574 million contracts, but it has declined to 1.304 million recently, a fall of 17.2%. Falling price and falling open interest does not typically provide technical support for a bearish price trend in a futures market. At the same time, the consolidation around the $3 per MMBtu level has caused the momentum indicator to cross to the upside in oversold territory which is a sign that the market could be building a base from which it will move higher, perhaps much higher, in coming months.

Finally, monthly historical volatility at 32.4% is low for the energy commodity with a penchant for combustible price variance. The current level of historical volatility makes option prices reasonable when it comes to positioning on the long or short side of the market for the coming winter months.

Look to build longs on price weakness this fall

I believe that the technical and fundamental state of the natural gas market presently supports building long positions on price weakness as the winter season comes closer each week. With natural gas trickling into inventories compared with past years, the price trading in a range around the $3 per MMBtu level, and the uncertainty of weather and demand for the energy commodity over the winter months, it will not be long before the energy commodity breaks out one way or the other.

I think the downside in natural gas is limited to the bottom end of the current trading range, but the upside is potentially explosive. I expect that we will see the price of natural gas surpass the December 2016 highs and a price above the $4 level before the snows of the winter of 2018 melt. Natural gas is trading around the $3 pivot point, but chances are rising that a significant move to the upside could be in the cards for the energy commodity.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.

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