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Dangerous to Stay Unhedged, Analyst Says; May Falters

May natural gas futures were limited to a narrow 6-cent trading range and fell nominally as risk managers noted an uninspired market, and described their methodology for wringing value from a low-volatility trading environment. At the close May had eased 2.3 cents to $4.389 and June shed 1.4 cents to $4.452. June crude oil lost a penny to $112.28/bbl.

"When you get into these trading range markets, you almost have to change your trading personality and learn to fade rallies and buy dips. This market recently has been like watching paint dry," mused an Oklahoma banker.

"I learned this a long time ago that when you get these one- to two-week up moves, you learn to be a fader, and if you get a dip, you buy something away from value. Right now if you get a price from $4.40 to $4.60 you've got to sell and if you get a price down at $4 and the market struggles, you have to be a buyer. You almost have to have a contrarian view until something proves different," the banker said.

The banker admitted that his time horizon was relatively short and his objective was to achieve favorable pricing for his clients for the balance of the year. "You can argue that in the fall of 2010 we started building value at around $4 and if you look at a continuation chart since then, we have been in a $3.50 to $4.50 range. We do hedge some gas on rallies above $4.50 and if we get the strip for the balance of the year above $4.50 to $4.75 and individual months above $5, we will sell those. We are selling rallies, but we are not going out two or three years. We are trying to take advantage of favorable prices for the balance of the year.

"I haven't developed a strong opinion about selling $5 gas in 2012, but if the strip got up to $5.40 to $5.50, it would be very hard not to fade that and buy a $5 put option and sell a $6 call option and at least you [producers] have a $5 floor. We have been pushing our clients that if you can get anything close to $5, you should take it. They are playing defense now, and if prices rise, you may leave a little on the table, but to be completely unhedged has some danger. We could go back to $3.50 one more time. Some people rely on hope in these bear markets, and that can be real, real dangerous," he said.

"It's only the horizontal plays that justify drilling for gas at these [price] levels and we've heard enough excuses of trying to hold leases and rich gas, but are these guys happy getting a 10% return for the risk they are taking? I don't know."

Perhaps a 10% return for drillers and producers won't be around much longer, for open interest data shows a significant shift in market sentiment from the short side of the market to the long side. In its most recent report the Commodity Futures Trading Commission (CFTC) showed greater interest in long futures and options and a migration away from the short side of the market. In its most recent Commitments of Traders report the CFTC for April 19 showed managed money at both the IntercontinentalExchange (ICE) and the New York Mercantile Exchange increased long futures and options contracts and liquidated short futures and options.

At the ICE long futures and options (2,500 MMBtu per contract) increased 38,977 to 311,534 and short holdings fell 19,784 to 47,247. At the New York Mercantile Exchange long futures and options (10,000 MMBtu per contract) rose by 1,829 to 142,142 and short positions fell by 4,157 to 231,274. When adjusted for contract size, long futures and options at both exchanges rose by 11,573 and short contracts decreased by 9,103 to 4,157.

For the five trading days ended April 19, May futures rose 16.4 cents to $4.262.

Others are also taking a short-term market approach. Mike DeVooght of DEVO Capital, a Colorado-based trading and risk management firm, is looking to take gains on earlier sales of put options. DeVooght had suggested trading accounts hold on to short May-July $4.00 put options sold earlier at 12-14 cents for a 30% position, but he recommended taking those gains Monday. Those end-user accounts that had made the same trade were also advised to book their gains Monday.

Producers and those with exposure to lower prices were advised to hold on to a May-October $4.50 put position offset by the sale of $5.50 calls at even money for a 10% position.

DeVooght feels that there has been little change in the fundamentals of the natural gas market. "Production is more than adequate, [and] demand is flat because of relatively slow economic growth in the U.S. Also, a huge negative for the gas market is the lack of urgency by end-users to lock in forward prices. There tends to be the feeling that if they wait and buy it in the spot market, it will be cheaper than it is on a forward basis," he said in a morning note to clients. DeVooght is not certain what is likely to change this prevailing market sentiment among end-users.

Although weather is typically not a dominant market driver during the shoulder period, forecasters are calling for periods of warmer temperatures in portions of populous energy markets on the East and West coasts and a cooling trend in the Midwest.

"In addition to three days of warmth for East Coast cities this week, we are also watching some quick heat spikes in the Los Angeles area midweek and then toward early to middle next week as well," said Matt Rogers, president of Commodity Weather Group in Bethesda, MD. "Like previous events, we could see upper 80s to low 90s there, while the East Coast warmth is mostly low to mid 80s (although some higher spikes are possible). Otherwise, the pattern is still trending toward more North Atlantic ridging and a cooling response over the Midwest, East and sometimes the South in the six-15-day [forecast]. By that point, the main warm-to-hot area is in the Southwest, sometimes Texas, and sometimes SoCal."

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