Thread by @mg10012

#COM @USAEnergyNatGas @oilmutt @RazorOil A thread/question on #natgas and the current contango.

Markets, like natgas, where the commodity is "just in time" consumed usually exhibit backwardation. There is a plausible theory for why con tango must be rare in such markets.

The argument goes like this: owning reserves is like having an option on natgas, where the strike price of the option is the total cost of extraction and the payoff at expiry is the then spot price.

If natgas were in contango, E&Ps would have no incentive to extract . . .

or exercise this option because they could get a higher price in the future. So, there would be no production under contango. It's a similar argument as to why no one exercises and American call prior to maturity. exercises and American call prior to maturity. In this case,

the maturity is the end of the E&P's lease rights. If the volatility increases, that gives the E&P even less incentive to exercise that option. Thus, natgas production would seem to require strong backwardation to promote supply and E&Ps keep it "in the ground" when futures

markets are in contango.

However, a weird game theory emerges if EVERYONE follows this strategy because it will result in a natgas shortage and spot prices will rise.

So, this thread is a plea to all the oil & gas gurus out there to help explain the current state.

I would appreciate it if folks could retweet this thread to get some exposure in the hope of furthering my understanding of what is causing the current contango. Here are some other possible explanations:

1. If there are to be natgas shortages in the forseeable future due to

rising LNG and industrial demand, investors should buy natgas futures all along the curve in order to hedge their access to diminishing supply. This would result in
contango. That is not the narrative told right now.

2. Larger inventory levels are needed. This could be because

of the delay in the Freeport liquifaction facility restarting and the worries in Western Europe over supply (which seems to have diminished). The market acknowledges that larger inventory levels will be needed. If storage capacity is tight or there is not enough spot available,

market participants go long futures contracts to buy the commodity in the future. This can result in
contango.

3. If the market anticipates the natgas supplies will be very tight in the short term, this could be a "rational expectation" type explanation of the
current contango.

If the marginal investor expects markets to be tight
in the near-term, they will go long futures out in the curve to hedge future consumption needs. This could result in contango. Again this story is strange because the reason for the contango is some sort of perception of

future shortages (which does not seem to be the current situation).

4. Regime change in inventory levels. If increased inventory is interpreted as oversupply, the spot price will go down resulting in contango. This would induce
those with storage facilities ...

to increase their stock until there is no empty storage left. This would be my guess as to why we have contango now.

I am curious to see others' perspectives on this, as I hope some industry folks share their know-how. I thank you in advance if you share your opinions.