Ask two traders about the direction of the natural gas futuresmarket and you will likely get two different opinions, and that wasnever more true than last week when Tom Saal of Miami-based PioneerFutures and Tom Riley of Riley Natural Gas spoke about hedging forproducers at GasMart/Power 2000 in Denver.

Saal favors a “keep-it-simple approach” to producer-side hedgingand looking at historical levels along with technical tools,believes prices have topped out. Alternatively, Riley, a producerhimself, points to what he feels is a “shifting paradigm” in thenatural gas futures market.

Saal favors a value approach to risk-management and hones in onthe $2.08 level, which he calculates to be the average of the last10 years of final settlement prices. Based on a normaldistribution, prices (May contract in the $3.00s) are now more thantwo standard deviations from the mean. “Looking at this simplechart, if you were to sell the contract right now, you’d havebetter than a 95% percent chance the May settlement will be lowerthan where you sold it. You probably won’t be up here too muchlonger,” he said.

A second way Saal looks at value is through the economicprinciple of marginal cost, which he associates with the mostexpensive gas or gas that has been put into the ground for storage.By looking at the final settlements over the past injection season,Saal calculates this cost to be about $2.40. And aside fromshort-term price moves to either side, which can be attributed tothe inelasticities of natural gas, he believes that the price levelwill naturally migrate back to marginal cost.

A third tool Saal uses to evaluate the price direction ofnatural gas futures is the Commitments of Traders report releasedevery two weeks from the Commodity Futures Trading Commission thattakes a snapshot of all the open positions in all markets in theUnited States. By comparing large commercial traders’ position withrespect to the futures price, Saal has drawn some conclusions. “Youcan see that when the market is moving up, commercial traders areputting on short positions, and when prices are going down, theyare increasing their longs,” he said. According to the latestreport released last Friday, which covers data through April 4,large commercials are net short 37,873. Although this is not alarge net short level from an historical perspective, it deservesmention because it appears that they have stalled out at this leveland historically they have shown that once their appetite forshorts subsides they typically start to accumulate longs, he said.

“Natural gas, as we know, has a short-term inelasticity factorwith all kinds of weather, et cetera, which can push prices uppretty fast and also push them down pretty fast,” Saal said. Themoral of the story is that prices should always migrate back tomarginal cost.”

However, while Saal believes prices will revert back to morenormal levels, Riley remains cautiously bullish. His foundation forthis sentiment lies in his assertion that there is a shiftingparadigm in natural gas.

“As a producer I would certainly like to believe that we are nolonger in the $2.00 area but that we’re probably up in the $2.50-60range. We hope prices will be much higher than that in times ofshortfall, and in other times of the year it will react and comeback down.”

He attributes the shift to a possible shortness of supply andthe current storage level, which was reached during record warmththis winter in the Northeast. “In the Pittsburgh area, which seemsto be about the median of degree days, a year ago we were 9.3%warmer than normal. This year through March we were 12.5% abovenormal. So here we have a winter which is over 3% warmer than lastwinter but the storage levels are 300 Bcf under.”

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