Volatility returns to natural gas market

By Ben Straus, U.S. Energy | November 26, 2014

Historically, natural gas is one of the most volatile widely traded commodities, but for more than three months, from July through mid-October, natural gas prices traded in a relatively tight range, from $3.72 to just over $4. Some might even have described the market as sleepy. However, in light of the price gymnastics of the past winter, especially in the East Coast and Upper Midwest spot markets, it was almost inevitable that the tepid cycle from low to high and back again in that tight trading range was set to burst. Since the end of October, the prompt natural gas contract has traded as low as $3.54, and as high as $4.54, creating a price range almost three times as wide as the previous three months. In contrast, from July through October, the average trading range of the prompt contract, from the daily high to the daily low, was 10.6 cents. In November, the daily trading range more than doubled to 21.6 cents.  

So what’s driving this volatility, and do we expect it to settle down? The answer to the first question is easier than the second. Obviously, we’ve entered the winter when natural gas demand scales up as the commodity is used in larger quantities to heat homes and businesses in addition to the base-load consumption associated with industrial processes and power generation. Markets are also a bit jumpier in light of last winter’s experience and less robust storage inventories. With heating a critical driver of prices, winter got off to a cold start with a November that featured a December-like blast of cold for an eight day stretch. The natural gas market is extremely sensitive to weather forecasts in the 11- to 15-day timeframe. Unfortunately, the major weather models have not provided particularly stable forecasts for that period of time, vacillating between warmer and colder than normal from one day to the next. These revisions imply substantially increased or decreased consumption, ultimately being manifested in the increased price volatility we have observed over the last four weeks. 

From a deeper perspective, contributing factors to forecast instability are the broad environmental parameters that the weather models attempt to capture. Over the course of the summer, observations of Pacific sea surface temperatures were statistically indicative of a weak El Nino. Unfortunately, a weak El Nino introduces a substantial amount of complexity to the forecast models, rather than increasing certainty. With the weak El Nino predicted to hold sway through February, lower-than-normal storage inventories and the stark memory of last winter, volatility in the natural gas market is likely to continue at least through the end of the year.