Commodities: Natural gas hedging strategy prudent this year

By Ben Straus, U.S. Energy Services | October 03, 2014

It’s been six months since the end of winter, but the natural gas market is still feeling the effects of one of the coldest five month stretches in the last 30 years. The hangover comes mainly in the form of a reduced storage inventory that has staged a solid but incomplete recovery thanks to record production and static demand. Moving into October, consumers are turning a weather eye to winter temperatures and wondering whether the upcoming winter season will be a repeat of the prior one. Unfortunately, weather forecasters looking at the same data come to very different conclusions. In light of the uncertainty and risk, natural gas consumers should take appropriate steps to cover risks, especially basis in areas where last winter proved that in periods of intense cold capacity was not adequate to meet market demand and prices spiked.

To understand the degree of uncertainty regarding weather in the upcoming winter, it’s easiest to look at two forecasts from accredited meteorologists. In the first, from the Climate Prediction Center, a division of the National Oceanic and Atmospheric Administration, the forecasters are placing weight on the historical correlation of an El Nino weather pattern with warmer than normal temperatures across the northern tier of the country, particularly in the Pacific Northwest.  The second forecast from WeatherBell Analytics mirrors other private sector forecasts in calling for another bout of colder than normal weather east of the Rocky Mountains in the same northern portion of the country where frigid weather dominated the last time around. While the private forecasters agree that the Pacific Northwest will be warmer than normal and the southern portion of Texas will be colder, there is very little else upon which the two forecasts concur.

So how can two institutions employing highly trained meteorologists come to such disparate winter forecasts? While weather forecasting has made great strides over the past two decades, the efficacy of long-term prediction models remains very low. Because of the low predictive value of these outlooks, it’s much more reasonable as an end-user of natural gas to take the predictions as bookends of the risk faced in the current environment. Given that at least one forecast suggests a return to the doldrums of last winter, it’s probably prudent to put some type of hedging strategy into place to protect against the risks observed the last time around, especially in areas that experienced deliverability issues during intense cold, and the price spikes that accompanied it. Ultimately, we won’t have a good view of the winter until we are into it, and by that time it will be too late to take protective measures if it gets cold.