Natural Gas Rallies, But Stiff Resistance Ahead

Today's Idea

Natural gas prices have been held to a relatively tight price range of just over $1 per mmbtu since the beginning of the year, with front month prices failing to surpass the 5.000 level. Some traders looking for prices to remain below the 5.000 area may wish to explore selling calls in front month Natural Gas options. With the current front month July contract trading at 4.735 as of this writing, the July 5.2 calls could be sold for about 0.021, or $210 per contract, not including commissions. The premium received would be the maximum potential gain on the trade and would be realized at option expiration in late June should the July futures be trading below 5.200. Some traders may wish to close out the trade prior to expiration should the July futures close above 5.200.

Fundamentals

Front-month Natural Gas futures prices continue to hold near their highest levels of the year, mostly on the back of weather forecasts calling for above-normal temperatures in the central and eastern parts of the US. However, a continued gloomy economic outlook may cap any rally attempts above $5, especially if industrial demand begins to wane. The Gas market received a somewhat psychological boost from the negative attention given to nuclear power generation following the earthquake and tsunami in Japan, with Germany going so far as to announce that the country will end all nuclear power generation in the next several years. This potential switch from nuclear power to other power generation sources could expand the demand for Natural Gas sharply in the coming decade. The US is awash in Natural Gas, with the US Energy Department predicting in its monthly Short-term Energy Outlook that US Gas output will increase by 4.5% this year, which should be ample to meet power generation needs through the heat of the summer. The increase in estimated production comes despite a decrease in Gas drilling rigs this year, as production increases coming from shale formations have transformed the industry. The increased supplies of Natural Gas coming from shale drilling may also help to take some of the potential "risk premium" out of the late summer and early fall Gas futures contracts that is usually in place during the heart of the Atlantic hurricane season, as the US dependence on Gas supplies from the Gulf of Mexico region diminishes. So unless we start to see industrial demand increase sharply or a major production outage, it may be difficult for front month Natural Gas prices to move beyond recent price ranges.

Technical Notes

Looking at the daily chart for July Natural Gas, we notice prices rallying this past week and briefly taking-out the 2011 highs made back in late January, before a larger than expected storage build moved prices sharply lower on Thursday. The 14-day RSI is moderately strong, with a current reading of 58.21. This is the third higher-high seen in the daily chart since late March, with only major psychological resistance at 5.000 standing in the way of a potentially strong upside breakout, as bears run for the exits. Support for July Natural Gas is seen at the 20-day moving average currently near the 4.475 area.

Mike Zarembski, Senior Commodity Analyst