NTMA's gamble... per NTMA release today:
On Tuesday 16 June, NTMA offered two bonds in the auction,
- the 3.9% Treasury Bond 2012 and
- the 4.6% Treasury Bond 2016.
"Total bids were received for €2.397 billion and it was decided to issue a total of €1 billion [as planned]. An amount of €500 million of the 4.6% Treasury Bond 2016 was issued where the total bids received were 2.5 times the amount allocated, while €500 million of the 3.9% Treasury Bond 2012 was also issued where the total bids received were 2.2 times the amount allocated. The 2016 bond was sold at an average yield of 4.755% while the 2012 bond was sold at an average yield of 3.056%."If you look at the table above, NTMA always preferred issuing €300mln in shorter maturity bonds and €700mln in longer maturity bonds - a 30:70 split. This time around, it appears it had to borrow heavier in shorter maturity range, hence 50:50 split. And this is for 2016 bond as opposed to 2019 bond earlier. Ouch...
Price spreads min-max were also relatively heavy on shorter maturity. Compare the following two screen shots:
June 16th auction: spreads of 19bps on 2016 bond (2.375 pa ) and 16bps on 2012 bond (5.33 pa)May 119th auction: spreads of 37bps on 2019 bond (3.7 pa) and 5bps on 2014 bond (1 pa).
Again, NTMA are doing excellent work here, but it is a tough job...
Natural Gas - upward?
Natural-gas prices have been lagging oil prices over the recent months despite the fact that gas drilling and production are on decline worldwide. This has been noted by some Irish analysts, most notably – Davy, whose June 15 quick daily note must be credited for spotting the trend first in the Irish market.
Per Davy note (Caren Crowley): “The ratio of the US oil price to gas price is reaching record highs. A reversion to more normal levels requires the oil price to pull back or the gas price to rally. With the oil price looking unstoppable, it is all up to the gas price, but it is an uphill battle.” There is not much of a real in-depth analysis in the Davy note, so here are some of my thoughts on the issue.
First some short-term facts:
US gas prices have fallen 34% in 6 months to June 2009 and 72% off 2008 peak. In part, this is driven by demand declines. But, as Davy note states, supply capacity has been catching up on downward trajectory: “the number of rigs exploring for, and producing, gas has fallen 56% since September 2008 when it peaked at 1,606, and is at its lowest level since 2002.” This is yet to translate into actual supply cuts as “US gas inventories are abnormally high and are 22% above their five-year average.”
In early April, US natural gas inventories stood at 1,650bn cubic feet in the week ended and steady, equivalent to 300 bn cf above 5 year average and 400bn above year before. Chart 1 below (courtesy of Energy Information Administration) shows that this abnormal situation has gone worse since then with gas inventories breaching the 5-year min-max range for the first time since May 2007.
Now, 25%-30% of US gas production comes from relatively young wells (drilled in the last 12 months). A significant cull of drilling rigs operating today will, therefore, translate into higher demand for imports in winter 2009-2010. The number of running (producing) rigs was down to 1,039 in the week of April 1, 2009, according to Baker Hughes (BHI) - down 49% from the 2,031 level seen in mid-September 2008 -- the highest since 1980.Chart 2 shows the same over the longer period, with clear signs of seasonality and a rising trend in inventories over time.
One noticeable feature here is that volatility below the trend has been declining throughout the April 2003-April 2006. Afterward, the maximal depletions of gas reserves have steadily increased through April 2008, before once again starting to decline in late 2008 through April 2009. The rate of the later decline has been so far consistent with the rate of decline in 2003-2006 period. This is exactly identical to the 4 years falling, 3 years rising and 1 year falling cycle in 1996-2002.Another feature is the lack of similar cyclicality at the maximum surplus inventories level, in other words – in peaks above the trend (dashed line). In fact, the trend here is identical (in slope) to the average trend line. Furthermore, when it comes to surplus inventories deviations, current historically high levels (for November 2008) are actually below the maximal inventories trend.
The two facts together suggest that high inventories are not being driven by excessively high supply of gas (which would be consistent with abnormally low minimal inventories in around April trough and abnormally high maximal inventories in and around late Autumn).
Yet another interesting feature of the data is captured in Chart 3, which clearly shows that in recent months, weekly growth rate in inventories has not fallen substantially for positive growth rates, while the rate of natural gas inventories depletion (the negative range) has declined.
Given that this already accounts for seasonality and the weather effects have not been dramatically out of line, what’s going on? The answer is: twin effects of demand changes and equity markets trends are driving prices of oil, while only demand changes have been instrumental in determining the price of natural gas to date. And this is about to change...
On the demand side, power gen accounts for 58% of all US gas demand and this has been falling – 6-8% down so far in 2009. It is also important to note that gas-based electricity generation in the US is concentrated in the Western Pacific states and Northern Atlantic Board states – all of which have seen serious economic pressures on demand side.
But these fundamentals do not really explain the historic trend in gas prices. Futures prices for natural gas have now hit their lowest levels since 2002. Recent pricing below $4 per million British-thermal-unit on the NYMEX, down from $9 mbtu in Q1 2008.
