Tuesday, January 26, 2010

Oil and Gas Risk Trade is Back Bigger than Ever

While the rhetoric is coming out of Washington is all over the map, the energy markets have been positioned for the risk trade to be put back on in masse for a variety of reasons.

Natural Gas has has burned off its surplus in storage and gone into a deficit, and weather forecast is for a blistering February/March, the worst in 15 years, according to leading forecasters. This provides cushion to being long the risk trade and buying natural gas now before the weather hits. Thus fundamentals will provide a floor or hedge to the trade, whereas six months ago, weather and gas surplus made it a much more risky trade. Now it looks like a winner up to $7/mmbtu, which based on today's close is a $1.50/mmbtu potential profit spread, which is massive.

The U.S. Dollar is starting to slide and positioned for further decline, given the fact that the global markets don't know where the U.S. Government is going with the Fed matters, deficit, etc. Even if the dollar holds in a narrow range, shorting at these levels is a fairly safe bet, as there is no chance Washington is going to convince the global markets in the next 90 days, that they have a plan.

While in theory, Banks and Hedge Funds are supposed to be de-levering, the simple fact is that they have nowhere to put their money, and have no choice but to put the commodity risk trade back on, if for nothing else as a holding pattern, until we get clarity on the U.S. Government matters, and allow them to collect the fundamental premiums in the natural gas market, and maintain a hedge on the U.S. Dollar.

Oil is a bit more difficult to justify, but the market does not have any choice there either. They must put the long oil trade back on, short the dollar, and what we are seeing is that rather than taking the absolute spread risk, they are buying substantial downside protection on the long oil position, which eats into their potential margins, but protects their capital, thus, they collar oil and take the full currency exposure by staying short the dollar.

There are other commodity risk trades, but by far, the most profitable and secure is the natural gas trade, followed by the oil trade.

Mr. Miller called the flip in natural gas storage from surplus to deficit, and is looking for $7/mmbtu gas in short order, as the Artic Storm hits the U.S. East Coast later this week. We will start pulling hard volume from storage again next week, which will also be affected by blistering cold weather in producing regions as well, and Mr. Miller is looking for more supply curtailments, well freeze offs, and other logistical complications in the physical market, which leads to more support for a spot gas spike at the city gates and will work its way up to price increases in the NYMEX futures contract, over the counter swaps market, and natural gas and oil producer equities.

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