How to Prepare for a Bull Market in Natural Gas

Anybody who has ever traded will know that nothing about markets is certain, so the idea of a predictable move is fundamentally flawed. That said, though, there are times in certain markets when it seems clear that a move in a particular direction is coming, it is just a matter of when it actually comes. That is true right now when it comes to US natural gas prices.

An analysis of the most basic supply and demand factors suggests that, at some point, natural gas prices are moving higher. The July Short Term Energy Outlook (STEO) from the US Energy Information Administration (EIA), reported on in this Reuters article, clearly stated why that is true. Output of natural gas is set to fall this year as demand continues to increase. You don’t have to be an economics professor to know what that means for price, or even to know why it is happening.

Natural gas demand has been increasing around the world for a couple of decades now as power generation has shifted from oil and coal to the “cleaner” gas powered plants. In response, production has increased but, as is the way with these things, output increases based on high prices prompted by that demand have more than covered the demand increases, and there has been a glut of gas in the market for some time. Prices, as compared to longer term averages, have fallen and have been hovering around their lows for some time.

That has prompted both an increase in demand and a halt to production increases, and it is now looking like, in America at least, low prices are resulting in an actual output reduction. Then add in the effects of the AI boom on electricity demand and we have the opposite of what we have seen recently, falling supply and rising demand, so it is logical to assume that prices will pop at some point.

The problem is that we might not yet be at that point.

The August STEO lays out why that is so. After a hot July that increased electricity, and therefore natural gas demand in the US, August has been relatively cool, resulting in a drop off that will likely continue as fall weather takes over. And don’t forget, there is still a glut of natty in the system.

Still, with tensions remaining high in the Middle East, the war in Ukraine, and now in Russia I guess, dragging on, and with North American output at best stagnant, it will only take demand slightly above expectations for there to be a significant move up in natty futures, and that seems like enough of a possibility to warrant a trade, albeit one with a relatively tight stop.

This is too risky a trade to get involved with a lot of leverage, so my preference here is for the straightforward US Natural Gas Fund ETF (UNG).

I will be buying UNG as close to $13 as possible, with a stop at around $12, well below the low of $12.58 achieved earlier this month. The initial target is a break back above $15, at which pint I would adjust the stop to just above my entry point, but ultimately, if this works in the short-term, I will be looking for around $17.50 on a longer-term basis. That gives a very nice risk/reward ratio that is enough to justify the short-term risk of losing around 10% or so of my initial investment.

Should that stop be hit, I will pause and think again, as is my wont, but given the long-term dynamics of the market, I will probably be looking for another opportunity and level to go long. That could change should peace break out around the world or if there are signs of a real global recession, but barring those unlikely events, a long-term long position in natty looks to be a play on the inevitable, or at least as close to it as you can expect in a traded market.