Morning Thoughts – Oldinvestor

Looks like the market is continuing down the same path. Production is suffering, even closer to the next bankruptcy or shut in contender. LNG is still the bane of Natgas, not yet showing signs of letting up. The prices is still bound to this range near, and below $2. I’ve not traded UGAZ for a while now. Might take this moment to mention contango is strong right now.

For anyone reading this that doesn’t know what contango is, essentially July contract is priced higher than June contract, that’s contango. When the next contiguous contract is priced higher than the prior contract.

Current prices of NG at Barchart.com

As you can see, there is contango for at least the next 5 months. I didn’t show Dec being 40c higher than Nov, and Jan 15c higher than Dec. 7 months of contango. This is some very big contango.

What does it mean? When UGAZ/UNG/DGAZ/BOIL/KOLD roll out of one contract into the next, they basically sell at the current price, and buy the next contract at that current price. All these ETFs have taken the money in the fund and I think are all holding position in July contract. July will eventually expire, so they must “roll” to the next contract. Simply put, if if an ETF were to roll based on the prices above, they would sell July at $1.874, and buy Aug at $1.950 (Or short if DGAZ/KOLD). So this doesn’t change the value of the ETF, it is simply moving the funds invested from one contract to the next. LIke if you had a million dollars worth on July contracts, you sell them and buy Aug, you still have the same value of contracts, but fewer contracts.

Why does the price of UGAZ keep falling. This contango is caused by the market believing that prices of natgas will be worth more in the future. For example. Maybe COVID 19 will at least be lesser of a problem in August. So the world will start using more natgas again, and no LNG exported loads have been cancelled yet for August. So August contract is worth more now, because the market believes demand will be higher than during July, making Aug contract worth more than July. UGAZ may roll into August contract with wide contango (the price of Aug being much higher than July), then something upsets the market price for August and UGAZ price falls further.

Let’s say $3 is the happy place for natgas prices, and I have a call to go to. i should return.

Back again. $3… Happy place… It is my impression that as long as nothing “bad” is expected for a given month, prices will gravitate toward $3. This is the price producers can make just enough and consumers aren’t too displeased. So June is in the worst shape because a bunch of LNG loads were cancelled, and that’s going to put a damper on the market. LNG loads have been cancelled for July, that’s another bearish event. No LNG cancellations yet for August, leading to higher demand, but the market isn’t going straight to $3 because the likelihood is still high that there will be a demand disruption, such as more LNG exports cancellations.

I think I’ve beat this to death. I want to look at one example of the contango problem for UNG/BOIL/UGAZ. Rolling from July to Aug contract, is 7.5 cents of contango. If August decides to move 7.5 cents lower, that is roughly 3.85% lower for UNG, 7.7% for BOIL, and 11.5% for UGAZ. These would be the losses due to contango, and August catching up to July, by falling on more bad news directed at August natgas markets.

The reverse of contango is backwardation, If June prices where higher than July, or July higher than August contracts. Because the discovered this supper efficient exploration method called horizontal drilling and fracking (into shale formations), we have found more gas than we need for quite some time, putting constant pressure on pricing. Contango is much more common than backwardation; this will continue to be the case as long as shale drilling is commonplace and greed will always drive competition up in the public sector. Well… as long as back room deals are kept under control. Even if half of all natgas production goes bankrupt right now, prices swing to $10 this winter, it won’t take long for shale production to ramp up and we’ll be back to low prices, and contango once again.

Even UNG is affected by contango…

UNG Seasonality y-o-y at Stockcharts.com

In the last 12 year, UNG has ended higher than it bagan only 3 times. Only once has UNG ended 10% above where it began, and all losing years are 25% or greater. Maybe I should be shorting UNG instead of going long. That’s for another post, another day. Day jobs are good. Hope your weekend has been good to you.

Oldinvestor