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Natural gas is trading in the tightest

Natural gas is trading in the tightest range in eight years as rising U.S. production pushes inventory levels close to last year’s record, undermining profit for traders who thrive on price swings

Natural gas is trading in the tightest

The fuel has stayed between $3.545 and $6.108 per million British thermal units this year, the smallest difference since 2002, amid government forecasts for U.S. production to reach the highest levels in 37 years. Gas may average $4.35 in the fourth quarter, according to the median estimate of 15 analysts surveyed by Bloomberg News, up 2.7 percent from the previous three-month period.

U.S. gas inventories will peak by the end of this month at 3.726 trillion cubic feet, 2.9 percent lower than last year’s record of 3.837 trillion, the Energy Department estimated on Oct. 13 in the monthly Short-Term Energy Outlook. Stockpiles have risen even as a 34 percent decline in prices this year and stricter pollution rules encouraged utilities to switch away from coal. Gas-fired power production will climb 31 percent in 2010 from five years ago, according to the department.

“Low volatility is the new norm in the gas market,” said Hamza Khan, an analyst at the Schork Group Inc., a consulting company in Villanova, Pennsylvania. “The upside is capped by supply and the downside by fuel-switching.”

Lower volatility reduced the need for gas producers to hedge their future production, according to Chris Kostas, a senior analyst at Energy Security Analysis Inc. in Wakefield, Massachusetts. Gas selling positions held by producers totaled 546, 548 contracts in futures markets in the week ended Sept. 3, the lowest level in six months, according to data from the Commodity Futures Trading Commission. Positions reached 552,782 in the week ended Oct. 5.

Implied volatility for so-called at-the-money options expiring in 30 days, a measure of expected price swings in futures and a gauge of options prices, dropped to less than 34 percent March 12, the lowest level in at least five years, according to data compiled by Bloomberg. It has averaged more than 47 percent this year, compared with almost 72 percent in the same period last year. Lower volatility can reduce profits for option traders.

“We’ve seen producers reducing their forward hedging as they are less concerned that prices will be volatile or fall further,” said Kostas. “On the speculative side, people are making less money selling options.”

Natural gas for November delivery fell 3.9 cents, or 1.1 percent, to settle at $3.657 per million British thermal units yesterday. Gas averaged $4.235 in the third quarter, down 2.6 percent from the previous quarter. The first-quarter average was $4.989, up 1.3 percent.

Companies have increased drilling of so-called unconventional gas, according to Baker Hughes Inc. The number of horizontal rigs, which are mostly used in shale-gas drilling, rose to a record 929 in the week ended Oct. 8, the Houston-based oil and gas field services provider said last week.

“The increase in the natural gas-directed drilling rig count since mid-2009, comprised of a growing share of natural gas-directed horizontal drilling rigs in the lower 48 states, contributed to the production growth in 2010,” the Energy Department said in the monthly report on Oct. 13.

Gas output will average 61.29 billion cubic feet a day this year, according to the Energy Department, the most since 1973. Production will be 2.2 percent higher than last year.

“The market is very well supplied and that has eliminated a lot of upside risks,” said Kostas.

Gas-Fired Power

Electricity generated using natural gas will rise to 2.461 billion kilowatt-hours a day this year from 2005’s 1.874 billion, according to the Energy Department. Coal-powered electricity will average 5.131 billion kilowatt-hours a day, down from 2005’s 5.458 billion. The percentage of gas-fired electricity will increase to a record 23 percent in 2010 from 18 percent in 2005, according to the department.

“You would expect utilities to use more natural gas, and it’s not likely that gas prices will fall below $3,” said James Williams, an economist at WTRG Economics, an analysis and research firm for energy companies based in London, Arkansas.

Gas demand may rise 2.4 percent this winter, led by power plants and industrial consumers such as factories, the Natural Gas Supply Association, a Washington-based industry group, said in a report on Oct. 5.

The absence of major storms in the Gulf of Mexico during September, typically the most active month of the hurricane season, has also curbed price swings.

About 10 percent of U.S. gas output will come from federal waters in the Gulf this year, down from 17 percent five years ago, according to Energy Department estimates. Gulf production dropped 52 percent in the past 10 years.

“Obviously we’ve got plenty of supply right now and we have no immediate storm threats on the horizon,” said Peter Beutel, president of Cameron Hannover, a trading advisory company in New Canaan, Connecticut.

The measure of natural-gas short positions held by producers includes an index of four contracts adjusted to futures equivalents: Nymex natural gas futures, Nymex Henry Hub Swaps, Nymex Henry Hub Penultimate Swaps, and ICE Henry Hub Swaps.

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