Natural Gas Volatility Often Provides Trading Opportunities

Natural Gas Volatility Often Provides Trading Opportunities
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Since natural gas began trading in the futures market in 1990, the price has been as low as $1.02 and as high as $15.65 per MMBtu. The long history of extraordinary price volatility in natural gas has caused speculators and market participants to flock to the market because of the many opportunities created by price variance.

The energy commodity has changed dramatically over recent years. Both the supply and demand sides of the fundamental equation for the natural gas market have expanded significantly. Discoveries of massive reserves of natural gas in the Marcellus and Utica shale regions of the United States together with technological advances in extracting the gas from the crust of the earth and fewer regulations have increased supplies. At the same time, natural gas has replaced coal in many power plants around the U.S. Moreover, technology has allowed for processing gas into a liquid form which allows for transporting the gas via ocean vessels for exportation to areas around the world where the prices are higher than in the United States. Therefore, growth on the supply side allowed for substantial increases in the demand side of the fundamental equation for the natural gas market. Since 1990, the natural gas market has matured, and two metrics in the futures market reflect that maturation. 

Source: CQG

As the monthly chart highlights, open interest or the total number of open long and short positions in the natural gas futures market has grown to almost 1.6 million contracts which is a result of the increase in both supplies and demand for the energy commodity. At the same time, historical volatility has declined and was at the 16.33% level on the monthly chart in August which is the lowest level in years. As the volume and open interest in a market increases, price variance typically declines.

While the natural gas market is a lot different today that it was back in 1990, the combustible energy commodity always has the potential for explosive or implosive price action. In March 2016, the price dropped to its lowest level since the late 1990s at $1.611 per MMBtu, and in December of the same year, it rose to just under the $4 per MMBtu level. Natural gas still has the potential to double and halve in value over short periods. At the end of August, the price at the $2.85 level was right in the middle of its trading range since March 2016.

We are now at the latter part of the middle of the 2018 injection season, and while production is at a record level, the gas is trickling rather than flowing into storage in preparation for the 2018/2019 peak season of demand that begins in November. We are likely to go into the winter withdrawal season in the coming months with the lowest level of stocks in many years as demand has kept pace with increasing production. With monthly historical volatility at the lowest level in years, we could be on the verge of a very busy winter season if stocks turn out to be insufficient to meet demand or if they drop to low levels because of colder than normal conditions. The last time we witnessed a rally on low stocks was during the winter of 2014 when the price rose to a high of just under the $6.50 per MMBtu level. As of the end of August, inventories according to the Energy Information Administration are over 600 billion cubic feet below where they were in 2013 at this time of the year during the injection season that builds inventories for the coming season of peak demand.

Natural gas is a market that reflects an expanding fundamental equation, but the odds still favor lots of price volatility in this energy commodity with a long history of extreme price variance. Volatility is the mother’s milk of trading opportunity for nimble traders with their fingers on the pulse of the market. 

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