Monday, September 28, 2009

Severe Contango in Action

Several times today I glanced at the ticker showing the natural gas near month futures price. It was a down day. At one point it was down about 6% and was trading about $3.75. A few minutes later I checked and it was at $4.80. My sudden burst of enthusiasm was tempered when I looked at the calendar and realized that today is three days before the end of the month, the day the near month futures contract expires. At some point during the day the various tracking indexes switched from the October 2009 contract to the November contract.

The difference between the October and November contracts illustrates contango, which is what traders call the situation when commodities futures prices are higher than the spot prices. Contango is a natural state for commodities markets because there is an implied cost of storing and financing commodities for delivery at a future time. But 33% between months is extreme. Part of this contango is seasonal because November is the beginning of the consumption months when prices are somewhat higher, but 33% is extreme.

Many people pointed at the extreme contango as a reason that natural gas prices will increase to the $5 to $6 range before the end of 2009. That optimism is tempered by the storage situation, which is approaching full. While there is available storage, the capacity number is a theoretical one. Most of the available storage is in the “consumption” areas, especially in the east, and not in the “producing” areas. If storage is filled up before the end of the injection season (October 31 or thereabouts), the spot price should plummet. If storage doesn’t fill up, the price should hold steady and hopefully rise. Not that I’m predicting anything…

[UPDATE 9/30/09: Here is a short article from the Wall Street Journal with more information about the transition between the Oct/Nov contracts and the coming end to the storage injection season.]

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