ETF Securities Research Blog

Natural gas rally over-done

US natural gas is currently trading at US$2.74/MMBtu, up from US$2.00/MMBtu in May 2016 (+37%) in response to the warmer weather forecasts. We believe that it will be difficult for natural gas prices to hold onto these gains.

The National Oceanic and Atmospheric Administration’s forecast of continued above-average temperatures this summer is likely to keep demand for air-conditioning elevated in the US. Natural gas provides about a third of electric power in the US. However, natural gas inventories remain elevated (more than 1 standard deviation above the 5-year average). Moreover, in recent weeks the net additions to inventories have continuously beat analyst forecasts, indicating that the warm weather has not drawn on inventories as expected.

inventory

High natural gas prices would be justified if supply for natural gas was tight, but with inventories elevated, we believe that prices should correct downwards. Although natural gas is trading at a fraction of the US$13.60/ MMBtu peak reached in 2008, production today is more than 50% higher due to fracking increasing supply and inventories. Natural gas is trading at the highest levels since May 2015.

We expect that natural gas prices will soften further as the peak summer demand period passes. Additionally, with natural gas futures currently in contango, taking a short exposure can benefit from a front month roll yield of approximately 2.3%.

futures curve

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