Natural Gas: Important Levels Traders Should Monitor for Clues

  • Sep 15, 2020
  • Investing

Another pre-peak season selloff could set the stage for the winter rally

Natural gas can be one of the most volatile commodities that trade on the futures exchange. Since the NYMEX introduced futures on natural gas for delivery at the Henry Hub in Erath, Louisiana, in 1990, the price has traded from a low of $1.02 to a high of $15.65 per MMBtu. The last time the futures traded above $3 per MMBtu was back in January 2019.

The United States is the world’s leading producer of natural gas. Massive reserves of the energy commodity in the Marcellus and Utica shales and technological advances in fracking have increased output. While the supply side of the fundamental equation has grown, natural gas has replaced coal as the input in power generation. Moreover, natural gas in liquid form now travels by ocean vessel, expanding the addressable market by creating an export market beyond traditional delivery points dependent on pipeline networks.

The natural gas market has expanded dramatically over the past years, but the price action reflects the supplies rather than the growing demand. Natural gas fell to its lowest price in a quarter-of-a-century in late June, but the continuous contract price rose by over 90% by August as it rose from $1.432 to the most recent high at $2.743 per MMBtu. Since the August high, the price has been backing off once again. The United States Natural Gas ETF product (UNG) moves higher and lower with the NYMEX futures price.

A bullish reversal in a futures market can be a powerful technical pattern that pushes a commodity’s price higher. When the price of a futures contract moves to a lower level than the previous session and settled above the prior session’s high, it is often a signal that higher prices are on the horizon. On September 4, the price action on the nearby NYMEX October natural gas futures contract caused the constructive pattern on the daily chart.

As the daily chart highlights, the price range in October futures was from $2.456 to $2.567 per MMBtu on September 3. The following day, the price fell to a low of $2.431 and settled at $2.588 per MMBtu creating the bullish pattern on Friday, September 4. Meanwhile, the volatile natural gas market ignored the pattern as it declined below the $2.25 level last week.

The failure of natural gas to follow through on the upside after the price action on September 4 was likely a function of technical and fundamental factors. From a supply and demand perspective, natural gas inventories in storage across the United States remain at significantly higher levels than last year and the five-year average as of the week ending on September 4.

Moreover, the recent rise to a high of $2.743 on August 28 came as Hurricane Laura was bearing down on the states bordering on the Gulf of Mexico. The delivery point for NYMEX natural gas in Erath, Louisiana, is near the Gulf.

The storm caused natural gas to rise to its highest price level of 2020, but it did not challenge the critical level of technical resistance at the November 2019 high.

The weekly chart highlights the failure to reach the $2.905 per MMBtu level, creating a lower high in the futures market. The total number of open long and short positions in the natural gas futures market edged lower during the rally that took the price from the late June low of $1.432 to the late August high of $2.743 per MMBtu.

Open interest declined from the 1.32 million to the 1.24 million contract level during the recovery rally or over 6%. Falling open interest as the price of a futures contract rises is not typically a technical validation of a bullish trend. At the end of last week, weekly price momentum was crossing lower from overbought territory.

The relative strength indicator turned to the downside and was heading for a neutral reading on September 11. Meanwhile, weekly historical volatility moved from 72.84% in late August to below 70% last week. The technical picture for natural gas supports a continuation of the price correction since last month’s 2020 peak.

Another pre-peak season selloff could set the stage for the winter rally

With approximately ten weeks to go before the start of the 2020/2021 withdrawal season, where natural gas inventories start to decline, there is still time for the price to move to a higher low. I do not expect natural gas to challenge the late June continuous contract low of $1.432, nor do I see a test of the $1.70 level, the low in the active month NYMEX October contract.

However, a move to $2 could be on the horizon given the market’s technical state. The fundamentals when it comes to inventory levels that are far higher than last year, the five-year average, and have the potential to move above four trillion cubic feet for the third time since the Energy Information Administration reported the data.

Natural gas is coming into the time of the year when the energy commodity tends to experience seasonal price strength. The peak season January 2021 contract was trading above the late 2019 high at the end of last week.

The chart shows that natural gas for delivery in January 2021 was trading at $3.29 per MMBtu at the end of last week, 38.5 cents or 13.3% above the peak price from November 2019, even though inventories are significantly higher going into the upcoming winter season this year.

Technical support for October natural gas futures is at the $2.20 and $2.00 per MMBtu levels. We were heading for a challenge of these downside levels at the end of last week after the energy commodity made a lower high on the weekly chart and failed to follow through after the bullish reversal pattern on September 4.

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The United States Natural Gas Fund L.P. (UNG) was trading at $12.55 per share on Tuesday morning, up $0.15 (+1.21%). Year-to-date, UNG has declined -25.56%, versus a 7.16% rise in the benchmark S&P 500 index during the same period.

UNG currently has an ETF Daily News SMART Grade of D (Sell), and is ranked #70 of 112 ETFs in the Commodity ETFs category.