Natural Gas Report
November 13, 2007
BY Casey Whelan, U.S. Energy Services Inc.
Oct. 28—The natural gas market has been in decline during much of 2006 and 2007 (from more than $14/MMBtu to less than $6/MMBtu). As such, forward purchases are oftentimes out of the money unless you were fortunate enough to execute hedges during small windows of opportunity (i.e., September 2006 and August 2007). Moreover, the carry (premium between the prompt month price and deferred month price) in the market has been significant, but has declined as the deferred month approaches, becoming the prompt month. Combined, the declining market and significant market carry have made hedging particularly challenging over the past two years.
Are there strategies that can be used to manage prices in a falling market and when there is a significant market carry? The first strategy is do nothing at all. The problem with "doing nothing" is that the natural gas market will eventually rally. We are likely to again see $10/MMBtu-plus market prices leaving customers with high prices and busted budgets. In addition, many of our clients have a corporate objective to be at least partially hedged at all times. In that case, a "do nothing" strategy is not consistent with corporate objectives.
Another strategy is using options to "buy" protection and market participation. Naturally, the more one is willing to pay, the greater the level of protection and participation one can achieve. It is also possible to structure a transaction that gives one some downside participation and provides a degree of upside protection at no cost. This structure combines the following three options: 1) buy an at the money call, 2) sell an out of the money call (above market), and 3) sell an out of the money put (below market). The structure can be "costless" if the revenue generated from selling the put and call is equal to cost of purchasing the call. There is some market participation on the downside and some market protection on the upside—all at no cost. If this type of structure is appealing, call or e-mail for more information.
Casey Whelan, vice president of strategic initiatives, can be contacted at cwhelan@usenergyservices.com.
Are there strategies that can be used to manage prices in a falling market and when there is a significant market carry? The first strategy is do nothing at all. The problem with "doing nothing" is that the natural gas market will eventually rally. We are likely to again see $10/MMBtu-plus market prices leaving customers with high prices and busted budgets. In addition, many of our clients have a corporate objective to be at least partially hedged at all times. In that case, a "do nothing" strategy is not consistent with corporate objectives.
Another strategy is using options to "buy" protection and market participation. Naturally, the more one is willing to pay, the greater the level of protection and participation one can achieve. It is also possible to structure a transaction that gives one some downside participation and provides a degree of upside protection at no cost. This structure combines the following three options: 1) buy an at the money call, 2) sell an out of the money call (above market), and 3) sell an out of the money put (below market). The structure can be "costless" if the revenue generated from selling the put and call is equal to cost of purchasing the call. There is some market participation on the downside and some market protection on the upside—all at no cost. If this type of structure is appealing, call or e-mail for more information.
Casey Whelan, vice president of strategic initiatives, can be contacted at cwhelan@usenergyservices.com.
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