Natural gas staged a small comeback last week, inciting some speculation within the blogosphere that a renewed bull market might be under way in the commodity. Evidence for this, say commenters, is the now heady height of the gas-to-oil ratio above the 20x mark.
Be that as it may, we would caution there are still some factors that investors should consider before rushing into in natural gas. Namely, the massively steep contango present in the term structure of the commodity — as can be seen in the chart below from Goldman Sachs:
While we are certainly no advocate of futures being a forecast of prices, there is no escaping the fact that at over $5/mmBtu for the January contract on September 10, natgas strength is priced in for the 2009/2010 winter. This means that anyone hoping to ride the rally higher by investing in today’s front-month prices — say by investment in an exchange-traded-fund whose methodology depends on that very model — would, even if prices converge a bit, accumulate losses on the ride higher unless prices outperformed $5/mmBtu by January — or the contango abated.
That might, indeed, be a possibility. However, it should also be noted that last week’s jump could also be explained by some more mundane and temporary factors like physical injection constraints. As Barcap noted on Friday for example:
The apparent tightening could be due to a host of factors — curtailed volumes, increased coal displacement, or fundamental market tightening — though it is too early to tell. While on a weatheradjusted basis, this week appears to be the tightest so far this injection season, the market will need confirmation in subsequent weeks, particularly with summer power loads passed. There are still approximately eight weeks until the traditional end-of- October injection season, and a test of capacity lies ahead. Thus, we think the recent spurt of price strength may be short-lived. Cash prices were mostly weaker today, with Henry Hub losing 4 cents to $2.68, Southern California Border off 5 cents to $2.88 and Transco Zone-6 shedding 8 cents to $2.95.
That said, Goldman Sachs said it believed prices were still set to outperform due to tightening supply on production cutbacks. Although note that even Goldman Sachs bases its forecasts as a comparison to the current term structure:
Going forward, although the large volumes of gas in storage will likely limit any upside to prices from current levels until the end of October and will keep the market well supplied throughout the winter, we believe that further expected declines in production will tighten the market balance sufficiently to require new investment in drilling over the next 6 to 12 months. Accordingly, we maintain our NYMEX natural gas price forecasts of $6/mmBtu and $7.50/mmBtu for the 2009/2010 winter and the 2010 summer, respectively, well above the current forward curve.