Natural gas has taken a pounding.
"Natty", as it's called in trading circles, has shed almost $10 in ten months, notching new contract lows last week following its explosion to $15 in the wake of Katrina.
The culprit was the warmer-than-expected winter.
Natural gas not needed to heat homes and business was injected into underground storage, leaving the market as much in need for it as the Savannah needs a sandbag.
Basically, natural is well oversupplied!
In a "normal" year these big supplies would probably be cause to leave this market alone.
But this is anything but a "normal" year...
Hurricane season may be upon us but natural gas is twice as cheap vis-à-vis crude as it should be.
At the same time, World War III may be in the process of breaking out in the Middle East.
And that folks, could change everything…
The exodus from the Gulf Mexico...
But war is not the only potentially bullish factor for gas...
Drilling rigs are being removed from the Gulf of Mexico and shipped overseas in the heart of hurricane season.
Nine days ago the Wall Street Journal reported an "exodus of drilling rigs from the Gulf to higher-paying gigs overseas".
In 2001 there were 148 rigs in the Gulf. Now, only 90 remain.
Five were destroyed by Katrina. The rest were sent elsewhere.
At the same time, the price of crude oil has skyrocketed, making natural gas a far cheaper alternative to crude and crude products for those end users who have a choice of fuels.
It takes roughly six units of natural gas to supply the same energy as one unit of crude oil based on the number of British Thermal Units (BTU) produced by each.
So, you'd expect one unit of crude to be around 6 times the price of natural gas.
With crude oil currently going for $75 per unit and natural gas currently trading for $5.70 per unit, crude oil is currently 13.16 times more expensive than natural gas.
This gives "Natty" twice the BTU bang for the buck, as my American colleagues say.
It means natural gas would have to double, rallying $12.50 from current levels, in order to get the ratio back to 6 to 1... and that's assuming crude oil rallies no further.
A hurricane doesn't have to hit to send the energy markets crazy... it's the thought that counts.
In fairness, most end users of crude products do not have the ability to change fuels – at least not yet.
However, enough do (power plants and other industrial users) to begin making a meaningful dent in supplies.
But what really could spark the next explosion in natural gas prices is another hurricane.
Considering the lingering psychological effects of Katrina, just the mere CHANCE of another big storm could send this market sharply higher in a hurry.
Spot gas rallied nearly $1.50 in June on news of a tropical depression with very little chance of damaging facilities in the Gulf.
I expect news of a real hurricane would have a far greater effect.
Natural gas is currently one of the most hated commodities on the board, making it all the more attractive from a contrarian standpoint.
And we love contrarian thinking here at Profit Watch!
Through thinking differently from the investment crowd, profits will be made.
Unfortunately, the December, January and February contracts have all priced in a big hurricane/heating season.
January futures are currently going for $10.54, a full $4.24 higher than the August contract. That’s a premium of 67% - a number that any gas trader worth his salt would find unacceptable.
October natural gas, on the other hand, has hardly any premium at all.
It's currently trading at 6.89 - a mere 59 cents higher than front month August.
Katrina and Rita hit in August and September last year. October natural gas contracts don’t expire until September 26.
It's enabling the "Natty" bulls to stay long through most of the hurricane season without paying through the nose for more time.
That's all from me this week.
Kind regards,
James Woodburn
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