Does the Natural Gas Futures Spread Indicate Bullishness?
On July 12, 2017, the spread was at $0.11. In fact, between these two periods, natural gas active futures rose 2.7%.
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The current direction of the futures spread, in which the near-month contract is trading at a higher price than the contract for delivery in the future, is called “backwardation.” In backwardation, natural gas prices are generally bullish. Rising natural gas prices were observed during expanding backwardation.
In one such example, natural gas prices closed at $3.42 per MMBtu (million British thermal units) on May 12, 2017. The futures spread expanded to $0.50 on the same day, its highest level in the current backwardation period.
A reversal in the futures spread from its current structure would be called “contango.” Generally, natural gas prices are bearish during contango. For example, on March 3, 2016, natural gas prices settled at a 17-year low. Incidentally, the futures spread was in contango then. The contango spread touched $0.84 on the same day.
The direction of the futures spread could be a reflection of demand-supply dynamics. So, it can give us an idea of prices as well.
In the week ended July 19, 2017, the backwardation spread and prices both rose, indicating bullishness in natural gas prices.
The implications of the futures spread aren’t limited to natural gas prices. The spread is also crucial to natural gas producers’ (XOP) (DRIP) hedging decisions. Midstream companies (AMLP) are also affected by the futures spread due to their exposures to the natural gas storage and transportation businesses.
In the past, the futures spread’s being in contango has yielded a lower return for the United States Natural Gas Fund LP’s (UNG) investors, compared to natural gas active futures investors.
To know more about other fundamental aspects of upstream stocks, read our upstream primer.