» » Natural Gas – Tale of two seasons (Bearish Summer/Bullish Winter)

Natural Gas – Tale of two seasons (Bearish Summer/Bullish Winter)

  • Natural gas vol curve is behaving as if both scenarios where Summer20 ends up closer to or greater than 4Tcf and Winter20-21 ends closer to or less than 1Tcf are likely leading to a bearish Summer20 and bullish Winter20-21 scenario
  • The bearish story is dominated by the LNG overhang created by record hot winter we had in US, Europe and Asia keeping storage levels relatively high. European storage levels are 65% full in the middle of February. US storage could end up closer to 1.9-2.00 Tcf as well, staring the injection levels at high level. On top of it, the Covid-19 has allowed some Chinese LNG importers to declare force majeure in an market already dealing with global glut.
  • Not all is gloom and doom though. There are various bullish factors working in the market as well:
    •  US production is down 3Bcfd from Novembers highs and is projected to go lower through the year.
    • There is an increased confidence in the market that US dry natural gas production has seen it’s highs and given the equity prices and looming bankruptcies in the sector, it is not going to go up any time soon. It is very hard to find new capital in the market and things are difficult for pure dry gas producers beyond the hedged volumes they already have.
    • Given the difficulty to attract new capital and the steep decline curves, the natural gas production train could slow down significantly
    • Lower prices are increasing coal to gas substitution making the Supply Demand picture pretty tight
  • However, assuming that the smart players have taken all the bullish and bearish factors into account and placed their bets accordingly, let us analyze what those bets in the option markets are telling us
  • What is driving this skew is that demand for $1.50 and lower puts remains high, it just keeps moving back and forth between front of the summer and back of the summer
  • Q1’21 calls have come into vogue since late January
  • Some people have started to build inventory early this year and/or they believe in the bullish story later in the year
  • Last year the skew went up early for the year ahead Q1 because of what happened in Winter18-19
  • This year people are trying to front run the front running or they are really bullish Q1’21
  • Either way Skew is almost at levels reached only by September-October except for last year and it is already very pricey to buy Q1 calls. If you want something for 2 cents you have to go all the way to $7-$8 area
  • Our strong opinion is that this high skew trade with puts at -4%, -5% at some strikes does not work at the current vol levels if prices continue to drift lower
  • The participants buying this skew have to believe that prices are close to a bottom in Q1
  • We can see this in the price action as Skew started to rise, Q1 prices found a bottom and even started to rise
  • Even as the front fell apart on Monday, Q1 retained it’s bid and the spreads had to really widen out for that to happen

So, what’s the take away from all this.

  • Q1 prices are likely at a temporary bottom and even with front bearishness, next winter fundamentals are considered bullish by market participants
  • If some kind of LNG event were to happen in Q2 or Q3, it will have to really widen the spreads out
  • We are witnessing the bearish bets on spreads with interest in V/F -60, -75 puts. All of these strikes have not been of interest for many years.
  • Though the flip side to these wide spreads is, in case of a rally Cal21, Cal22 will get pinned with producer volumes and the spreads can snap back in in a hurry
  • Given the large spec short interest, things can change quickly in this market, but this is the way the options world is set up right now
 
Next, we will analyze if buying all that skew really paid out last year and what would be potential strategies for this year? Keep an eye out for it by subscribing below for the free blog.