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Futures Price Jump Breaks Downtrend

Futures Price Jump Breaks Downtrend

The gas futures market toppled its Berlin Wall last week, a technical downtrend that has confined trading since December 1996. A number of fundamental factors, including tightening supply and peaking cooling demand, and some very significant technical indicators conspired to boost the near month contract up 34.1 cents to $2.528/MMBtu and the 12 month strip up 19 cents to $2.60 from the previous Friday.

"I've got to say on a short-term basis we were a little surprised by the magnitude of this move up," said John Saucer of Salomon Smith Barney. "[Thursday] was kind of a wow, but [Friday] was kind of what you would expect. Anytime a market breaks out of range like that with that type of range expansion and at that type of volume, it's pretty impressive." On Friday, Nymex gas futures volume for the Henry Hub contract set a new record with an estimated 198,806 contracts. The previous record of 168,057 contracts was set Sept. 26, 1997, nearly two years prior.

Clearly there was a general realization last week that bullish market fundamentals and technical indicators were aligned. On the fundamental side, "I think people are now recognizing the market is a couple of Bcf/d tighter than last year," said Saucer. "The average size of the gas market is about 60 Bcf/d so taking 2 Bcf/d out of the market causes a huge change at the margin. I think people are a little bit more concerned about the winter."

The price gains were not limited to the front months. In fact, the 12-month strip went up 15 cents in two days, Thursday and Friday, to $2.60. "This is not just a short squeeze on the front end," said Saucer. "It's a market where the whole curve is moving up. The winter contracts are quickly closing on $3. You have January hitting $2.90 and December in the high-$2.80s. I think the fundamentals will be extremely tight even if we just have a normal winter. I'm not going to suggest the highs will occur during the winter. You may see them sooner than that. Concerns about the winter may yield highs long before they are dealing with the winter."

Although few if any observers predicted the launch that occurred on Tuesday, there were quite a few bullish factors that presented themselves early last week. Crude oil futures played a supporting role in the rebound despite falling off late in the week. And the hot weather and record power demand triggered significant energy market jitters.

Many of the nation's largest power utilities hit demand records. Chicago-based ComEd reached all-time peak demand of 19,940 MW at 4 p.m. Thursday, beating Wednesday's peak of 19,714 MW. But the utility said it did not have to implement any voluntary curtailment programs. Power send-out records also were reported by Dayton, OH-based DPL Inc., and Columbus, OH-based American Electric Power. AEP said its three million customers in seven states set a new summer load record of 19,795 MW. North Carolina-based Duke Power customers set a demand record with 17,982 MW Thursday after a record the day prior of 17,683 MW. Cinergy and PJM power prices were astronomical at between $350/MWh-$750 MWh.

Meanwhile, most eastern gas cash prices started the week a nickel higher. By Wednesday Henry Hub was a dime higher than the previous Friday and by Friday had jumped well into the $2.40s. New York went from $2.38 to $2.60 Friday to Thursday.

"You come into this week and you have hot weather, super strong power prices, gas cash market prices above index, and that lays the ground work for a strong start. Then you have a technical component," said Saucer. On Thursday, the August contract gapped higher at the open and then pulled back. After being unable to fill in the chart gap, it easily held the low-$2.30s. At that point, a sudden and tremendous amount of buying occurred. "A lot of it most likely was short covering, and that carried us all the way to $2.40 Thursday," said Saucer.

A futures technician with New York-based Trot Trading Corp. agreed the rally was fueled by short-covering but said the battle was decided earlier in the week when sellers could not retest the $2.10 low from July 12, 1999. "There was hardly anyone willing to sell the market from $2.11-2.17 and that enabled long-term buyers to push their orders higher with confidence," he said. Long-term buyers, he explained, represent a combination of commercial and speculative traders who attempt to capitalize on trends rather than daily market moves.

"Locals tried and failed three times last Friday, Monday and Tuesday to push the market past $2.25," a Gulf trader added. "Not until [Wednesday] was the market able to punch through stubborn resistance there."

On Thursday, there was a major price-range expansion, which occurred on a high-volume of trading with over 100,000 contracts changing hands. "It wasn't some thinly traded day," said Saucer. "The sharp rally came on very brisk activity. You would expect to see some upside follow-through just on the technicals alone, but then cash broke to $2.45-2.46 [Friday] morning. We had a gap on the open and this thing was on a tear."

On Thursday, the contract crossed a major technical threshold at about $2.38, breaking a downtrend that has existed on the futures charts since December 1996. Prices escalated from there in waves. "I think [Friday] there were a lot of people who were selling the initial push up to $2.49," said Saucer. "They thought 'oh $2.50, that's a pretty good number; It's already too high, blah, blah, blah. Cut it short.' Then the market came off to $2.43-44. But it went right back up, and guess what happened when it crossed $2.50? They were covering their shorts, and their buying helped push it to $2.55. Same thing happened this afternoon at $2.55; people started selling it, and it sold back down to $2.50. But guess what, it bounced back and made new highs at $2.58. I think people have been trying to sell this because they have been thinking it's too high, but that's always a relative way of looking at the market. Gas can trade anywhere to $1.05 to $4[-plus]."

Despite the major price increases late last week, traders remained in disagreement on direction this week for the expiration of the August contract on Wednesday. Some feel it might cool off as traders take profits into the settle. However, Tim Evans of New York-based Thompson Global Markets believes it is too soon for this rally to fade. He believes the futures market might try to repeat the past.

In order to try to pin down a potential top for this rally, Evans takes a look back to the week ending March 19, when prices began to climb from a $1.67 low. By the end of April, prices had completed a 74-cent move to notch a $2.415 high. "Add that to last week's $2.10 low and you're talking about a potential for the market to rally to the $2.84 level," he said.

Evans said if the buying power was there once, it will be there again. "Although the market is now statistically overbought in the day market, the speculators are not even close to the maximum amount of long positions they will hold," he said.

Saucer wouldn't make any specific price target predictions. "But I would tell you to go back and look at what happened in 1997 during the exact same period of time. 1997 has pretty much been a mirror image of this year, both in the ups and the downs, basically from the first quarter until now. It's really pretty amazing. In August 1997, it went ballistic and traded well above $3.

"If you've got good fundamentals and good technicals and the funds are buying" the sky's the limit. "[The speculative funds] certainly still have room to buy. Whether they are now still short [is questionable], but remember between February and May they went from being short to being long 50,000 contracts. They certainly have the wherewithal to buy a lot of contracts. As of last Tuesday they were short 10,000, so if they rebuild their long position that's a lot of buying."

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