Where Have All The Arbitrageurs Gone?
Natural Gas in the worst performing commodity this year. It has come down 66.2% this year and 77.6% from the top. Reduced industrial demand combined with absence of hot weather which has reduced electricity demand and consequently natural gas demand has weighted heavily on the natural gas price.
Chart 1. US Natural Gas Futures
Working gas in storage reached 3258 billion cubic feet, 22.7% higher than last year and about 20% higher than the five year average. Despite huge decline in rig count of 50% the production is still stubbornly high and it could push stockpiles to the level where there’s no available storage capacity.
Chart 2. DOE Working Natural Gas Estimated Storage
To make things worse United States Natural Gas Fund (UNG) ETF which held approximately 70% of open interest in front month futures contract has ran out shares to create in the beginning of July because of the late filling to the regulators. During the time the fund manager was awaiting a regulatory approval new federal and exchange position limits were enacted aimed at curbing “negative effects” of speculation on commodity prices. In late July UNG fund manager announced that despite acquired approval it will not issue new shares due to “current and anticipated new regulatory restrictions and limitations that have been and may be imposed by the Commodity Futures Trading Commission, the New York Mercantile Exchange and the Intercontinental Exchange”. Further, they decided to reduce fund holdings overall and substitute futures exposure with OTC swaps. Due to lack of UNG buying front month futures price broke down to the multi year low. UNG has on the other hand started trading at premium to its NAV which has reached 18% yesterday.
Chart 3. Spread UNG Market Price vs. NAV
The natural gas futures curve, which is most of the time in contango, has steepened even further with spread between October and November contracts reaching 38.8%. I question myself, where have all the arbitrageurs gone?
Chart 4. US Natural Gas Futures Curve
All dough these kind of broken markets are my favorites to trade (they offer the highest reward to the brave and smart) I see no credible instrument to trade. Contango is too steep in front month futures curve and price is too high for the contracts on the long end. Steep contango eliminates ETF’s as the loss on a negative roll is too high.
The price is interesting (looks like its going further south), given some signs of normalization in all the aspect I covered looks like very interesting potential investment. I will be watching it closely and exploring trading strategies.