The natural-gas market is heading into its most volatile trading time of the year, as market participants start to look at the winter forecast for many northern parts of the country that use the fuel for heating.
Seasonality charts on EquityClock.com from the past 20 years show natural-gas futures prices can rise up to 25 percent from September to December, with most of the gains coming in December. Gas prices start sliding in the first quarter as winter winds down and the need for heating fuel is lower.
Because of the chance for big gains heading into winter, some investors look to the natural-gas market for small, tactical trades. There are nine natural gas exchange-traded products, and to underscore how some investors try to ride the wave of the natural gas market’s inherent volatility, three of the top five ETPs by assets under management are leveraged securities.
But the advisors who are considering adding natural gas exposure either for tactical reasons, or for a strategic energy position, should understand how this commodity market works.
Bob Iaccino, co-founder and chief market strategist of the Chicago-based trading firm Path Trading Partners, says natural gas is similar to crude oil since they both are affected by supply and demand factors, and both have seasonal timeframes when prices can be higher. For crude oil, it’s the summer driving season; for natural-gas, it’s winter for heating needs. Natural gas is also used for summer air-conditioning use, although to a lesser extent.
The Energy Information Administration at the U.S. Department of Energy notes that suppliers put natural gas into storage from April to October, a period known as “injection season,” to help buffer some of the winter withdrawals. Starting about July, natural-gas prices start falling as the supplies grow, and then prices rise again in autumn. Futures markets estimate values one to three months ahead of time, which is why prices can rise before winter strikes, Iaccino says.
“The interesting part about natural gas is you … have to be able to look at the weather and understand what weather is affecting which region of the country,” Iaccino says.
When estimating prices, traders will compare current forecasts with the previous year’s forecast, he says. Traders also receive weekly data about supply and demand, which can make natural gas prices more volatile than other commodities.
Also critical to understanding natural gas is the price curve. Normally prices are in contango, where deferred futures prices are higher than nearby prices, which reflects storage and other future costs. When a futures contract expires, prices roll over to the next most-active contract. However, exchange-traded products based on nearby futures can suffer from “roll drag,” meaning they don’t track the actual futures price as closely. When futures contracts roll over from the expiring month’s contract to the next futures contract, traders sell the often-cheaper, expiring contract and buy the more-expensive contract.
That’s an issue with any ETP that follows front-month futures contracts, like the biggest non-leveraged natural-gas ETF, the USCF United States Natural Gas Fund (UNG). According the USCF, UNG tracks in percentage terms the movements of natural gas prices as measured by the NYMEX Henry Hub natural gas futures contract. Because there are monthly expirations in natural-gas futures contracts, UNG rebalances monthly to reflect these changes.