Natural Gas: Link between the Futures Spread and Prices
Futures spread and natural gas prices
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When active futures trade at a discount to futures contracts for a later date—a situation referred to as “contango”—it indicates market sentiment toward weaker demand for natural gas today and the likelihood of higher demand and higher prices in the future.
Historically, periods of weak natural gas prices coincided with the contango structure. The active futures contract switched to a discount to the contract 12 months ahead on December 30, 2016. Since then, natural gas active futures have fallen ~9.5%.
Backwardation and natural gas prices
On the other hand, when there’s an immediate demand for natural gas, active natural gas futures trade at higher prices than futures contracts for the months ahead—a situation referred to as “backwardation.”
Historically, periods of strong natural gas prices coincided with the backwardation structure. Natural gas (GASL) (UGAZ) (DGAZ) (FCG) active futures closed at $13.60 per MMBtu on July 3, 2008, after almost four months of the active natural gas futures contract trading at a premium to the contract 12 months ahead.
Notably, active natural gas futures traded at a premium of $1.86 to futures contracts 12 months ahead at the peak on June 6, 2008. As the premium switched to a discount on July 24, 2008, with active futures hitting a discount of $2.94 to futures contracts 12 months ahead on August 27, 2009, natural gas prices lost 79.1%. The dynamics of futures contracts in the natural gas market can hint at coming changes in natural gas prices.
Impact of the forward curve
The dynamics of futures contracts in the natural gas market can have implications on natural gas processing and storage companies (AMLP). They also impact upstream natural gas producers’ (XOP) hedging decisions.
The dynamics of futures contracts in the natural gas market can offer important implications for the performance of commodity tracking ETFs such as the United States Natural Gas Fund (UNG). Due to expiring futures contracts trading at a discount to the next series of futures contracts, UNG underperformed natural gas futures.
Importantly, when the discount of active futures to contracts 12 months ahead decreases, it could point to tightening in the natural gas demand-supply balance. It could mean that the market sees higher prices ahead in the spot natural gas market. When the discount expands, the opposite could be said.
Look for our natural gas range forecast for the week ahead on Market Realist’s Energy and Power on Mondays.