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Gas: Speculators vs. hedgers: Who’s right?

23 May 2018,

I have been receiving a lot of questions about the gas lately. Some bear spreads are very tempting due to very favorable seasonality. But there is one problem – COT analysis. Both groups of market participants suggest a different sentiment. That’s why some traders are confused. Which market participants we should actually believe? Today I will briefly tell my point of view and also explain what strategy did I select.


Gas price development

In the beginning, let’s just look at the technical analysis briefly. The price has moved more or less to the side for several months. This move has its reasons. There are several different factors that pushes the price to up or down. For example, record production holds the price under pressure. On the other hand, the supplies after a strong winter are positively pushing the price. In the short term, the market is also boosted by the warmer weather in the US, which is currently relatively increasing demand for gas in power plants due to air conditioning operation.



COT analysis

Now let’s look at an important analysis of sentiment. Here we come across a very special thing. Usually both groups (big speculators and hedgers) signals a very similar market situation. But with gas, it’s different now. Speculative long positions are increased at first glance. This behavior is generally negative for the commodity price and suggests proximity to the local maximum.



On the other hand, the group of hedgers is hardly securing themselves at current prices. The difference between their long and short positions is approximately zero, and compared to similar situations in the past, this is positive for the price. In most cases, this situation means that for producers it is not worth it to secure themselves on current prices and for manufacturers it is not worth buying. Usually it expresses expectations of higher prices. This is exactly the opposite conclusion than in the case of a group of big speculators.



 So, to whom believe and why this discrepancy has appeared?

It is, of course, difficult to answer this question with certainty. But I still have one theory to explain this market behavior. We can help ourselves by checking the market structure that we visualize using the term structure. The blue curve represents the current market, the 5-year average is the red curve and the green curve is 15-year average.



The current curve is obviously below both averages. Gas prices across the term structure are very low compared to the past. From this comparison, however, we cannot conclude that gas is now underestimated. We have to take into account lower production costs, interest rates and other changes in the market over the years. Still, I think the gas price below $ 2.5 for producers is unprofitable. Simply put, it does not pay off to invest in future production below this price.

The second very important thing is the shape of the term structure. The curve is flat, especially when compared to the 15-year average. The flatness of the beginning of the curve in this period is a relatively normal phenomenon. But the bigger problem is the more distant term structure, specifically the winter months. Compared to the closes expiration, prices are not much higher.

And here I am getting to the possible cause of what we see on COT positions. The low securing activity of the producers probably reflects both too low gas prices and, above all, lack of interest in hedging even for the distant months (very flat term structure). The market now does not offer to producers good prices even for the winter months. Simply said, it does not pay off to secure their future production at current prices and they consider the market to be undervalued.

So why do big speculators suggest the exact opposite? One of the reasons may be increased inflation expectations, rising oil and other energy prices, which can depict gas in the eyes of investors as an interesting cheap speculation. Various index funds that invest in a wider portfolios of commodities can also play their part. But I think this strategy is not entirely appropriate because US gas is largely isolated from other commodities and even from the international gas market. In any case, this could be one of the reasons for such a large income of speculative capital.

What is my strategy?

Hedgers see the gas market as very underestimated. From a very long-term perspective, they might be right. In the short term, however, I think that the impact of record production will prevail, and gas prices will continue to be under pressure. That’s why I expect the gas price to be within the range of $ 2.5 – $ 3.0 in the coming months. In the medium-term scenario, only weather, especially above-average temperatures during the summer, can change the situation.

My strategy is therefore clear – the more distant bear spreads. If the market keeps moving and strong production keeps the market in contango, bear spreads should grow. Specifically, I have selected the more distant NGG19-NGF19 spread. The gas situation as well as the analysis of this spread have been discussed in details in the last Spread Report.





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