Since the expansion of shale gas exploration began in earnest in 2005, US domestic production of natural gas has been on a steady march higher (Chart 3), with demand unable to keep pace with the growing supply. This has effectively capped the upside for natural gas prices in the US, trapping spot prices in a tight range. Long-term prospects for higher prices are developing; however, the realization of higher natural gas prices is still a distant event, one that will be discussed in detail in a later note.
Adding further wind to the sails for short sellers is the persistently positive roll yield in the natural gas forward curve. Over the past 12 months, shorts have earned a cumulative return of about $1.08 rolling their positions each month, a substantial profit equal to roughly 25% of the underlying price of gas at current levels. While the forward curve has flattened in recent months, the positive carry persists, and natural gas front-month spreads have demonstrated a consistent tendency to widen as they approach the roll date.
We have been long-term bears on natural gas, and given the overbought condition of the market coupled with recent weather reports calling for above-normal temperatures beginning in April, now is a good opportunity to establish a new short position. Sell May natural gas, placing initial stops at $4.40.