HOW MUCH IS ENOUGH?
Prepared by
The Kansas City Board Of Trade
For many of us, winter conjures up images of cold weather, snow, sledding and holidays. But in the natural gas market, winter often brings a different picture to mind–the picture of volatility.
And this winter is no exception. By early November the market already had one runup under its belt, and observers say that a wide range of prices is possible during the season given the various fundamental factors coming into play. This issue of MarketWatch examines those factors and how Kansas City Board of Trade Western Natural Gas futures and options might be used to deal with them.
One factor affecting the psychology of this winter's market is storage. Last winter, observers say, many natural gas suppliers were initially inclined to hold on to storage and turn to the spot market, fearful that tapping into storage too early would leave them without adequate supplies if prolonged cold spells developed. This strategy may have come about in response to the winter of 1995, when some suppliers were forced into the spot market and a significant price runup occurred.
A similar approach of holding on to storage early may have been at least partially a cause of a price spike this October, but whether that approach will continue to be taken further into the winter is unknown.
Jacquie Mitchell, vice president, KN Trading, said in early November that prices were being supported by storage. While storage levels were ahead of a year ago they were behind the three-year average, raising some concern. “Prices are where they are now largely because of storage,” Mitchell said. But Sam Weaver, manager of natural gas trading for GSC Energy, noted that for the moment, storage appeared to be adequate.
“You hear those fears (about storage),” Weaver said. “But the reality is there is plenty of gas out there for now. The question is, is there enough if we have a much colder-than-expected winter?”
And as always, winter weather will be another important factor for the market.
The El Nino Influence
When talking about the weather outlook for this winter, El Nino has received a great deal of press as a dominant influence.
–But what is disputed is just how El Nino will impact weather in the U.S., and in turn the natural gas market.
El Nino is “an abnormal warming of ocean temperatures across the eastern tropical Pacific that brings important consequences for weather around the globe,” according to the National Weather Service. The current El Nino event is being called one of the strongest on record.
Typically, the NWS says, an El Nino brings wetter, cooler weather to the southern half of the United States from November through March, while the northern part of the country from Washington east to the Great Lakes experiences warmer-than-normal temperatures.
But some forecasters note that El Nino does not always result in such a wintertime pattern. On occasion, El Nino has brought brutally cold temperatures to parts of the U.S. And uncertainty over exactly what this El Nino will bring means an uncertain outlook for the gas market.
Production Questions
Production is yet another uncertainty heading into the winter.
“Supplies right now don't appear to be as prolific as was earlier thought,” KN's Mitchell said in early November.
Delays in the startup of some deepwater production in the Gulf of Mexico, combined with a decline in some conventional Gulf production, meant that supplies were not meeting previous expectations. And it is unclear just how rapidly increases in deepwater production will come online.
Combined with varying ideas on storage and the weather, the production uncertainties are yet another factor that could contribute to volatility in the natural gas market this winter.
Many Ways To Trade
Kansas City Board of Trade Western Natural Gas futures and options can be used by natural gas suppliers and end users to hedge against price changes in this potentially volatile market, and also can be utilized by speculators in an effort to capitalize on the price changes.
Investors expecting prices to fall can sell a KCBT futures contract, while those expecting prices to rise can buy.
Trading strategies also can involve intermarket spreads. KCBT Western Natural Gas futures have a delivery point in west Texas and strong correlations to western markets. Henry Hub natural gas futures traded on the New York Mercantile Exchange, meanwhile, correlate well with many eastern markets. Consequently, an investor expecting a change in the relationship between western and eastern U.S. prices could execute a KCBT/NYMEX natural gas spread trade. Differing weather patterns, as well as differing supply situations, can change the price relationship between the two regions.
For example, analysts say, this winter a “classic” El Nino in which the southern U.S. is cool while the northern U.S. is mild might tend to compress the east/west basis, bringing KCBT prices closer to NYMEX prices as opposed to the scenario in early November, which had NYMEX trading around a 30-cent premium. On the other hand, an extremely cold winter in the eastern U.S. could widen the basis further.
In December of 1995 a combination of weather factors and transportation logistics widened the east/west basis dramatically, with eastern prices gaining substantially on the west. The incident has been dubbed the “basis blowout” by the industry, and many caution that such an event could occur again under certain conditions.
Intra-market spreads are another option for trade. An investor expecting changes in the price relationship between winter and early spring gas prices, for example, might trade a KCBT January/March spread.
