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Natural Gas Trading Weathers Financial Storm

While the troubles that have swept across global financial markets have added new pressures to the natural gas trading arena, some of the market reformation measures that followed the implosion of Enron Corp. and other large marketers in 2001 have enabled the natural gas market to withstand major disruptions and continue on a relatively smooth course.

Daily physical trading volumes, as reported in the price surveys conducted by Natural Gas Intelligence, are down roughly 25% to about 35 Bcf/d in the last six weeks compared to earlier this summer, but that's a long way from the 3.9 Bcf/d market bottom in November 2002. And, there are other factors at work in today's lower trading volumes, including continued hurricane shut-ins in the Gulf of Mexico and the mild weather between the air conditioning and heating seasons.

The greater impact of the financial market crisis has been on natural gas prices, some market analysts claim.

In 2001 the problem was underfunded marketing companies; today it's underfunded banks. The never-again idea following the earlier market collapse was that only big banks and companies with large asset bases and deep pockets would be considered credit-worthy and eligible to be major traders in the natural gas market. The "banks" part of that equation has proved the weak link.

"A lot of the credit problems, particularly in physical energy markets, stem from unsecured bilateral trading," said George Sladoje, CEO of North American Energy Credit and Clearing Corp. "Participants are carrying unknown and inconceivable risk even when, as we've recently seen, dealing with highly rated banks and financial institutions."

Most of the major U.S.-based investment banks that had taken big positions in the physical commodities markets have been slammed by the financial turmoil, either being forced to sell, forced to file for bankruptcy, or forced to become bank holding companies. But the backstop in today's natural gas market are the large producer marketers and a whole host of counterparty credit rules that most companies have followed since the earlier debacle.

Lehman Brothers, and its Eagle Energy Partners subsidiary, together had been one of the top U.S. gas marketers, until Lehman was forced into bankruptcy, and its various operations were sold to UK-based Barclays Capital and Electricite de France subsidiary EDF Trading. For Barclays, it's business as usual, said spokesman Seth Martin. Barclays is committed to all of its commodities businesses, "including physical energy trading," said Martin. Barclays plans to keep investing in all of its commodities markets -- and Martin noted that "we have found our clients to be receptive to our participation."

For those investment institutions still trading physical gas, credit terms are tight.

Producers and refiners want pre-paid, secured letters of credit or are requiring that transactions be cleared on the New York Mercantile Exchange, OTC Global Holdings LP's CEO Javier Loya told The Wall Street Journal. "We have seen trading companies and major oil and gas companies reduce counterparty exposure to financial institutions," Loya said. "Because of the credit crisis, financial institutions, in turn have reduced their inventories."

Reassuring clients appears to be key at this point.

Take, for instance, Sempra Energy. The San Diego, CA-based company, which has consistently been one of the top domestic natural gas traders in NGI's quarterly energy marketing surveys, saw its shares pressured days ago on concerns that its energy trading joint venture with trading partner Royal Bank of Scotland plc (RBS) might collapse. The UK-based RBS has seen its fortunes fall with the rest of the financial sector, and on Wednesday the United Kingdom announced it would provide support to its banks, including RBS.

Because of "numerous inquiries," Sempra told the Securities and Exchange Commission (SEC) in an 8-K filing Thursday that the RBS joint venture's net trading liabilities and credit facilities were being supported and guaranteed by Sempra.

"RBS is one of the world's largest banks and Sempra Energy believes that RBS will continue to provide all ongoing funding and credit support for the joint venture as provided in the joint venture agreement," Sempra stated. As a "transactional measure," however, Sempra noted that it would provide "back-up guarantees" for a portion of RBS Sempra Commodities' trading obligations and certain credit facilities with third-party lenders.

Sempra told the SEC that it still expects to turn over its trading obligations to RBS in the first half of 2009, according to the filing. RBS agreed to "fully indemnify" Sempra for any costs assumed to guarantee the trading operation, which are estimated at $1.1 billion of net trading liabilities "consisting of guaranteed trading obligations net of collateral." The joint venture, Sempra noted, also has a $500 million three-year credit facility that expires in May that it is supporting.

What about the impact on prices? Gas supplies are up, storage is on its way over the top, demand is down, and hurricane season is nearly over. The fundamentals would point to lower gas prices, but these fundamentals are not the only factors moving the price of natural gas today, said Valerie Wood, president of Wisconsin-based Energy Solutions Inc.

"While some big players have fallen by the wayside, there are still a large number of speculators involved in commodities trading," said Wood. "There's more at work here than just the fundamentals of supply and demand. The fallout from the current financial crisis is also impacting natural gas prices."

Wood's firm took a look at the comparisons to the timing of recent gas price moves and the timing of recent financial collapses. It noted that on March 14, Moody's Investor Services, Standard & Poor's Ratings Service and Fitch all downgraded Bear Stearns and forced it to put up additional collateral.

"One way to acquire that additional collateral is through the liquidation of assets and Bear Stearns, like many other financial institutions, worked in numerous markets, one of which is commodities," Wood noted. "As Bear Stearns met its demise, the price of crude oil and natural gas commodities traded on the Nymex plunged. We believe this price plunge was a direct reflection of contract liquidation taking place by Bear Stearns or companies involved with Bear Stearns, and the liquidation involved aggressive selling, which in turn pushed prices down quickly."

The price decline turned out to be short-lived, and by the end of the month both commodities rebounded substantially, Wood noted. "Therefore, we've concluded that the price decline was caused by an exiting of positions associated with the failure of Bear Stearns."

Meanwhile, several investment firms continued to encourage investors to move money from the poor performing stock market into commodities citing the huge upside potential, said Wood. "As more investors became unhappy with the stock market, more money flooded into the commodities market, and higher price predictions became reality as the influx of buying pushed commodity prices higher even amidst growing reports of a weakening economy and a reduction in demand."

On July 2 the front-month natural gas Nymex contract reached a high of $13.69/MMBtu, and on July 11, the front-month crude oil Nymex contract reached a high of $147.27/bbl. By Sept. 3, the front-month natural gas Nymex contract had fallen to $7.02/MMBtu and by Sept. 16, the front-month crude oil Nymex contract was $90.51/bbl. Since then, front-month values have fallen even further to $6.535/MMBtu and $77.70/bbl as of Oct. 10.

"In essence, the rally that took natural gas and crude oil commodity prices higher for the first six months of 2008 was entirely erased in less than half that time," said Wood. "While a portion of the recent price declines in natural gas and crude oil could very well be due to declining demand, resulting from a weaker economy, we believe a substantial portion of the price decline really relates to the liquidation of contracts by some financial players to raise collateral."

Wood noted that the financial problems at Lehman, Merrill Lynch and AIG "hit just after a major hurricane swept through major production areas of the Gulf of Mexico. Historically, a storm the size and strength of Hurricane Ike would cause a price rally in advance of the storm, but instead during the week of Sept. 8 as Ike barreled toward production areas, the front month natural gas Nymex futures price for the most part held steady and the front-month crude oil Nymex price fell by about $10 per barrel.

"In fact, it appears that the natural gas and crude oil industries didn't even care about Ike when you look at price activity," said Wood. "But that doesn't make any sense. However, what if panic-buying from Ike was offset by an ongoing liquidation of positions by some financial players in an effort to gain additional collateral?"

Meanwhile, investor confidence in the stock market continues to erode, but Wood believes "some investors will redirect their money back toward commodities. Even with lower demand and a weak economy, from an investment perspective, commodities are still an asset, and some may view that as a safer bet because they won't decline to zero. We believe this type of investing will only help to support natural gas prices longer term."

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