6. Technical Price Support for a Bullish Conclusion

So far this paper has looked exclusively at fundamentals. It concludes with a quick glance at technical price considerations in the natural gas market. Natural gas has been in a price range between $3 and $4.5 for the past 5 months (Figure 10).


When a market trades in a range like it has for the past 5 months, it is because there are large market participants on both sides of the trade. To date, it appears that producers are not willing to produce below $3.5 and will aggressively buy futures below this level. Producers hedge a percentage of their production: to do this they sell futures contracts with the intent to deliver the product at some agreed upon month in the future. Once the futures contract has been sold, a producer still has the option to buy the contract back. If they buy the contract back at a price lower then they sold it they will immediately pocket the difference. They then have the choice of either:
• Selling the (originally hedged) gas on the spot market
• Capping wells, or not drilling them in the first place
It appears that producers have been buying back future contracts when the price is below $3.50. On the other side of the coin, there appears to be a segment of market participants who are willing to short large quantities of gas when prices rise above $4. This segment is most likely large speculators (I say this based on Commitment of Trader Reports), who have been short natural gas for the past 12 months. It also could be large end users (industrial, electric generation plants, utilities) but it seems unlikely they would choose to un-hedge future deliveries at $4 when they have gotten used to $7+ gas over the past 5 years!
Just last week, prices once again tested the sub-$3.5 region and once again this price range was rejected by some market player (most likely natural gas producers). The fact that prices did not break the April low can be seen as bullish. However, sometimes a break to new lows is necessary to create a capitulation in the market. If prices were to break below $3.15 we would likely see a capitulation; prices would probably fall for an additional week or two in this scenario, but then turn around quickly. However, since prices did not break to new lows, it suggests that the most likely outcome is that medium term or even permanent lows have now been made in this (historic) bear market.
Zooming in our time frame to the past few weeks (Figure 11), we can see that Wednesday’s selling last week was vehemently rejected by buying after the Thursday inventory report. While it is dangerous to read too much into an isolated price movement, the current formation is at least consistent with the beginning of a powerful rally.