Buying Strategies for a Volatile Market
Compiled May 11, 2009
Market Overview:
Natural gas and electricity prices posted new multi-year lows last month but have reversed direction in early May and increased significantly, despite ongoing bearish fundamentals. May natural gas futures expired at $3.32, the lowest NYMEX contract settlement prices since September 2002 when they expired at $3.28. May futures fell $0.45 or 13 percent during the month while June futures rallied to $4.31 (up 33 percent) during the first eight days of May. The rally occurred as a result of changing sentiments on the state of the economy and aggressive commodity buying.
Although there are some signs of improvement, current supply and demand fundamentals have not changed. The natural gas storage surplus reached 34 percent, compared to levels from a year ago due to the ongoing supply-demand imbalance. At the current pace, there will be a storage glut by the end of the storage injection season, which could push spot prices significantly lower. Long-term prices however continue to reflect a more bullish market outlook—beyond the near-term—due to the expectation that the economy will eventually recover or that there could be a negative supply response to sustained low prices.
Electricity prices have followed the same trend as natural gas with very attractive prices for almost all terms and markets, in additional to current low day-ahead prices. After vacillating around $50, crude oil futures have surged to a 6-month high at $58.63. The rally is similar to natural gas, as inventory levels are high but expectations regarding future demand have improved.
Outlook
The current rally complicates any attempt to determine future market direction. When building your strategy, do not assume that prices have to go back down. The economy remains the primary market driver—this has not changed. Fundamentals seem bearish, but the sentiment regarding the eventual recovery of the economy has changed drastically over the last month and has encouraged a rally in prices.
A natural gas storage glut still seems likely and the prompt-month pricing could turn back toward $3.00 based on the current supply and demand imbalance, along with growing liquefied natural gas (LNG). Although forecasters are calling for a mild summer in regards to both heat and tropical activity, it is very risky to rely heavily on long-term weather forecasts. More bullish long-term fundamentals remain in place as a result of the improved outlook for the economy and the potential supply response.
The question still remains: Has the long-term market seen its low? And, there is no definitive answer—only speculation. Even if the recession continues, we do not expect 2010 prices to reach 2009 lows due to declining natural gas drilling activity. The most bullish scenario would be a simultaneous recovery by the economy and a decline in supply.
Fixed-price Customer Recommendations
Despite the recent rally in prices, our recommendation for fixed-price customers is mostly unchanged. Prices have maintained the bulk of the value gained over the last nine months and prices for the remainder of 2009, and as well as 2010, still present excellent value.
If a customer is unable to transact for 2010, lock in 2009 purchases through the end of the summer, at minimum, to protect against the risk of summer heat price spikes. For 2011, prices are higher, but the risk-reward balance is more balanced and there may be potential to fix long-term prices at attractive rates. If you wait, be sure to set a realistic price target.
Portfolio Customer Recommendation
Depending on the extent of protection that is already in place, some portfolio customers may want to take advantage of the product flexibility and hold off on their next purchase. Keep in mind though that a hedging strategy does not try to pick the bottom but rather it focuses on locking in value and managing risk.
If hedge levels are extremely low, recognize that there is still excellent value based on the extent of overall prices—which have been on the decline since July 2008—and based on analysis of forward curves over the last five years. We continue to recommend base hedge levels for 2009 and 2010.
Customers who are considering higher hedge levels, as well as hedges for 2011, should consider their own goals, risk tolerance and business constraints, in addition to market conditions. Customers should also balance the risk of further upside versus the possibility that the current rally could be reversed by a storage glut/enduring recession.
If purchases are deferred, establish specific target prices and deadlines based on recent market movements and customer-specific price targets (budget, previous year costs, etc.). In addition, consider market risks, including summer weather and hurricane season.
As always, consider your budget and/or year-on-year comparison and consult with your Portfolio Strategist regarding the appropriate strategy for you.
Bill - Hoffman Estates, IL - 05/24/09
Great information. Concise and to the point.Submit your comments about this article.
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