Using ETCs to ride the natural gas wave

Simona Gambarini, research analyst at ETF Securities, looks at whether recent gains in natural gas are sustainable and how to play this theme using exchange traded commodities (ETCs).

A combination of production cut-backs and increased demand over the summer has helped drive a strong rally in natural gas prices.

For prices to hold, expectations of a cold winter will have to be met, although given the still large inventory overhang, if the expected hike in heating demand fails to occur, natural gas prices have the potential to fall sharply.

Still, the current relatively low price of natural gas versus oil and coal caused some switching to natural gas by end-users, where substitution is feasible.

Although the excess supply narrowed considerably this summer, natural gas stocks still remain 8.5% above their five-year average.

Inventory overhang is still an issue          

Natural gas prices tend to be inversely correlated to storage surpluses. Although this is particularly evident in the price dynamics of last winter, more recently expectations of a smaller than average increase in gas inventories, coupled with forecasts for cooler US Midwest weather, prompted an over 20% price rise to almost $3.5/MMbtu [millions of British thermal units] in September 2012.

However, given the still large supply overhang, the natural gas price would appear to be susceptible to a correction if the expected hike in heating demand fails to occur.

The majority of US electricity generation is from fossil fuels, with petroleum, coal and natural gas representing the core sources.

As most utility companies are able to source their power depending on the relative price of oil, gas and coal, the downward correction in natural gas prices has affected relative demand.