Again, El Nino could have an impact on this strategy. If a typical El Nino winter pattern sets up in the U.S., it could put downward pressure on prices for late winter and early spring contract months in comparison with early and mid-winter months, observers say.
The KCBT also offers options on Western Natural Gas futures, giving investors yet another vehicle for trade. Natural gas suppliers and end users can use KCBT futures and options to help protect their business against the volatility in natural gas prices, establishing a price for their production or consumption in advance of actually selling or purchasing the physical commodity.
As with any investment, investors should investigate the risk and appropriateness of trading futures and options before entering into a transaction.
Weather Sidebar
The winter natural gas market is often weather-driven. This year, much attention has been given to El Nino and its potential impact on conditions in the U.S. and worldwide. As a result, the gas industry also has been studying the climate phenomenon. But there is little definitive agreement on just what impact El Nino will have on U.S. weather this winter.
Following are forecasts from selected weather services as of mid-November:
The Weather Center Co. Inc.
The winter will feature a split flow jet stream, which does seem to have a tendency to occur in El Nino years but also occurs in non-El Nino years, according to Jeff Penner of The Weather Center Co. Inc., Gladstone, Missouri. Precipitation will be above average from California eastward across the southern third of the United States. Below-average precipitation will be found from the Pacific Northwest eastward through the northern Rockies and Northern Great Plains.
Above-average temperatures will be confined to the Pacific Northwest, Penner said, with average temperatures prevailing over most of the U.S. Temperatures may be slightly above average along the East Coast, including the big northeastern cities. The most likely area for below-average temperatures will be in the southern tier of states, while the western Great Lakes and upper Midwest may also have an area of below-average temperatures.
Bridge Global Weather Services
A traditional El NiNo pattern seems to be setting up for the U.S. this winter, said Drew Lerner with Bridge Global Weather Services, Overland Park, Kansas.
For the December through March time frame, this means warmer-than-normal temperatures for the Northern Great Plains and the Pacific Northwest, and a few areas experiencing cooler-than-normal conditions including the Great Lakes. The southern U.S. from California through Texas should experience above-normal precipitation, while Florida also may be warmer than normal.
Freese-Notis Weather Inc.
In mid-November, it still was difficult to gauge exactly what impact El Nino would have on the United States, according to Harvey Freese with Freese-Notis Weather Inc., Des Moines, Iowa. At that time, not all the worldwide phenomenon typically associated with an El Nino had occurred, he said.
Regardless, Freese-Notis in its initial winter forecast in TradeWinds newsletter was calling for the U.S. as a whole to have a normal to warmer-than-normal winter. Of the 22 El Nino years since 1900, the service said, 11 were warmer-than-normal and another five were less than one degree below normal. Based on its fall and winter outlooks, the service said, the best chances for higher natural gas prices would come in the fall, with the wintertime featuring lower trending markets.
National Weather Service
Most of the northern U.S. will be warm and dry from December through February, according to a National Weather Service outlook issued November 13. Temperatures will be above normal from the Pacific Northwest through the Dakotas, Nebraska and northern Kansas into New England, as well as California. Much of the remainder of the country has equal chances of near-, above- and below-normal temperatures.
Precipitation will be above normal in most of the southwestern U.S., as well as the central and southern Plains.
Weather Derivatives
On a population-weighted basis, the U.S. will have temperatures near to slightly-below normal this winter, said David Salmon of Weather Derivatives, Belton, Missouri.
While geographically there may be significant areas in the north that experience above-normal temperatures, they are less populated areas. The northeast will see near-normal temperatures, while the mid-Atlantic and southern U.S. will have below-normal temperatures in February and March. California is a close call, as the state may have above-normal temperatures but the storminess that sometimes comes with El Nino there could offset the temperatures in terms of heating demand.
Earth Satellite Corporation
Matt Rogers with Earth Satellite Corporation, Rockville, Maryland, expects an El Nino pattern to take more hold of the nation later in December. This will translate into warmer weather for the northern half of the U.S. and seasonal to cool and wet conditions for the south from January through March.
Earth Satellite Corporation (copyright © 1997)
6011 Executive Blvd., Rockville, MD 20852
Phone 301-231-0660 Fax 301-231-5246/5020
November 18, 1997 Kansas City Board Of Trade
4800 Main Street, Suite 303, kansas City, Missouri
Added to the WWW 11-21-97
Last updated on 11-21-97
Hosted by:
One Crossroads Place
610 West Maple Ave, Suite WWW
Independence, MO 64050
(816) 252-4080
sysop@kcmo.com
