Thursday, September 3, 2009

Natural gas prices below zero?

How low can natural gas prices fall? The commodity is now down almost 60% from the beginning of this year.

This has to be the bottom, right? Maybe not so fast. From the FT: "A 2006 gas glut in the UK briefly pushed wholesale prices there below zero." How's that possible? It is possible when you have too much supply and not enough storage.

The chart below shows just how steep the natural gas futures curve has become.

If you own a storage facility with capacity, you can buy gas in the spot market, sell it in the futures market a couple months out, and generate over $1/MMBTU a month, or over 40% per month! Of course there are the financing and the storage costs. But it's still a great return. So why aren't people doing that?

In fact people are doing that, but most already got into this trade earlier. And as everyone was storing gas, the US storage capacity became increasingly limited. We are now significantly outside the historical levels for the amount of gas in storage (chart below from EIA) and the store-and-sell-forward trade doesn't work any more.

The demand for power has declined because of the slow economy as well as mild weather, which is limiting demand for gas. As market participants get deliveries of gas, some have no place to store it and are forced to sell at lower prices. That's how UK prices once dipped below zero.
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