Calling the period that the energy markets are entering a “dramatically new phase,” Alan Levine, senior vice president of the Morgan Stanley Private Client Futures Group, said higher natural gas prices — mainly above $6 — are likely here to stay.

Speaking at GasMart 2004 in Denver, CO, Levine said that the risk management marketplace has changed significantly, noting that the distribution of players has shifted. In addition, Levine pointed out that new entrants are emerging and current business models are changing, with tighter controls on trading functions being implemented.

“After a 20-year period that commodity prices in general have been falling, they are now starting to recover for a whole variety of reasons,” Levine said. “So, they become a place of interest for new investment.”

Backing up the fact that the natural gas marketplace is changing, Levine pointed out that from January-June 2002, 66% of the Nymex natural gas futures market participation in open interest came from marketers. From January-June 2003, the marketers share of participation had dropped to 56.5%, with funds, the financial community and floor traders taking up most of the slack.

“It’s these changes that have changed the risk parameter of what’s happened in the market,” he said. As to what caused it, Levine said a host of events forced the shift to Nymex clearing:

Touching on the Enron scandal and the collapse of the energy merchant sector, Levine said “it was hardly felt on [Nymex]…We didn’t see a huge variation in prices” directly as a result of the fallout.

Looking ahead, Levine said he is expecting the natural gas futures market to get even stronger in the weeks and months ahead. He added that he wouldn’t be at all surprised if the current $6-plus natural gas futures market rose “considerably” higher.

He said the next good shot to be a buyer may come sometime in July or August, but there are no guarantees this year. There wasn’t even a shoulder period like there had been in the past, he noted. “I don’t know when there will be [a shoulder period]…because gas doesn’t trade on its own, it trades in conjunction with all other energy.”

With crude oil and gasoline setting new all-time highs, Levine said he doesn’t see natural gas receding lower anytime soon. “I don’t see in the current environment, the [natural gas] price settling back in any dramatic way. While we fully expect some sort of setback, we are now skeptical it can go much below $6.” He set a top of around $7.40, but added that it wouldn’t surprise him if it went higher.

Levine also said that if Middle East tension disrupts oil supply, it is conceivable that crude could top $50 and certainly would put more upward pressure on natural gas. By the same token, a collapse in liquids prices also would put downward pressure on natural gas prices.

Thomas Riley, executive vice president-Production, Natural Gas Marketing and Business Development for Petroleum Development Corp., said he currently is employing a strategy of buying puts below the market and selling calls above the market. Because of his bullish outlook of the market, coupled with the fact that call options are generally more expensive than puts, Riley buys twice as many puts as calls that he sells. Specifically, he might sell a $7.00 call for roughly 80 cents and use the proceeds to finance the purchase of two $6.00 puts. This asymmetrical options strategy allows him to capture two-thirds of any run to the upside, while limiting his exposure to a price collapse to just a third of his production.

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