Schork Oil Outlook: Liquids Recovered — NatGas Hasn't

Natural gas… waiting for the rally

Since the start of the winter, the spread between the Nymex Henry Hub natural gas futures contract for March 2011 delivery and the April contract has morphed from a premium (backwardation) of 0.9%, to a discount (contango) of -0.7% as of last Friday. The spread has been yo-yoing around unchanged all winter long.

Over the previous ten winters this key cross-seasonal spread began the winter in December at an average 6.8% premium, but then finished in February at a discount of around -0.2%. Despite this winter’s very strong drawdown in underground stocks, 19.3 Bcf/d, the end-of-season curve is showing no sign of concern regarding the availability of supply.

That is not exactly earth-shattering news, with 2.35 Tcf of product still in the ground at the start of February.

Be that as it may, the longer dated end of the curve is hinting of some concern with this summer’s potential refills. Since the start of the winter the discount between the end of summer (Oct’11) and start of winter (Nov’11) has narrowed by 200 bps to 3.1%. Over the last ten winters the carry on this end-of-season spread has increased by 42 bps on average to a 5% discount. Therefore, recent tightening in the Oct/Nov spread could be indicative of pending supply woes. Per the latest update from EIA, total production of natural gas is forecast to fall by 0.3% this year.

The government makes note of the extant decline in rig counts. It’s a fair point, but then again, the ratio of vertical rigs to horizontal ones has blown out from 6:7 in June 2009 to 7:13 as of last Friday. In the process gas output in the Lower 48 has risen 7.8%. A 21% decline in offshore GoM production was more than offset by a 65% increase in Louisiana (Haynesville) and a 23% jump in “Other” (Marcellus).

Bottom line, unlike the liquids, the gas market in the U.S. has failed to recover from the implosion of 2008 bubble. Nevertheless, production continues to rise despite the prolonged bear market.

On this note, as of last Tuesday gas producers were holding their largest net short position, 40,538 contracts, since 2008. As highlighted in today’s issue of The Schork Report, bear market or no, that gas is going to get produced.


Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.