Futures spread and natural gas prices

On April 19, 2017, natural gas (UNG) (FCG) (BOIL) (GASL) May 2017 futures were trading at a premium of $0.3 to May 2018 futures contracts. On April 12, 2017, the spread was at a premium of $0.33.

Is the Natural Gas Futures Spread Bearish?

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) (GASX) 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 forward. Since March 8, 2017, when active futures switched to a premium compared to futures 12 months ahead, active natural gas futures have risen ~9.8%.

Contango and natural gas prices

On the other hand, 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 and prices for natural gas.

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. Between December 30, 2016, and March 7, 2017, natural gas active futures fell 31.9% before the spread switched to a premium on March 8, 2017.

Active natural gas futures traded at a premium of $1.77 to futures contracts 12 months ahead at the peak on June 6, 2008. As the premium switched to a discount with active futures hitting a discount of $3 to futures contracts 12 months ahead on August 27, 2009, natural gas prices lost 79.1%.

Thus, 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 for 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 also 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 futures.

When the premium of active futures to contracts 12 months ahead decreases like it has over the trailing week, it could point to concern regarding natural-gas-demand-supply balance. The contraction in spread could point to upcoming weakness in prices.

Look for our natural gas price range forecast for the week ahead on Market Realist’s Energy and Power page on Mondays.

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