Big chill heats up natural gas futures
01/04/18

Crude oil usually gets most of the press (especially when it's hitting levels it hasn’t seen in more than two years), but another energy market has been on the move recently, and this one rallied four times as much as crude oil on a percentage basis between December 26 and January 2.

If you live in the Midwest or Northeast and you ventured outside during the holidays, you probably wouldn’t be too surprised to find out the US set a record on Monday for the amount of natural gas it burned—surpassing the former peak usage during the 2014 “polar vortex.”1 Baby, it’s cold outside. (West Coast, don’t be smug.)

Now look at the following chart, which shows February natural gas futures (NGG8) jumped approximately 15% from December 26 to January 2—which just so happens to correspond with the worst part of a deep freeze that walloped much of the country. Seems like a pretty simple formula: Cold weather = increased natural gas consumption = higher natural gas prices. Supply and demand at work.

February natural gas (NGG8), 12/14/17 – 1/3/2018

Source: OptionsHouse

And with more nasty weather predicted in the near future ("bomb cyclone," anyone?)2 and severe cold in the upper plains actually hampering some natural gas production, the stage seems set for an extension of the natural gas futures upswing.3

But how could anything in the markets be that simple—especially when you toss in something as unpredictable as the weather?

That last bar on the February natural gas chart—yesterday’s drop of more than 2% intraday—offers some insight into the ways of the natural gas market. The following chart, which shows the past 10 years of spot natural gas prices, offers even more. It’s clear that natural gas has not—a few isolated spikes and the modest 2012-2013 rally aside—made a habit of mounting sustained uptrends.

Spot natural gas, 12/31/07 – 1/3/2018

Source: U.S. Energy Information Administration (data)

Now let’s get back to the recent rally and yesterday’s drop. Through Tuesday, February natural gas futures had put together a string of four consecutive higher closes, with the last day also being the highest high of the past 15 (or more) trading days. That’s only happened 66 other times since 2006 in natural gas, and here’s a snapshot of what happened after that:

●In 60% percent of the cases the market closed lower the next day (as was the case yesterday).

●After the 43 times the market closed lower the next day, natural gas tended to move sideways to lower over the next five trading days, with the odds of an up day below 50% for the next three days (and below 33% on the third day).

Source: OptionsHouse

The chart above shows February natural gas futures set a contract low in mid-December, so there is arguably a lot of room to the upside. And yes, cold weather can sometimes trigger surges in natural gas prices, but such moves can be hard to sustain; sharp up moves can give way to equally sharp down moves in some cases. An extended colder-than-average winter might feed a longer-term up move, but without help from the weather, the market’s long-term downward bias could reassert itself.

 

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1 Bloomberg.com. The U.S. Just Burned the Most Natural Gas Ever. 1/2/18.

2 CNN.com. Winter 'bomb cyclone' threatens East Coast, bringing temps colder than Mars. 1/3/18.

3 Reuters. Cold chills U.S. shale gas production as heating demand jumps. 1/2/18.