While many industry experts use the gas futures market to predict realized spot prices at the Henry Hub, a new study by the Energy Information Administration (EIA) determined that out-month futures contract are "relatively poor predictors" of the Hub spot price that is eventually realized when the contract settles. Even the final futures price for a given contract often does not match the realized average spot cash price, EIA said.
Authored by EIA analyst Lejla Alic, the study acknowledged that futures contracts are most widely used for hedging, offsetting the risk of fluctuating prices and locking in a price by buying or selling a corresponding paper contract at the same time and for the same delivery date that a trader contracts to buy or sell physical supplies of a commodity. However, some industry and market participants tend to use the prices for futures contracts as predictions of commodity prices that will be realized in subsequent months, although Nymex itself does not explicitly encourage this view.
Using data from NGI's Daily Gas Price Index, the EIA examined futures contract prices for heating season months (November through March) during three consecutive years (2002-03, 2003-04, and 2004-05) and compared them with average monthly spot prices at the Henry Hub. The period of analysis for each heating season is the 12 months from April of one year (the start of the storage refill season) through March of the succeeding year (the end of the heating season).
Looking at the November 2002 futures contract as it was traded through the months of April through October 2002, the EIA found that the forward November 2002 futures contract prices in this period differ by as much as 81 cents per MMBtu, or 20% from the realized November average Henry Hub spot price of $4.042. The November contract price was below the realized price in all months prior to October. The closing price for the November contract, which was established in October, was $4.126 per MMBtu, which was 8 cents, or about 2% higher than the realized average Henry Hub spot price in November.
"Thus, except for the final settlement price, the November contract prices could not be used as a reasonably accurate predictor of the realized average commodity spot price in November," the EIA discovered. "As a futures contract gets closer to its delivery month, it is expected that futures and spot prices will tend to converge so that the final settlement price of the contract at expiration will be quite similar to the spot market price. However, conformity between final settlement prices and the realized spot price is not assured in all cases."
As an example, the EIA highlighted the February 2003 contract, which traded as low as $3.610 per MMBtu, but closed at $5.660. The closing price was $2.073, or about 27% lower than the average February Henry Hub spot price of $7.733 per MMBtu.
In addition, the EIA found that futures prices may be influenced by current market conditions even though delivery is not obligated until some time later, when market dynamics will likely have changed. "The price change patterns of the November  contract prices and the concurrent spot prices were quite similar," the EIA said. "In April 2002, the November futures contract was priced at $3.707 per MMBtu. After increasing by 16 cents per MMBtu in May, the November contract fell by 64 cents, to $3.230 per MMBtu between May and July 2002. The net change of 48 cents per MMBtu for the price of the November contract in these 3 months is very similar to the net change of 44 cents for the average Henry Hub spot price."
The EIA added that in the subsequent, and last three months of trading for the November 2002 contract, both prices again exhibited a similar overall change. Data shows that the futures contract price increased by roughly 90 cents per MMBtu in those three months, which was almost 79% of the $1.14 increase in the monthly spot price.
The prices for the set of futures contracts for delivery during the 2002-03 and 2003-04 heating seasons (November - March) generally tracked the monthly Henry Hub spot price during the period from April through the following March. However, the monthly spot price varied by more than $1 in the months preceding each winter. "Although the futures prices correlate well with concurrent spot prices in those years, the resulting wide variation in the futures prices caused at least some large differences between futures contract prices and realized spot prices," the EIA study found. "Consequently, the futures prices were relatively poor predictors of the Henry Hub spot price during the winters of 2002-03 and 2003-04."
The EIA said it appears that current market conditions have a strong influence on the market expectations for future spot prices in those years, noting that unusually low inventories of working gas in storage in February and March 2003 led to much higher Henry Hub spot prices and the futures prices at the time. "This condition apparently also affected the futures contract prices for delivery in the next (2003-04) heating season during early trading in the following heating season," the agency said.
As for the 2004-05 heating season, the study pointed out that Hurricane Ivan's damage to oil and gas infrastructure in the Gulf of Mexico put pressure on prices through production shut-ins. The loss of production contributed to futures price increases at that time of 20-28% for the set of futures contracts for delivery during the following heating season, while the Henry Hub spot price increased by more than 23%, the EIA said.
The EIA added that owing to the large price changes in a futures contract over time, "it is evident that even if the futures price correctly anticipates the target spot price periodically, continued price changes inevitably lead to differences from the future realized price." The study also found that the differences between futures prices and the corresponding realized spot prices do not necessarily diminish over time.
"While the prices of some futures contracts performed adequately as predictors of the Henry Hub spot price in the last month of trading, settling within 4% of the realized Henry Hub spot price, the prices for these contracts and those for delivery in other months generally failed to perform very well as predictors during the course of trading."
Although the EIA found that prices for futures contracts in any given heating season may exhibit a systematic bias (e.g., consistently underestimating prices for the 2002-2003 heating season), the patterns do not evolve in a predictable way between seasons. "This would impede attempts to use futures prices to predict actual heating season prices based on previous patterns in the data," the agency said.
The EIA concluded in its study that prices of natural gas futures contracts expiring during the past three heating seasons (2002-03, 2003-04, and 2004-05) generally did not perform well as a predictor of realized spot prices at the Henry Hub. However, the EIA pointed out that trading in futures contracts provides benefits to market participants by providing some degree of price certainty, market transparency and liquidity. It added that trading in futures contracts is an "important tool" in an array of options for gas managers to consider in establishing their supply transaction portfolios and the trading in futures contracts is expected to remain an important tool for managing price risk.
For more information on the EIA's report, visit www.eia.doe.gov. The report can be found under the heading "What's New."
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