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Conclusion: There is a noted lack of seasonality in natural gas prices this year, which we view as a bearish leading indicator.

There is no shortage of prognosticators on commodity prices who are bearish on the price of natural gas heading into 2011. As I sat in my hotel room in California yesterday watching CNBC, two things were obvious after listening to much of the commentary. The consensus is to be long U.S. equities and short U.S. natural gas. Since we are currently short the SP500, we disagree with the former, but on the latter we’ve been consistently bearish on natural gas prices for most of 2010. Currently, seasonal prices moves, or lack thereof, seem to be supporting this view.

Since 2000, natural gas prices (based on the Energy Information Administration’s wellhead price) have shown a consistent seasonal pattern. In 9 of the last 10 years, from 2000 - 2009, natural gas prices have increased from October to December. On average the price increase from the full month average in October to the full month average in December has been 15.5%. Clearly, we’ve seen meaningful seasonal moves as the weather starts to get cold heading into December.

While the EIA hasn’t reported their wellhead prices for October or December yet, if we look at their reported front month contract prices, it becomes clear that this normal seasonality is not occurring this year. On October 1st the front month contract for natural gas, according to the EIA, was priced at $4.04 per Mcf and as of yesterday the front month contract was priced at $4.06 per Mcf according the EIA. Seasonality? Not so much.

This lack of seasonality is likely a signal that the market remains in imbalance and will remain so heading into the winter. Some of the recent data points, which we’ve previously highlighted, support this. Specifically:

Supply - Currently, natural gas in storage is 8.5% above the 5-year average with 3,368 Bcf in storage. This is obviously a bearish amount of natural gas in storage, though it is down about 1.6% on a year-over-year basis, but remains well above historical norms.

Production – Our energy Sector Head Lou Gagliardi has written about this point extensively, but the growth of production in the United States continues to be one of the most overriding bearish factors for natural gas price. With seemingly little concern for the growth of supply, major E&P companies continue to invest in the natural gas industry in the United States, especially in the various shale plays. In fact production growth is so high that the Department of Energy is predicting that storage by March 2011 will be 10% above 2010 levels.

Demand – We’ve been quite vocal as to our expectation of slowing economic growth in the United States in 1H 2011 due to tough comps, consumer headwinds, and a lack of future government stimulus. If we are correct in our assessment, it is likely that demand for natural gas could be flat or fall in 2011 versus 2010. In 2009, demand for natural gas was down more than 2% from 2008 levels. Moreover, natural gas is not exactly a growth industry as overall consumption has only grown 9.1% over the 40-year period from 1969 through 2009. The Department of Energy is currently expecting demand to be flat in 2011.

It seems that many investors still are not bearish enough on natural gas. While there are many arguments as to why demand should increase overtime, we currently are in a supply glut driven by production. In the chart below, we show monthly production numbers in the U.S. going back to 1994. This chart quite clearly shows that we are in a new paradigm as it relates to the production of natural gas, primarily due to technology advances via horizontal drilling and massive discoveries in the shale areas.

The reality is, natural gas can go a lot lower. It is a localized commodity that is not driven by the same global demand (emerging markets) and price (U.S. dollar weakness) as oil. In fact, from 1994 to 1996 natural gas varied between $1.50 per Mcf and $3.00 per Mcf and spent most of that period below $2.00 per Mcf. This lack of seasonal price moves is an important data point as we consider the next move in price.

Daryl G. Jones

Managing Director

Natural Gas Seasonality, Or Lack Thereof - monthly natty