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Gas Futures Have Phenomenal Week, Hold Above $4

Gas Futures Have Phenomenal Week, Hold Above $4

The natural gas futures market had one of its more volatile weeks last week as daily price fluctuations averaged more than 20 cents and price ranges averaged a substantial 28 cents. As of Friday afternoon, the July contract stood at a lofty perch of $4.160/MMBtu, 11.7 cents higher than the previous Friday and 94.3 cents above where the near-month contract stood one month earlier.

The 12-month strip now rests at $3.938, a record level, and the July contract twice in the past week and a half has come shockingly close to the all-time high for any gas futures contract of $4.60 set in the winter of 1996-97. And it is the beginning of summer.

As close as July has come to reaching a new peak, however, it has come equally close to plummeting back into the mid or low $3.00s, according to some sources, who expect the extreme volatility to continue until near-month futures can either take out support at $3.80 (the low on June 1) or bust through resistance at $4.55, "a nice friendly little trading range."

"One of the main characteristics of this market for the last week has been that you get these wide swings and clear out all the resting orders. We've cleared them all out above and below, and there's nothing but a vacuum in here. If this market wants to move in a direction, there's nothing that's going to stop it, so expect to see it move 15-20 cents a day," said Ed Kennedy of Pioneer Futures.

Because July took out $4.185 on Friday, Kennedy believes it will continue into the "upper reaches" of the recent trading range. "...I'll guarantee you there will not be any selling up there to stop this thing. That would tell me to expect a move back up to the $4.30s and $4.40s."

But if you ask what brought the market to these price levels and why the 12-month strip is at record highs, Kennedy has no answer. "It doesn't make any sense," he said. "Oh, by the way, there's more demand in the wintertime than there is in the summertime. We got through the winter with low prices in a high demand period, and now we're in a low demand period and you're telling me that the strip is worth $3.93. I think it's a bunch of hype."

Kennedy blames the high prices and increasing volatility in part on the "noticeable absence of the natural short sellers, the large producers" and the on the absence of many end-users in the market. "The structure of the market is really interesting here. It lends itself to being controlled by the large marketers." The end-users didn't have a good opportunity to enter the market during the shoulder months this year, he added. They didn't get their seasonal slide in gas prices during the shoulder months so they're currently under hedged. The producers, he said, historically have been reactive rather than proactive and only recently have stepped in to lock in the attractive strips.

Despite the hype that may be affecting prices, there are quite a few bullish factors that can be identified. Number one is the low inventory situation in storage, although its impact was far from bullish last week. The American Gas Association reported a higher-than-expected injection of 78 Bcf into the nation's gas storage facilities last Wednesday and the July contract plummeted 34.9 cents to $3.945. Despite being the smallest injection for the week ending June 2 in the last six years, many observers had been expecting even less than 55 Bcf, given the significant lack of incentive to store gas at these prices. The current backwardation in the futures market, with high prices in the near months and lower prices in the outer months, provides little or no incentive to buy gas and pay to put it in storage for next winter.

The 78 Bcf storage injection report apparently "spooked some people" because if next week's report shows another 78 Bcf injection, it would show a smaller deficit compared to last year for only the second time this season, noted Kyle Cooper, futures research energy analyst for Salomon Smith Barney.

"Quite honestly, that injection came in 20 Bcf above what I had estimated. I was thinking it was going to be 58 Bcf so it shocked me as well. I think it's the first time that you've seen injections above 10 Bcf/d [this season]."

At 1,352 Bcf (41% full), working storage levels are 442 Bcf less than levels at the same time last year and 183 Bcf less than the six-year average. Even if the injection pace for the rest of this season matches that of last year, a lower-than-average year, working storage levels still would end the season at historic lows of 2,500 Bcf. If injections are able to reach the average pace of the past six years, working storage levels would end the season at 2,750 Bcf, which still would be much lower than average.

The market also got its first weather scare of the hurricane season, a tropical depression that was about 425 miles southeast of Brownsville, TX, Thursday morning in the Gulf of Mexico, but the system degenerated by late afternoon into a broad area of low pressure with a few 30 mph squalls.

Meanwhile, renowned hurricane forecaster Dr. William Gray and his team of soothsayers at Colorado State University announced last week that they are raising their projections on hurricane activity this year. The number of named storms now expected this season is up to 65 from 55. They also upped the ante on hurricanes to eight from seven, predicted 35 hurricane days instead of the earlier April forecast of 25 and now believe there will be four rather than three intense hurricanes in the Atlantic Basin this season (see related story this issue).

With low storage levels, increasing demand from new gas-fired generation plants, flat production and few cyclones added to the mix, the gas market appears is poised for further growth despite already being near record levels, according to some observers.

"The thing is going to go a lot higher, but before it does it has to build a base," said Ira Hochman of New York City-based Trot Trading Corp. "They tried testing the highs the other day (Tuesday), and as soon as they lost day structure it just collapsed. There's a double top at $4.55 and $4.50. If we break through $3.80 that will confirm those tops and we'll probably pull down to the $3.60 or $3.70 level. We could still pull back to $3.25 and still be good [for another rally]. I mean there's a lot of wind in this thing." Hochman, a local floor trader, said he's in this market for the long-haul and expects gas prices to potentially move above $7 over the next couple years.

Peter Hattersley of Rafferty Technical Research said he sees more optimism in this market than ever before at these high prices. "I don't know that it's going above this because there always has to be somebody to buy it, and optimism and buying are two different things. But you've got just a tremendous amount of optimism. People are buying $6, $7 and $8 calls. I've never seen that before over the counter."

Rocco Canonica

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