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Natural Gas: Are Prices Heading for a Breakdown?

PART:
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Part 4
Natural Gas: Are Prices Heading for a Breakdown? PART 4 OF 4

Futures Spread: Is More Pain Ahead for Natural Gas?

Natural gas futures spread

On July 26, 2017, natural gas (BOIL) (GASL) September 2018 futures were just $0.06 below the September 2017 futures. On July 19, 2017, the spread (or discount) was at $0.15. In fact, natural gas September futures fell 4.6% between these two dates.

Futures Spread: Is More Pain Ahead for Natural Gas?

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When the futures spread is at a discount, like it is now, natural gas futures are said to be in “backwardation.” In backwardation, natural gas prices tend to be strong. On May 12, 2017, natural gas active futures settled at $3.42 per MMBtu (million British thermal units) and the discount rose to $0.5. It was the highest closing price for natural gas active futures in 2017. The futures discount was the highest since June 16, 2014.

However, a contraction in the discount could mean that the strength in prices is waning.

When the futures spread is at a premium

When the 12-month futures contract trades at a premium to active natural gas futures, it’s called “contango.” During contango, natural gas prices tend to be weak. When the contango premium expands, prices tend to fall and vice versa. On March 3, 2016, natural gas active futures settled at their 17-year low. On the same day, the 12-month futures traded $0.84 above the active natural gas futures.

What’s the futures spread saying?

On July 26, 2017, the futures spread between natural gas September 2018 and 2017 futures contracts was on the verge of shifting to a contango premium. The backwardation spread has been contracting since May 12, 2017. Natural gas prices have fallen 14.9% during this period.

If the spread switches to a contango premium and the premium continues to expand, it could be a bearish signal for natural gas prices. It could be reflecting the markets’ expectation of mild weather causing demand to fall short of supply.

Energy sector

US energy companies engaged in natural gas production (XOP) (DRIP) and storage and transportation (AMLP) are sensitive to the futures spread. The prices of futures contracts for delivery for future years can impact natural gas producer’s hedging decisions. Prompt futures trading at prices lower than the next futures contract diminished the United States Natural Gas Fund’s (UNG) returns compared to natural gas active futures.

Read Market Realist’s upstream premier to learn more about upstream stocks.

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