Is It Time to Lock in Prices for Natural Gas?

May 2012

• While natural gas prices for nearer-terms have seen a recent rally, gas purchasers should exercise caution in making decisions based on these price movements.
• Although fundamentals and other price signals suggest an apparent near-term bottom for natural gas prices, this does not translate into an automatic and permanently sustained increase in prices.
• The decision to buy forward should be based on price risk considerations, and not on market timing considerations. The question is, "is there a risk of prices I cannot afford to pay?"

After several months of declining North American natural gas prices, this spring's rally in the markets has created discussion about the 'making of a bottom' in the market. At first glance, this may be worrisome to some gas purchasers who feel that they have missed a great buying opportunity. On the other hand, it's worth closely examining the rationale to buy and go beyond the headlines to see what has been happening.

The recent rally in prices has most strongly affected nearer term prices, especially the contract for next-month delivery. The fluctuations in this near-month contract are what is reported in the media and attracts attention, with articles speaking of a 40% price increase for natural gas since it settled at a 10-year low in the second half of April. However, for gas buyers who hedge their portfolios to establish stable prices to accommodate their tolerance for price risk, prices have not changed much during the rally and for later years, prices have fallen. This kind of movement suggests that market participants are not convinced that the bullishness for near-term prices is highly applicable to future prices.

The graph shows that while buying gas for delivery as far out as 2015 has become more expensive than in April, consumers interested in buying gas in May 2012 for delivery in 2016 or later would have paid less than if they had bought that gas earlier this year for delivery in 2016 or beyond. Indeed the price for gas to be delivered in 2018 has fallen from an average of $5/MMBtu in February to about $4.70/MMBtu in May. A consumer who might have bought gas at roughly $5/MMBtu in February for delivery in 2018 may experience buyer's remorse on seeing that the prevailing price for that delivery is now 7% lower.

For consumers considering buying gas for the 2013 calendar year, they face a large premium relative to 2012 with the price for delivery next year being nearly 30% higher than for 2012 delivery. Hedging natural gas now for 2013 fixes the price at that level and denies consumers the opportunity to acquire natural gas at a lower price if prices for 2013 fall later this year. High production levels are still forecast by the U.S. Department of Energy into 2013 and projections are that gas in storage will be at a new record-high of 4,096 Bcf by November 1, 2012, the start of the heating season. In addition, it is anticipated that the current price advantage enjoyed by natural gas for power generation relative to coal will fade as gas approaches $3/MMBtu. This means that as the near-month price of natural gas approaches or exceeds $3/MMBtu, demand for natural gas should fall thus limiting the upside for gas prices. In other words, it is hard to point to fundamentals that suggest gas should be worth 30% more in 2013 than it is trading for today. While natural gas prices for nearer-terms have seen a recent rally, gas purchasers should exercise caution in making decisions based on these price movements. Although fundamentals and other price signals suggest an apparent near-term bottom for natural gas prices, this does not translate into an automatic and permanently sustained increase in prices. Markets move in ebbs and flows.

For consumers, the decision to buy forward should be based on price risk considerations, and not on market timing considerations. The question is not, "is this the bottom?" The question is, "is there a risk of prices I cannot afford to pay?" Locking in prices eliminates the chance for a decrease as much as it eliminates the risk of an increase. It makes sense to give up that potential for lower prices only when the chance and consequence of a potential increase is considered unacceptably high.

Price Risk a Key Element in Balancing Natural Gas Supply  Read more »

High Natural Gas Production, Low Demand and Prices: The Interplay  Read more »