The price spread between natural gas and crude oil hasn’t been this high since 1990. Is a natural gas long position every buy and hold investors dream? Goldman Sachs doesn’t necessarily believe so:
Closing: Long oil/gas ratio trade
While demand stabilization in the petroleum markets has slowed the build in petroleum inventories and, consequently, has lent support to crude oil prices, natural gas prices remain under pressure. This has been particularly the case as cooler-than-average temperatures led to lower demand and associated higher than expected natural gas
inventory builds. Although we continue to expect the oil/gas ratio, currently at 20.7 in the prompt (September) contracts, to increase further between now and the end of the
summer on the back of improving oil timespreads, we believe this is a good exit point for
this trading recommendation. This is especially so given the downside risk we currently
see for long-dated oil prices, which are currently above our estimated marginal cost of
production. Hence we are now closing our long oil/gas ratio trading recommendation at a
total profit of 3.37.
A large hedge fund disagrees with the Goldman position. This intriguing trade crossed my desk yesterday. Apparently an undisclosed big player is betting on much higher Natural Gas prices in the coming moths. The FT reports:
A hedge fund has made a large bet that natural gas prices will triple by winter just as the price of the commodity slides to a seven-year low.
Traders took notice last week when the fund, as yet undisclosed, spent millions for the right to buy US natural gas at $10 (£6.03) per million British thermal units in January and February, up from Wednesday’s spot level just above $3 per mBtu.
“This is the first bullish play I’ve seen in quite a while,” said Raymond Carbone, president of Paramount Options on the New York Mercantile Exchange floor. “It caught the eyes of people in the [options] ring.”
The bet echoes purchases of call options – contracts that give the holder the right to buy at a fixed price and date – in late 2007 to cash in if oil moved to $150 a barrel by mid-2008.
The options were referred to as “lottery tickets” at the time because of their low cost and high potential reward, but the move paid off when oil surged.
US gas futures on Wednesday fell to $3.049 per mBtu, the lowest in seven years, as the market remains over-supplied. However, some say there is potential for a recovery once drilling rig shutdowns due to weak demand over the past year start to bite.
Ben Dell, an analyst at Bernstein Research, said that with US natural gas output falling 30 per cent this year, the steepest rate ever, a glut will turn into a deficit and prices will rise. But forecasters do not expect the market to hit $10 per mBtu soon.
Yet the hedge fund sees a chance of a spike. For months, an average 2,000 gas call options have traded each day for the New York gas benchmark contract. Last week, however, volume spiked one day as 10,000 January $10 calls were bought. Over the next two days, nearly 8,000 February $10 calls traded.
The slim chance of reaching double-digit territory was reflected in the price of the call options. January calls sold last week for about 5.6 cents, meaning that buying 10,000 contracts cost $5.6m.
Chris Thorpe, at Hudson Capital Energy, a New York options dealer, said the fund could be a winner even if the spot price did not reach $10. “If a 5-cent option goes to 10 cents, they’re happy,” Mr Thorpe said.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.