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Futures Spread: What It Says about Natural Gas Prices

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Futures curve and natural gas prices

On March 1, 2017, active natural gas (UNG) (FCG) (BOIL) (GASL) futures were trading at a discount of $0.5 to futures contracts 12 months ahead. On February 22, 2017, the spread was at $0.65.

When active futures trade at a discount to futures contracts for a later date—generally referred to as “contango”—it represents markets’ sentiment for 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 ~20.1%.

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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 the futures contracts for the months ahead. The situation in the futures market is called “backwardation.”

Historically, periods of strong natural gas prices coincided with the backwardation structure. Natural gas (GASX) (UGAZ) (DGAZ) active futures closed at $13.6 per barrel on July 3, 2008, after almost four months of the active natural gas futures contracts trading at a premium to contracts 12 months ahead.

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 over the following 13 months—with active futures hitting a discount of $2.94 to futures contracts 12 months ahead—natural gas prices lost 73.2%.

So, the dynamics of futures contracts in the natural gas market can hint at coming changes in natural gas prices. The narrowing of the spread in the trailing week could indicate some positivity for natural gas prices ahead.

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Impact of the natural gas forward curve

The dynamics of futures contracts in the natural gas market can have implications on natural gas processing and storage MLPs (AMLP). They could impact upstream natural gas producers’ (XOP) hedging decisions.

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 coming in the spot natural gas market. When the discount expands, the opposite could be said.

The dynamics of futures contracts in the natural gas market could have 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 prices. It could change if the spread switched to a premium.

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