Besides an uneventful 2013 hurricane season, which “technically” ends on November 30, the natural gas injection season is also coming to an end. According to the Energy Information Administration (EIA) storage injection report released on November 7, 2013, natural gas inventories are 1.5% above the five-year average. The latest near-term weather forecasts suggest that the gap will increase during the next two or three weeks. In other words, according to the EIA, there should be sufficient natural gas in storage to meet the projected natural gas heating demand for the upcoming winter.
So what does this mean for natural gas and power prices in the coming months? Approximately 50% of American households use natural gas for heating purposes. It is no secret that volatility in natural gas rises and prices tend to increase prior to and throughout the winter season as the market gauges future heating related demand. Traders monitor weather forecasts very closely, and they make decisions to buy or sell as weather forecasts shift the outlook on heating demand across the most populated regions of the country.
The Weather Outlook
Early forecasts, such as The Farmers’ Almanac, called for a harsher than normal winter. The following map shows its forecast, which was released in late August.
Source: FarmersAlmanac.com
While this report set off a flurry of discussion, recent prognostications using more advanced scientific methods have been calling for a more mild winter. According to AccuWeather, the winter season will get a later start with November being overall above normal in the Northeast and winter not fully taking effect until sometime in Mid-January. The following map depicts the winter forecast AccuWeather is predicting:
Source: AccuWeather.com
A wide range of winter weather forecasts leads to the big question: what does this mean for the natural gas and power prices over the next several months?
The worst case scenario
If the Farmers’ Almanac weather prediction is correct, this is going to be a particularly nasty winter, where cold temperatures could spark a rally in natural gas prices. With this scenario, we see greater probabilities of price risk to the upside. Natural gas forward prices can move suddenly and significantly, especially nearer the front of the forward curve. Lately, price swings of +-$.14/MMBtu in the front months are not unusual. A good example of adverse price movements can be seen from the price action that occurred between 10/4/2013 – 10/15/13 when natural gas prices rose $.35/MMBtu. From an energy risk management perspective, end users should protect against adverse price movements consistent with their risk profile and performance expectations. It is critical to understand risk tolerance as a function of the impact in budget goals being derived from price swings on open exposure. A disciplined and proactive energy management approach is required to lower energy spend and optimize savings.
The best case scenario
If the milder weather scenario, which is being forecast by more scientific means, is accurate, this could create downward pressure or limit the upside on natural gas prices. Recent price action clearly shows the impact of weather on prices. Between 10/25/13 – 11/4/2013, prices dropped approximately $.40/MMBtu due to the expectation of lower heating demand during the first half of November. This drop was a complete reversal from the rally discussed previously. The bearish trend has breached significant support levels; however, there has been bargain hunting recorded around the $3.50/MMBtu mark. Nevertheless, the mild weather scenario could further weigh on prices and compound the effect of the bearish fundamental drivers that are currently in play:
- Record natural gas production
- Below normal nuclear plant outages
- Robust inventory level
What does all of this mean?
Currently, weather is seen as the main wildcard for price action. In the near-term, there is room for technical short covering correction and additional bargain hunting. The upside will be limited until there are clear signs of sustained cold temperatures.
In light of all of the variables involved in generating winter forecasts, it is close to impossible to accurately predict specific weather conditions months into the futures. With conflicting forecasts, it can be difficult for end users to determine the absolute best course of action. Talk to your energy advisor to develop a sound risk management strategy that will help you to better manage energy spend and maximize savings. Being exposed to natural gas prices during the winter months is a risky proposition. It is important to understand that natural gas price volatility is well correlated with electricity prices in markets where natural gas is the marginal fuel (e.g. Texas, Pennsylvania). Therefore, increases in natural gas prices will impact electricity prices in those markets in the same direction, but to a lesser degree.
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