Excell with Options: What's the winter forecast for natural gas prices?
Executive summary
In this article, Rich Excell discusses weather forecasts, supply and demand dynamics, and the positive moves in the Natural Gas futures market. He then details the use of a broken wing butterfly spread to express a bullish position.
Earlier this summer in another Excell with Options article, I wrote that Natural Gas futures may be at an inflection point, with fundamental and technical catalysts emerging. Traders can create spreads to capitalize on directional moves with attractive reward-to-risk and leverage, but risk management is essential.
While it took a few more weeks than expected to breakout, Natural Gas futures prices have indeed moved off the low prices that plagued the late spring and early summer period. Can this price action continue?
Image 1: Relative performance of all CME futures products the past three months
In fact, over the past three months, the Natural Gas futures market has been on fire. Natural Gas futures have been the best performing futures product, doubling the gains of bitcoin and becoming one of the few markets to move positively in what has been a negative summer for most markets. On the one hand, traders may look at this price action and think to themselves that perhaps we have moved too far too fast. This mindset may point to a mean reversion type of idea. Other traders will note that futures had been down for such an extended period, and sharply from the previous year, that this move is only the beginning of what may transpire.
Image 2: One year chart of natural gas spot prices
The chart above comes courtesy of EIA and shows the extent of the negative price action over the course of the last two years. Having peaked at close to $10 / BTU in the summer of 2022 on the back of the massive shortage of global energy supplied, particularly in Europe, prices had fallen to $2 / BTU by the start of 2023 and stayed there for the first half of the year. From this vantage point, the move in spot to about $3 / BTU is a tiny fraction of what could happen going forward, not that the prices we saw in 2022 were anything close to what we normally might expect. However, even before the shortages in Europe, we saw natural gas spit in the $4 to $6 / BTU range, which does suggest there could be remaining upside.