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Seasonal gas storage pricing spreads reach new heights.

Since the end of the 2003-04 winter, the NYMEX gas futures market has been in a "contango" pricing configuration, which simply means that the price of the near-month NYMEX gas contract(s) is less than the price of the out-month contracts.

In comparison, the NYMEX futures market for crude oil is in a "backwardated" pricing configuration and has been for some time. In a backwardated market, the price of the near-month NYMEX contract is higher than the price of the out-months contracts, just the opposite of a contango market.

At the close of trading on Aug. 27, when the September NYMEX futures contract expired, the difference, or spread, between the average price of the two near-month NYMEX gas futures contracts (September and October) and the average price of the five winter-month NYMEX futures gas contracts (November '04-March '05) was just under $1.42 per MMBtu ($5.135 per MMBtu vs. $6.554 per MMBtu). See Figure 1.


The magnitude of this contango pricing spread is a gas storage operator's dream. Filling gas storage capacity in September and October at the average NYMEX price for those months on Aug. 27 will allow a storage operator (or its customers) to capture this contango pricing spread by hedging the stored inventory through forward sales during the upcoming winter months at the five-month winter NYMEX strip price, locking in the $1.42 per MMBtu gross pricing differential (less the cost of storage).

In investment terminology, the ability to capture this spread differential through a contango storage arbitrage position would yield a nearly 28% gross "cash-on-cash" return on the initial investment in stored gas inventory over a seven-month period ($1.42/$5.135)--an annualized rate of return of more than 47%. Not too shabby!

There are several factors that have acted in concert to produce this unusually attractive contango pricing spread for stored gas inventory.

First, the EIA's weekly gas storage inventory report issued on Aug. 26 reveals that, through the week ending Aug. 20, natural gas stored in inventory in the U.S stood at 2,614 Bcf vs. the year-ago total of 2,352 Bcf and the five-year average of 2,449 Bcf for the same time period. So, we're 262 Bcf or 11% ahead of last year and 165 Bcf or 6.7% ahead of the five-year average as of Aug. 20. With 10 weeks left in the traditional storage injection season, an average weekly injection of only 58.6 Bcf is required in order to reach a total of 3.200 Bcf by the start of the 2004-05 winter heating season. This is the generally accepted beginning-of winter total storage inventory level deemed necessary to ensure adequate supplies to meet winter season gas demand and should be reached without difficulty by the end of October.

Second, gas demand at the burnertip this summer has been lower than expected due to relatively mild summer temperatures in every gas-consuming region of the U.S except California and certain other parts of the far West. As of the end of August, the number of cooling degree-days (essentially a measure of air conditioning demand) was reported to have been 18% lower than the seven-year average. As a result, summer demand from gas-fired electric generation facilities was considerably less than in recent years, which in turn had a pronounced downward effect on natural gas prices as the summer progressed. With summer now essentially over, there simply is not much actual burnertip gas demand in the fall "shoulder" months to look for ward to, which has prompted NYMEX gas futures prices for this fall to retreat further still.

At the same time, however. NYMEX gas futures prices for this winter have held firm. The five-month average winter strip price on the NYMEX for the November 2004-March 2005 gas futures contracts closed at $6.554 per MMBtu on Aug. 27 and only a week earlier was poised to reach $7 per MMBtu as the price of crude oil on the NYMEX approached $50 per barrel. At the start of the spring 2004 storage injection season, the five-month average NYMEX futures strip price for the 2004-2005 winter stood at $6.179 per MMBtu.
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Title Annotation:Dancin' The Contango
Comment:Seasonal gas storage pricing spreads reach new heights.(Dancin' The Contango)
Author:Hopper, John M.
Publication:Pipeline & Gas Journal
Geographic Code:1USA
Date:Oct 1, 2004
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