Hedging Against Falling Natural Gas Prices using Natural Gas Futures

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Contents

The Cool Spread: Hedging Natural Gas – LNG Price Movements

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Natural Gas (NG) Forecast, Page 1

US Stock Market Overview – Stocks Close Lower, Experiencing a Roller Coaster Session

Home prices dipped in March

Natural Gas Price Prediction – Prices Surge on Cold Weather Forecast

Prices are still undervalued

Natural Gas Price Forecast – Natural Gas Continues to Rally But on Borrowed Time

Natural gas markets gapped higher to kick off the trading session on Tuesday to reach towards the 50 day EMA midday. However, we are starting to see a little bit of a pullback at this technical level.

Natural Gas Price Fundamental Daily Forecast – Rally Fueled by Colder Weather Forecasts, Lower Production

After showing signs of the presence of buyers late last week, prices jumped on Monday as the latest weather models became even more supportive by pushing the 15-day forecast period to the cold side of normal, according to Bespoke Weather Services.

Is Natural Gas Ready For An April Rally?

Our research team believes April and May 2020 could be very exciting for Natural Gas.

Natural Gas Price Prediction – Prices Rise on Cold Weather Forecast

Prices surged as hedge funds cover

Natural Gas Price Forecast – Natural Gas Markets Gap Higher To Kick Off The Week

Natural gas markets have gapped higher to kick off the trading week on Monday, as the oversold condition has seen a little bit of relief. Perhaps the slightly shrinking coronavirus numbers have people thinking that there could be more demand.

Natural Gas Price Fundamental Weekly Forecast – Supported by Possible Oil Deal, but Demand Remains Key Worry

It is possible that cheap prices, cooler weather and a possible bottom in crude oil are providing support for natural gas, but until the new case coronavirus curve begins to flatten, demand destruction will continue to keep a lid on prices.

Natural Gas Price Prediction – Prices Rise as Rig Count Declines

Prices rebound as rig count declines

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Natural Gas Weekly Price Forecast – Natural Gas Markets Somehow Look Even Worse

Natural gas markets were a bit choppy during the week, but as you can see, we have formed a candlestick that looks a lot like an inverted hammer. The next question is will we break the bottom or the top of this candle?

Natural Gas Price Forecast – Natural Gas Markets Test Previous Support

Natural gas markets bounce a bit during the trading session on Friday, reaching towards the $1.60 level, which is an area that markets had used as support recently.

End Of Week Technical Take on Indexes, Metals, Currencies, Oil: April 3, 2020

See what to expect today and next week as we have some huge moves about to start up again.

Natural Gas Price Fundamental Daily Forecast – Oil Price War Truce Could Trigger Short-Covering Rally

Yesterday’s EIA report indicates a lot of demand destruction. The price action suggests perhaps short-sellers had overdone it on the downside.

Natural Gas Price Prediction – Prices Drop Following EIA Inventory Report

Inventories declined by 19 Bcf

Natural Gas Price Forecast – Natural Gas Markets Break Major Support

Natural gas markets initially tried to rally during the trading session on Thursday but then broke down below the $1.60 level, an area that had been so supportive recently.

Natural Gas Price Fundamental Daily Forecast – Bearish EIA Miss Could Trigger Another Steep Plunge

Estimates ahead of the EIA report have ranged widely from a withdrawal as small as 16 Bcf to as large as 31 Bcf.

Natural Gas Price Prediction – Prices Fall Ahead of Inventory Report

Expectations are for a 4 Bcf fall

Natural Gas Price Forecast – Natural Gas Markets Fall to Test the Low

Natural gas markets initially tried to rally a bit during the trading session on Wednesday but have rolled over to reach towards the $1.60 level yet again. Looking at this chart, it’s obvious that natural gas simply can’t get off the floor.

Natural Gas Price Fundamental Daily Forecast – Mild Weather, Virus-Related Demand Destruction Capping Gains

NGI said on Tuesday as the coronavirus pandemic hangs over the global economy, natural gas traders had to factor in potentially major impacts to both supply and demand.

