For the longest time it seemed that natural gas prices hovered around $2-3 with a spike here and there. Now the range is $5-10. Oh, how times have changed. Speakers at GasMart 2007 in Chicago Thursday remembered the old days, briefly, while they advised attendees on how to deal with the new era of prices.
“It’s not that long ago that we saw gas below $2, and when you looked out at that [Nymex] forward strip… it didn’t make any difference if you were going one, two, three, four, five, 10 years out, it was $2-3,” remembered Janelle Scheuer, Wachovia director of commodity derivatives. “Well, we’re not there any more, and I think you all know we’re not there any more.”
Indeed, the current market conditions — high (if you’re a consumer) and volatile gas prices with no end in sight — are anything but ideal for consumers. And the old risk management tricks don’t work quite as well or as easily as they used to, pointed out Jerry Afdahl with Cargill Risk Management’s energy derivatives marketing group. Consider the choices:
In other words, “It’s great if you’re a natural gas producer in Midland, TX, who already has gold-plated horns on his Hummer, but for consumers it’s not good,” Afdahl said.
For consumers braving the market, one of the strategies Scheuer offered is the buffer hedge, a means of combining a swap with the sale of a call to yield a discount on the swap and provide upside protection (an index-minus price) at the same time. This type of transaction is typically popular with local distribution companies who must go before their regulators and demonstrate prudence in their commodity purchases, she said.
In a gas market like the one with which the industry is dealing today, knowing when to buy/sell and when not to is key. Afdahl enumerated a number of trading room pratfalls that he said have likely befallen many in the industry. One is “cancel if close,” when management calls for the cancellation of a trade because it expects the market to go lower. It does, but then bounces right back up again, and the price of the previously attractive but canceled trade is lost.
Another is “missed it by that much,” where the market drops but the buying trader can’t act because he or she can’t get clearance from management. By the time word to buy comes through the market has gone back up. Then there’s the “oops, I got it,” where a buyer puts on a hedge and then five minutes later the market drops. Finally, Afdahl recounted how traders can time the market perfectly and hit their targets and the board of directors only says, “‘Why didn’t you do more?'”
As for knowing when to be a buyer, a seller or neither, the third speaker on the panel, Tom Saal, Commercial Brokerage Corp. managing director, said stochastic analysis can be a good source of market signals.
“What a stochastic does is try to measure the level of the cycle of the high and the low [prices],” Saal said. “As it reaches a high it quantifies it by creating a range from 0 to 100%. If the numbers are close to 80-100% it’s considered overbought; below 20% to zero it’s considered oversold. The idea is that simply when the indicator is oversold, you want to have your buying cap on.”
In other words, Saal looks to what traders are doing more so than to market fundamentals.
“These charts are about what human beings are trading in the marketplace and not necessarily about what commodity we’re talking about,” he said. “We’re talking about human behavior.”
Saal also presented a bell curve of natural gas trades dating back to January 2006. The peak of the bell curve was $7.25, the most popular price for natural gas during the period. A hollow area of the bell curve was in the $8-9 range. “We’re going to trade back to $8-9 in the near term, probably in the next month or so,” Saal said. “And $7.25 is where when the market starts to fall it’s going to hit a rock bottom there because all of the traders in this market have said that’s the value. That is the most popular price for natural gas. Coincidentally, it’s almost halfway between your $5 and $10 range.”
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