How to trade rising natural gas prices and falling oil prices

How to trade rising natural gas prices and falling oil prices (Part 1 of 6)

Why natural gas prices are up and oil prices are down

A strong rally has pushed natural gas prices up over 25% since early November

The front month contract for natural gas as priced at Henry Hub (the main benchmark for natural gas prices) is currently trading above $4.40 per MMBtu. The commodity has had a strong rally since early November, when it was trading at around ~$3.45 per MMBtu, over a 25% increase in price.

2014.01.16 - Nat Gas STEnlarge Graph

During this period, natural gas inventories experienced a string of larger-than-expected draws, indicating more demand or less supply than anticipated and resulting in a bullish catalyst for natural gas prices. Strong natural gas demand has also been driven by a colder-than-normal winter so far. Weather can significantly affect natural gas prices during the winter, as the fuel is used for home heating.

Meanwhile, crude oil prices have sunk over the past few weeks

WTI crude oil prices were trading at over $100 per barrel as recently as December 27, 2013. They sank over the past few weeks to touch ~$92 per barrel just a few days ago. A major reason for the bearish movement in oil prices was that the U.S. Energy Information Administration reported inventory data that indicated weaker demand for crude oil. For example, on January 3, 2014, the EIA reported large increases in inventories for distillate and gasoline. These commodities are refined crude oil products. Their inventory increases indicated that less crude oil might be needed at refineries to produce these fuels (see Why is the market read on oil inventories data bearish? for more analysis). WTI futures dropped over 6% for the week ended January 3.

2014.01.17 - Crude OIl PricesEnlarge Graph

Note that the most recent inventories report, released on January 15, was bullish and caused oil prices to recover some recent losses, with prices ending at $94.34 per barrel on the day compared to $92.59 per barrel at the close of the prior trading session. At current prices, oil still remains 5% off from late December levels. Plus, oil is down significantly from early September levels, when WTI prices reached $110 per barrel. Part of the relief in prices since then has been due to the market’s perception that geopolitical tensions in the Middle East and North Africa have quieted.

For investors with a strong opinion on the direction of natural gas or oil prices, there are several ways to play a rally or a fall, which we’ll discuss in the following parts of this series. We’ll also see why an individual investor might not want to invest directly in energy commodities.

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