Long Gas Short Oil on Nuanced Macro Conditions

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When prices diverge, like shadows in the night, spread trading strategies unfold in plain sight.

WTI Crude Oil (“US Crude”) and Henry Hub Natural Gas (“US Nat Gas”) Futures have diverged recently. US Crude prices continued sliding amid easing supply concerns and weak demand from the US and China. Meanwhile, US Nat Gas prices rose steadily on rising demand, shrinking storage surpluses, and rising exports.

As OPEC+ weighs delaying output hikes and gas producers reduce supply, energy markets remain volatile, presenting interesting trading possibilities.

WTI CRUDE OIL HITS NEW 2024 LOW AS SUPPLY DISRUPTION CONCERNS EASE

The US Crude Oil has posted two consecutive monthly losses owing to a weak economic outlook. US Crude prices briefly rose on supply disruptions in Libya and heightened tensions between Israel and Hezbollah.

With tensions easing and the expected resumption of Libyan supply, prices dropped sharply as the risk premium diminished.



Reuters reported that the cartel is considering delaying the hikes to support the US Crude prices. Yet downside risks loom large due to weak manufacturing data from the US and China.

Additionally, July JOLTS job openings in the US dropped by 237k to a three-and-a-half-year low of 7.7 million, missing expectations of 8.1 million, cementing further bearish sentiments.

OPEC faces a dilemma of optimising between price support and market share. Delaying the Q4 OPEC output hike may not be enough to support prices as current production is already high amid feeble demand.

Output cuts are essential to support prices, but doing so risks losing market share to non-OPEC producers and shrinking oil revenues. Convincing OPEC members to approve deeper cuts may prove challenging.

GAS PRICES REBOUND ON STRONG DEMAND AND SHRINKING STORAGE SURPLUS

The US Nat Gas prices have been bearish throughout 2024 due to excess storage resulting from the mild winter last year. Prices tanked 31% from the peak of USD 3.313/MMBtu on 12/Jan this year.



Prices recovered between May and June and then slumped again, falling 39% between 11/Jun and 27/Aug, hitting a four-month low.



Since 28/Aug, gas prices have rallied with strong demand from power generators who have switched from coal to gas.

Source:EIA

Modest inventory injections have supported the uptrend, with builds below the five-year average in sixteen of the last seventeen weeks.

For the week ending 30/Aug, inventories rose by 13 Bcf, below analyst expectations of 26 Bcf and the five-year average of 51 Bcf, thereby reducing surplus. Storage for the week ending 30/Aug was 10.7% above the five-year average, down from 12.1% the previous week.

Source: EIA

Rising LNG export flows and the US Department of Energy’s approval of a five-year export license for New Fortress Energy further supports prices.

Natgasweather.com forecasts moderate temperature-driven demand for natural gas. This outlook supports steady natural gas demand in the near term.

Gas majors such as APA and EQT are forced to reduce volumes for the second half of the year due to above-average gas storage. This could lead to tighter supply during winter as seasonal demand picks up.

Steady growth in LNG feed gas deliveries will support the US Nat Gas prices, driven by robust exports from the US to Europe. Europe’s demand for gas peaks during winter.

The current macroeconomic and geopolitical backdrop is exerting significant downside risk to US Crude Oil prices. Absent a sharp economic recovery in China and an exogenous geopolitical shock, oil prices will remain under pressure.

The US Nat Gas prices remain under pressure from excess supply. Easing storage levels, rising demand from power generators, robust winter-led demand from Europe will serve as tailwinds pushing up prices in the near term.

Source:Barchart

The US Crude Oil prices are presently trading above it 5-year average price range. Meanwhile, the US Nat Gas prices trade significantly below the five-year average.

Source: Barchart

The options skew is -3.71 as of 05/Sep for crude oil signalling that puts are more expensive than calls. This reflects expectations of stronger downside price risk.



Source: CME Group

In sharp contrast, skew for the US Nat Gas options is positive at 6.01 as of 05/Sep suggesting that calls are more expensive than puts. This shows expectations for upside price risk.



Source: CME Group

HYPOTHETICAL TRADE SETUP

Given this backdrop, this paper posits the following hypothetical spread trade comprising a long position in CME Micro Henry Hub Natural Gas Futures (MNGV4) and a short position in CME Micro WTI Crude Oil Futures (MCLV4).



To establish a spread trade between MNGV4 and MCLV4 given the current prices, a portfolio manager needs 3 lots of MNGV4 to be matched against 1 lot of MCLV4 to ensure that the notional values are identical.

The set up and the pay-off under different scenarios from this spread trade is summarised below.



Portfolio managers can better manage downside risks with options. More on that in a future research note.

MARKET DATA

CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme.


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