Hedging Natural Gas Prices

    Randolph Grant 4 years ago Views:

2 The residential and commercial groups have fairly stable baseload demands and large, variable heating demands. This heating demand is the main force that drives the natural gas market during the winter; approximately 43% of the natural gas consumed throughout the year is actually used in the four-month period of December through March. Over the short term, residential and commercial heating demand is weathersensitive, varying primarily in response to the severity of the winter temperatures. Many manufacturers consume natural gas, both as a feedstock and as a fuel for their manufacturing process. Generally, there is no other fuel that can be used for these purposes, or else the potential substitutes are costly, so this portion of industrial demand is not sensitive to residual fuel oil prices. However, both processing demand and boiler fuel demand are sensitive to changing levels of industrial activity especially in the glass, food, paper, chemical, petroleum refining, primary metals, fabricated metals, and machinery industries. For most electric utilities, air conditioning use is the major variable in market demand for electricity, and more and more power producers depend upon gas to meet peak demand. Since electricity demand peaks in the summer in most of the country, consumption of gas by electric power producers is counter-seasonal, helping to some extent to smooth out the highly seasonal demand pattern set by residential and commercial heating users. La Plata County and Natural Gas La Plata County sits on one of the largest natural gas reserves in the country. As such, the natural gas industry in La Plata County provides a substantial amount of tax revenue, providing the local community with many amenities that would not be possible otherwise (Walker and Sonora, 2005). Consider that: Direct spending by the natural gas industry in La Plata County for the year 2003 was approximately $215.7 million. Each dollar spent by the natural gas industry in La Plata County generates approximately $1.43 in additional sales (or output), or an additional $308.4 million dollars spent on productivity in La Plata County in This represents over 22% of the total personal income (or output) of La Plata County. Direct earnings spent in La Plata County increased by $42.6 million in 2003 because of natural gas operations. Total household earnings that can be attributed to the natural gas industry in La Plata County in 2003 equaled $78.5 million. Direct employment by the natural gas industry in 2003 was about 305 jobs which generates an additional 623 related jobs in La Plata County. This is approximately 4.2% of the total employment in the County. In 2003 the natural gas industry paid average salary was approximately $84,000, as compared with the average annual wage in La Plata County in 2003 of over $28,000. In 2003/2004 the natural gas industry accounted for about 48%/62% of all La Plata tax revenues, if natural gas prices continue, this share should grow. The natural gas industry generated an additional $6.2 million in sales tax revenue for La Plata County in 2003 or about 62% of the total sales tax revenue.

3 Hedging Natural Gas Derivatives are financial instruments that ‘derive’ their value from an underlying asset; in this case the price of natural gas. Derivatives can range from being quite simple, to being exceedingly complex. Basic types of derivatives include futures, options, and financial swaps. Natural gas futures are traded on the New York Mercantile Exchange (NYMEX) in units of 10,000 million British thermal units (mmbtu) up to 36 months in advance. Consider the plot of natural gas prices since 1998 below. Prices have been as low as $2 and as high as $16 per mmbtu. The price of natural gas is set by market forces; the buying and selling of the commodity by market players, based on supply and demand. There are two distinct markets for natural gas: the spot market and the futures market. Essentially, the spot market is the daily market, where natural gas is bought and sold ‘right now’. To get the price of natural gas on a specific day, it is the spot market price that is most informative. The futures market consists of buying and selling natural gas under contract at least one month, and up to 36 months, in advance. For example, under a simplified futures contract, one could enter into an agreement today, for delivery of the physical gas in two months. There is a significant market for natural gas derivatives and financial instruments in the United States. It has been estimated that the value of trading that occurs on the financial market is 10 to 12 times greater than the value of physical natural gas trading. Trading financial derivatives can help to mitigate, or ‘hedge’ risk. A hedging strategy is created to reduce the risk of losing money. For example, purchasing homeowner’s insurance is a common hedging activity. Similarly, a marketer who plans

