After rallying for six straight sessions, natural gas prices hit their highest level in 22 months before settling in to a tight consolidation range. However, those forecasting the energy commodity’s long-term trend has turned bullish need to tread cautiously. When prices are not correcting despite the obvious bearish fundamental backdrop, chances are that speculators have gained control over the market. The main problem with these “not so smart money” operators is that when one big player goes short, the domino effect can affect all those that bought at the top.The result of situations in which the market is overwhelmingly on one side of a trade can lead to a quicker correction as sentiment tips.

Two Main Seasonal Peaks

Like crude, natural gas has inched its way higher since bottoming during the spring of this year. Much of the grind higher was due to output cuts, as producers reacted to prices dipping below breakeven levels during the prolonged tumble in natural gas. The latest strength in prices is largely a function of Hurricane Matthew and the anticipated damage to production within the Gulf Coast. However, Matthew’s minimal impact, and the over-enthusiastic speculative charge was just what the well operators were waiting for to hedge their future production. With prices trending above their breakeven costs, producers are effectively able to lock in prices in the event of another dramatic slide in prices.Now that natural gas is entering its late October seasonal peak, prices seem to have moved ahead of fundamentals, suggesting a heightened potential for a correction.

The natural gas market is typically defined by two main seasonal peaks. The first occurs during spring months and the other during the final weeks of October. The current demand and supply mismatch is strongly indicated by storage injections last week coming in at 80 billion cubic feet, over 11 BCF higher than the consensus estimate of 69 BCF. When taken in tandem with less than anticipated damage to natural gas installations across the Gulf of Mexico, these factors suggest prices have moved well beyond their average seasonal peak. The peak may become more evident as investors realize the market is still flooded with supply, while demand remains tepid on a seasonal basis. However, despite domestic factors that are weighing on prices, there are some external factors that may put a floor in US natural gas prices.

Gas Exports to Climb

On factor that could help support the latest price climb is the latest decision by the US Federal Energy Regulatory Commission to allow Cheniere Energy to double its shipment volume from its landmark Louisiana terminal.Although the move should help ease the current supply glut to a degree, added volumes of US LNG exports comes at a time when the international market is reeling from a global supply glut – set to worsen in the next couple of years amid a demand slowdown from key Asian buyers. There is a big question mark about where all this gas is going to go and its implications for European and Asian gas prices which are already tumbling in response to oversupply.

Adding to the bearish outlook is the fact that short sellers have not completely disappeared and are waiting in the wings for any weakness. One sign that shorts are still active is that natural gas prices fell at the end of September to finish the third quarter at $2.901 per MMBtu. Institutional fund managers, at the end of each quarter, mark their positions to the market, receiving compensation based on those performances. The weakness in price at the end of third quarter is evidence that bears are still lurking in the natural gas market and waiting to pounce on any signs of overvaluation.

Weather Expectations and Hedging Driving Sentiment

Commercial traders, another prominent group that is active in trading natural gas futures, have been net sellers in 14 of the past 19 weeks. This is a strong sign that they expect the winter to remain warmer than usual, given the developing La Nina cycle. Data suggests their selling increases with every move higher. As a result, the higher the price goes, the more producers come to the market, adding overhead resistance to what is fundamentally inflated price. Furthermore, it has given beleaguered firms that have suffered from the crushing weight of price weakness an opportunity to hedge against another rapid decline in prices, helping to protect their operating margins.Commercial traders remain committed to the market irrespective of whether prices rise or fall because their actions have no profit motive and are primarily driven by hedging needs.

Due to their regular needs, the trading activities of commercial traders remain a notch above those of speculators, giving a better view of overall sentiment. Speculators, on the other hand, are here to catch the momentum move. A classically strong sign of an instrument that has run beyond its intrinsic value is when smaller speculators or retail traders are getting involved in a trade towards the end of momentum.These traders are the ones behind the latest rally and when weak hands drive prices, a reversal is never far off.