Whee, it sure is fun being a natural gas trader, don’t you think?
Bloomberg yesterday reported:
Natural gas futures plunged 10 percent, the largest one-day drop in almost three years, as warmer-than-normal weather slashed demand for the furnace fuel….U.S. heating demand will run 30 percent below normal for the next week and 22 percent below normal from Jan. 2 to Jan. 6, according to Weather Derivatives, a Belton, Missouri-based forecaster…. Prices are down 30 percent from a record $15.78 per million Btu on Dec. 13 and are the lowest since Sept. 13.
Yes, the weather’s been nice in New York, but a 30% price drop? Another relevant fundamental here is the price of oil. Many firms have the ability to switch between oil and natural gas depending on price and availability. Longer term, consumers or firms making a fixed commitment to oil or natural gas will of course look at the relative prices. Furthermore, it’s possible to produce a synthetic liquid from natural gas that makes an excellent jet or diesel fuel.
A barrel of oil has about six times the energy content of a thousand cubic feet of natural gas. The graph at the right compares the price of natural gas with that of crude oil using a price comparison factor of 6:1. Between December 2003 and July 2005, oil prices shot up about 50% (logarithmically) whereas natural gas was only up 25%, leaving gas undervalued relative to oil. Between July and October, natural gas was up 50% logarithmically with oil little changed, leaving gas relatively overvalued. At least part of the recent drop in natural gas prices may be a correction to that.
If you speculate in commodity prices, don’t forget the long-term fundamentals. Or your Tylenol.