Over the last two months, the prompt Henry Hub futures contract has advanced 56.07% from the October 2018 closing price of $3.021 to the December 2018 expiration price of $4.718 on November 28th.
The December 2018 last price of $4.718 is the highest settlement since April 2014, when the contract settled at $4.813 at the end of the Polar Vortex winter of 2014. The higher prices in 2014 went up in a reasonably orderly fashion, going up 43.44% from the July 2013 settlement price of $3.446 to the January 2014 settlement price of $4.943. This current move has really occurred in just four months, going up 67.08% from the August 2018 settlement of $2.822 to the December 2018 close of $4.718. While predicting any commodity price is impossible, we will examine the recent price action to see if we can gather any clues to future price action. For now, this natural gas rally has been mostly contained to the front end of the curve.
This makes sense in a commodity rally led by lack of supply. The low storage levels and cold weather really did create a supply-side panic. Some of the movement in the front end of the curve can also be attributed to speculation. A review of Chart 1 shows that the rolling 12-month Henry Hub Futures price spent the first 10-months of the year coiling up between $3.00 per MMBtu and $2.75 per MMBtu in a market that could only be termed boring. Prior to the sharp move up, open interest in the Henry Hub futures contracts was at its highest level ever recorded. This indicates that there was a bit of a tug of war between speculators who have been accustomed to selling the top end of trading ranges and large natural commercial buyers who perceived value even at close to the $3.00 per MMBtu level. When the market finally broke through the $3.25-$3.50 level, it caused many speculators to have to cover their short positions, which in turn caused a further cascade of buy orders. On November 14th, the front-month December 2018 Henry Hub futures contract traded to a high of $4.929 with an 87 cent range.
This type of volatility has not been seen since 2008 during the financial crisis.
It is important to recognize that while there was some slight spillover into the Calendar 2019 price curve (this was mostly because the January and February 2019 prices rose sharply), the rest of the natural gas complex did not really move that much (see Chart 2). This is important since most of our readers are commercial buyers who have obligations to secure natural gas for as long as they will be operating their businesses. It is also important because the backwardation may not remain as sharp as we go forward in time.
We do think what happens after November is somewhat weatherdependent. If we have an extremely cold winter going forward (not currently in the longer-term forecast) we could break $5.00 in the prompt month, and the rest of 2019 will probably move higher.
As risk managers, we need to assume normal weather over time and look at the entire curve, and we still see value in the further-dated curves (see Chart 3).
Currently, the spot price for Henry Hub is approximately $4.25 cents per MMBtu. When compared to the Henry Hub 2020 calendar price of $2.66 per MMBtu, it is a difference of $1.59 per MMBtu, which is a price advantage that must be recognized.
One of the characteristics of natural gas and electricity pricing is event risk (weather, loss of generating or pipeline infrastructure, regulatory, etc.), and the recent natural gas price move is an example of event risk. We would argue that the forward prices for 2021 and 2022 of $2.64 and $2.70 per MMBtu, respectively, do not reflect an inordinate amount of event risk premium, and commercial customers should lock in fixed prices for a significant amount of their forward natural gas requirements for these time frames. In some areas of the country, basis risk has increased, but the Chicago City Gate forward calendar prices for 2020, 2021, and 2022 of $2.59, $2.57, and $2.64 per MMBtu, respectively, are priced for perfection, and Chicago-based commercial customers should be looking for spots to lock in fixed prices for these tmi e frames.
Analyst – David Mousseau
Source – Reuters and CME GROUP