Friday, January 22, 2010

Natural Gas Investors vs Meteorologists: The Eternal Struggle

Here are three headlines from the Wall Street Journal, each of them from the month of January:
I particularly like the 1/6 and 1/22 headlines, clearly demonstrating that WSJ commodities reporters are proficient with a middle school thesaurus. Anyway, take a look at Natural Gas prices over the last month:
That is some crazy volatility, and it has almost everything to do with weather forecasts. Though natural gas could be used to do just about everything oil does, currently, the cleaner burning fuel is used primarily for heating homes and other buildings. As such, during the winter months, when people are burning a lot more natural gas just to stay warm, the price can be driven by minor changes in the local weatherman's ten day forecast. In the summer, by contrast, Natural Gas is much more likely to follow energy patterns in general, and be driven by the same things that oil prices are driven by (reserves, projected refining capacity, projected demand, currency effects etc. etc.). I can just imagine natural gas speculators listening to the weatherman's tone before he actually announces the forecast, trying to get some glint of an overarching mood: upbeat means sell, foreboding means buy. Those who bought natural gas expecting the price to go up, no doubt, must become furious when the weatherman announces, jubilantly, that "this weekend's not going to be nearly as cold as we thought," with some sort of big, game show host smile. By contrast, when the forecast is worse than expected, natural gas bulls likely experience a kind of odd schadenfreude, delighting at the weatherman's gloomy and altogether dejected countenance as he warns his viewers to stay inside where it's warm. Truly, by literal definition, the weatherman is the natural gas investor's nemesis. By the same token, I've got to imagine natural gas sellers are quick to send the weatherman flowers when the forecast's got him down.
Obviously in the winter you'd expect prices to go up and in the summer to go down; in fact, there are whole businesses built around simply buying gas in March, pumping it into a salt cavity in the ground, and then selling it in November at much higher price. Why I find this so interesting, however is that the nature of the natural gas market changes every year from your typical energy market in the mild months, to a crazy spot market when the weather's cold.
Allow me to demonstrate. Here's a graph showing natural gas prices (in red) compared with oil prices (in blue) for the months of May, June, and July, 2009:
Now, here's the same chart from 11/1/09 to today:
Look at that divergence. It's as though people are buying natural gas to, you know, use it. Winter month natural gas prices are a perfect example of when a commodity market actually does its job: establishing prices for commodities.
A word of advice to any tri-state weathermen out there: stay away from the NYMEX building, unless you're looking for a fight.

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