Reading the gas price tea leaves
When natural gas prices dropped below $4 per gigajoule (GJ) in early October 2006, down from record highs above $12 per GJ the previous January, Dan Collins was able to coolly respond: “We expected that.”
Collins is a Calgary-based director of North American natural gas for Cambridge Energy Research Associates, an analyst and adviser for 600 client corporations or governments around the world needing unbiased and critical looks into the crystal ball.
During the 2004-05 hurricane seasons, for example, massive storms such as Ivan and Katrina ravaged the gas producing fields of the Gulf of Mexico, wiping out critical supply sources. No sooner had prices soared than the question was raised: Will it happen again in ’06?
“We know how much production was lost, and how long it would take to get all that production back on line,” explained Collins. “The weather forecasters can give you an idea of whether they think there’s a higher or lower risk. And they’re pretty good, better than they’ve ever been, but no one really knows for sure.”
For Collins, and more importantly his clients, the important point was not whether hurricanes would again present a risk, but whether the futures markets were accurately pricing the risk. Relying on extensive knowledge of the North American energy system, including details such as pipeline capacity, Cambridge ran models with and without hurricane damage.
“If we had the same hurricane damage as last year, our outlook for the winter was the same as the futures market for the winter,” said Collins.
That told the Cambridge analysts that the futures market was pricing in a hurricane. What does that mean? Well, if you’re buying futures, then you’re buying an event that hasn’t happened – and may not happen. And if you’re selling, you’re going to get the benefit of that event that has not yet occurred.
“What that told us was that fear was driving the market,” said Collins. “It wasn’t that the futures contract was wrong – it could have been right had there been hurricanes, but that’s not the point. The point is to understand what you’re buying. That’s what we share with our client.”
Carol Crowfoot, president of GLJ Energy Publications Inc. of Calgary, relies on impartial sources such as the U.S. Energy Information Administration, National Oceanic & Atmospheric Association or the International Energy Agency to provide the basic information for her modelling.
“I would call myself a fundamental analyst,” said Crowfoot. “I like to look at fundamentals of supply demand and transportation. This spring was a perfect example of weather forecasting being as inaccurate as commodity price forecasting, in that they were expecting La Nina conditions and oscillating weather, another active hurricane season. But it didn’t come through. This winter is going to be mild.
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