4 on selling natural gas in the spot market for the next month may be worried about falling prices, and can use a variety of financial instruments to hedge against the possibility of natural gas being worth less in the future. Futures and options markets provide a forum for commercial interests in a commodity to hedge against price risk by transferring that risk to those more willing and able to bear it, or to those commercial interests with inverse risk profiles. Thus, the futures market allows industry marketers to lock in a purchase price for gas they have committed to deliver, or to lock in a selling price, including a profit margin, for gas they have committed to buy. Pricing in a volatile market makes it difficult to maintain flexibility when planning. Without futures, market participants must accept fixed-price contracts, which can prove disadvantageous. The futures market provides flexibility in forward planning. This flexibility is further enhanced by the options market which provides participants with, among other things, the ability to set price floors or ceilings, hedging against adverse price movements while retaining the ability to participate in favorable ones. Financial natural gas markets may also be used by market participants who wish to speculate about price movements or related events that may come about in the future. The main difference between speculation and hedging is that the objective of hedging is to reduce risk, whereas the objective of speculation is to take on risk in the hope of earning a financial return. Speculators hope to forecast future events or price movements correctly, and profit through these forecasts using financial derivatives. Consider the following examples where futures and options could be used to hedge risk (i.e. lessen the probability of losing money): Fixing short-term fuel costs: End users may sometimes look for extra protection against seasonal price spikes or may want to lock in their near-term fuel costs for some other reason. Locking in an attractive spot price: The end-user who finds the current natural gas spot price attractive can use the futures market to lock in that price for at least 36 months. Or the end-user can purchase call options to set a ceiling purchase price for gas. Hedging storage gas: End-users who have put gas into storage can hedge against falling prices by selling futures, buying puts, or even selling calls against their stored gas. Protecting against sharp price spikes caused by occasional pipeline congestion which results in shortages or delivery slowdowns. When abnormal weather, concerns about storage levels, or other factors cause natural gas spot prices to strengthen, that strength will frequently be reflected in prices paid for futures contracts deliverable some months ahead. This presents opportunities to lock in attractive forward selling prices. Producers can earn additional revenue in flat markets by selling call options on their reserves. Protecting against increasing or decreasing electricity prices. In general, financial institutions are more willing to lend against hedged reserves than unhedged reserves and, in some cases, hedging is a prerequisite for borrowing. Either the sale of futures or a put options purchase is considered a suitable instrument for hedging gas still in the ground.

5 In general, the natural gas futures market provides investors with many attractive opportunities. Demand for gas is highly seasonal, but the seasonal impact on pricing is unpredictable. Variables include the severity of the winter weather, inventory levels, producers’ needs to generate cash to cover their expenses, unexpected changes in demand for gas-generated electricity, transportation prices and constraints, and the cost of natural gas versus the cost of other fuels. Futures Example Assume you are in the business of selling natural gas or in the case of La Plata County your tax income is dependent upon the price of natural gas. Assume it is year 2005 and future prices of natural gas are $12 per mmbtu. You could short future contracts at $12 in 2005 for up to 36 months. Consider the price of natural gas today of $7 per mmbtu. What does this all really mean? You have a contract to sell your natural gas for $12, no matter the price today. This future contract allows you to either physically deliver your natural gas at $12 or you could simply cash-in on your financial contract. Your short future position has a current value of $5 per mmbtu today ($12 – $7). You could close out your futures contract and pocket $5 per mmbtu and then sell your natural gas at $7 per mmbtu; for an effective selling price of $12 per mmbtu. In other words, if you correctly hedged your natural gas exposure in 2005 your gross profit today would be 71% higher versus selling only at the spot price. Let s consider the opposite scenario today where the spot price of natural gas is $16 per mmbtu. Your future contract would be worth negative $4 ($12 – $16), however, you could sell your natural gas at $16 per mmbtu, for an effective selling price of $12 per mmbtu. In other words, the spot price is $16 and you effectively sold the natural gas for $12. Thus, hedging is a practice to lock in a particular selling price or profit margin. If you are happy with the currently quoted profit margin for your business, then futures are an instrument to guarantee it. To put things in perspective, La Plata County produces approximately 525 million mmbtu each year. At an average selling price of $12 per mmbtu this equates to $6.3 billion in gross sales versus $3.7 billion in gross sales at $7 per mmbtu. References NYME, Risk Management with Natural Gas Futures and Options, Walker, D. and R. Sonora, The Economic Impact of the Natural Gas Industry in La Plata County, Economic Impact Study, 2004.

GAO NATURAL GAS. Analysis of Changes in Market Price. Report to Congressional Committees and Members of Congress

GAO United States General Accounting Office Report to Congressional Committees and Members of Congress December 2002 NATURAL GAS Analysis of Changes in Market Price GAO-03-46 December 2002 NATURAL GAS

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