Flash Crash Takes a Bite of Natural Gas

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By EconMatters

After infecting the stock market last May and hit the precious metals market , silver in particular, primarily due to raised margin requirement, flash crash has now taken a bite of the natural gas market as well.

FT.com reported that the Nymex (New York Mercantile Exchange) floor had been closed for more than five hours on the evening of Wednesday, June 9 when July natural gas dropped 8.1%, to $4.510 per mmbtu (See Chart). The fall also triggered a 20-second trading pause for the August Henry Hub futures contract.


Natural gas is one of the very few commodities that actually moves more inline with supply and demand fundamentals since it is trapped within the producing region and is not even affected by dollar currency movement that much. Therefore, while there are many geopolitical factors that could explain certain wild swings in crude oil, pretty much none of them could be applied to natural gas.

More curiously, coincidence or not, this flash crash took place in the confluence of the following market events this week, which most likely should encourage the long natural gas trade: 

  • The International Energy Agency (IEA) said on Monday June 6 that it expects global gas demand to overtake coal before 2030, and come close to oil around 2035, and that global gas demand to grow by an average of 2% a year, which will end the current gas glut by 2015, by when demand would begin to outstrip supply.  
  • On Thursday, June 9, Exxon Mobile announced that it bought two privately held natural gas company--Phillips Resources and related company TWP Inc.--for $1.69 billion last week, adding about 317,000 acres for exploration in the Marcellus shale basin.

According to FT, Nymex owner CME Group said the sudden price drop was due to “news of one of the largest oil and natural gas discoveries in the Gulf of Mexico.”  It is true that the flash crash happened hours after the news that Exxon Mobile has made two big new oil discoveries and a natural gas find in the deepwater Gulf of Mexico. Nevertheless, it will probably take a year or more before the new gas discovery comes into production, and traders typically look things at a time horizon of a few months, instead of something so far removed.

At the same time, some market players blamed the overnight drop on computer algo trading, while other says it is a 'fat finger'..... again (probably the same one from last May?), and that there could be another round of inquiry or investigation by the Commodity Futures Trading Commission (CFTC) and the Exchange.   

Henry Hub price has risen 15% in the past month, close to a one-year high of $5 per mBtu, on warmer than usual weather and prospects for future LNG exports .  While fat finger or computerized trading may very well be the cause behind the sudden crash, it looks more like technical profit taking by some big player(s).

Natural gas prices in the U.S. have been stuck in a rut due to ample supplies from the shale gas boom, as a result, many players have increased their short positions on natural gas. According to CFTC, as of May 30, commercial participants, who accounted for 64.7% of open interest, held net short positions, while non-commercial participants, who accounted for 24.5% of open interest, also increased their increased their short positions by 7.1%.

That means, if the same player(s) change their positions, instead of a flash crash, we probably will see a natural gas prices spike by short squeeze.  This is just one characteristic of a modern day  commodity paper palace  where a majority of the trades does not take physical delivery.

For now, natural gas for July delivery has recovered and settled up 1.8%, at $4.757 a million British thermal units by Friday, June 10.  Futues rose 1.1% for the week.

EconMatters , June 11, 2011 | Facebook Page | Twitter | Post Alert | Kindle



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Commodities , Futures , US Markets

Referenced Stocks: UNG

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