Calling Natural Gas Experts – Let’s Find a Trade Here

Long time readers may remember an old post I wrote about how futures prices in markets like the S&P 500 are not predictive – they are derivative from the spot price based on carrying costs (dividends and interest).   There are a lot of futures prices that are like this: basically, any commodity which can be stored without perishing.   Which brings me to the question at hand – a subject I am not an expert in, thus I am asking the audience:  Natural Gas ($UNG).

If you look at the current natgas futures curve, you’ll notice that it’s in steep contango: further out months are trading at a significant premium to current months.   Some people make the mistake (well, as noted, I’m not a natgas expert, but I believe it’s a mistake) of thinking that this means that future nat gas prices are expected to be much higher than current levels.     For example, the May 2012 contract is trading at roughly $2.00, while the October 2013 contract is about $3.30.  That’s 65% higher for a contract about 18 months out.  The question is: why?     Well, let’s think about it:  how do you capitalize on these prices if you’re a big hitter?   You buy the near future, take delivery of natural gas, store it, and sell the far future.   This can be done with natgas, right?   Your profit is 65% minus your cost of storage.

This of course begs the question:  how much does it cost the big players to store nat gas for 18 months?   I have no idea, but I wouldn’t think it would account for that whole spread.   In fact, looking at the rest of the curve (ie, the early 2013 futures expirations) – it doesn’t look like ongoing storage costs are the issue.   I would guess that the bottleneck is in the storage capacity-  the equipment/tankers needed to store the natgas, or perhaps the pipelines needed to move it to where storage is available.

In other words, if there were ample, cheap, storage capacity for natural gas available, we wouldn’t see this kinds of futures curve pricing: we’d see people doing exactly what I described above:  buying the near month, taking delivery, storing the product, and selling the far month.  Rinse, repeat, profit, until the pricing variation collapses.

Now, I am sure that I’m not saying anything too enlightening for natgas experts here – this is something that you all know already.   Nevertheless, I think this thought experiment is a good one for most readers to understand why futures prices look like they do.

Finally, it brings me to the question:  how do we make money off of this?   Which companies are in the business of natural gas storage, and are they set up to increase capacity to capitalize on the current state of futures prices?

I’ll leave that to my readers for the comments section.

-KD

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