Again, supply-demand analysis does not explain this. Fundamentals analysis focuses on abnormally cold weather in early 2008, which pushed spot prices up and resulted in higher levels of exploration activity. Production capacity increased, but demand collapsed. Fine theory, except, recall prices are down more than 50%, although US Energy Department expects natural-gas consumption to decline by only 1.3% in 2009.
And US gas prices are linked to global gas prices – which are facing significant pressure on the Russian supply side. How? In two ways:
Short-term pressure is rising due to delays in pumping annual storage reserves in Ukraine – a technical issue that can derail gas supplies to Europe. Basically, the principle here is a simple one. To run gas pipe between Russia and Western Europe (the pipe transiting Ukraine), Soviets built a pressure maintenance system that requires intermediate storage facilities (positioned on Ukraine’s territory out of the Soviets’ consideration for ‘balanced regional development’ and owned by Ukraine) to be filled to capacity. This ensures that if Ukraine’s own gas purchases start depleting the pipe flow, the flow can be topped up with reserves of gas. Ukraine is broke and has no cash to pay for this gas – which it will own once it is pumped into storage. Russians are telling Ukrainians that they can’t give them a $2bn loan for gas and are offering to split the loan between Russia and the EU. EU is refusing. So we have stalemate. Now things are getting even more complicated because Ukraine also owes Russians further $3bn worth of cash for gas supplied to the Ukrainian consumers. In short – if gas is not pumped into storage tanks within the next 2 months, there will be serious risk of disruption of gas supplies to Europe in fall/winter 2009-2010. This in turn will lead to price increases for gas globally.
Long-term pressure is also rising due to Russian gas production now shifting to the Eastern Siberian plains. Completion of the new pipeline to service China and Japan is a sign of this. The problem here is that unlike Western Siberian plains, Eastern Siberian plains have smaller gas fields, fewer developed fields and geology that is much more challenging (shale, smaller reservoirs, more complex folds and more broken folds) that the near-perfect sands of Western Siberia. Again, this signals an upside to gas prices in the longer term (I will write about this in few days in more details).
So in the nutshell, future supply constraints are daunting. And these should be working in both short term and long term in the future... Again, supply is not the main driver for the abnormal situation of falling gas prices and rising inventories.
So what is? One word answer is ‘oil and gas price correlations with equity markets’. In my view, it is a speculative buying of oil as a hedge against inflation and the ‘blue chip’ low risk commodity that is driving a wedge between oil prices and gas prices and simultaneously driving closer oil prices and equity prices.
A series of charts below illustrate this point.
Chart above shows relatively coincident long-run trends in DJIA and Oil prices that are not replicated in gas prices. This is confirmed in the scatter plot below. Here, strong correlations in oil and gas prices against DJIA occur over significantly different slope relations. If 100 points increase in DJIA index leads to a $1.4 increase in the price of oil, the same change in DJIA index is associated with a $0.16 rise in the price of gas. While at parity this appears to be a movement in favour of oil, given current conditions in the market (the extremely high negative correlation between price of oil and price of gas and extremely low price of natural gas) any changes in the stock markets valuations should, based on fundamentals, drive prices of gas closer to the price of oil. Expressed in current price percentage terms, table 1 below the chart shows these historically-justified price responses.
Chart below illustrates what I mean by extreme correlations
Notice that current correlation is:(a) within the range of -0.75-1;
(b) the change in correlation between peak of June 2008 (+99.3) to today (-88.1) is the highest on record for downward adjustment.
Chart above shows the replay of the oil and gas prices correlation in line with the broad equity markets. Here, while correlation between DJIA and oil prices stands at +0.78 and remains in the positive territory since September 2008, the correlation between DJIA and gas prices is at -0.57 and has moved into negative territory in May 2009.This is interesting, because the structure of gas prices to date contrasts the findings of the recent research on links between oil and gas prices. Jose A. Villar (Energy Information Administration) and Frederick L. Joutz (Department of Economics, The George Washington University) paper The Relationship Between Crude Oil and Natural Gas Prices, prepared for Energy Information Administration, Office of Oil and Gas in October 2006, shows that there exist “a cointegrating relationship relating [natural gas] prices [and] the WTI and trend capturing the relative demand and supply effects over the 1989-through-2005 period. The dynamics of the relationship suggest a 1-month temporary shock to the WTI of 20 percent has a 5-percent contemporaneous impact on natural gas prices, but is dissipated to 2 percent in 2 months. A permanent shock of 20 percent in the WTI leads to a 16 percent increase in the [gas] price 1 year out all else equal.”
So the lags structure implies that a temporary shock to oil price should be followed by a delayed shock to gas prices 12 months after and that the magnitude of changes in gas prices is roughly 80% of the magnitude of shock to oil price.
Clearly, as table above and charts illustrate, this relationship is currently being reversed, suggesting two emerging short- and medium-term trends:
- fundamentals (firming demand/falling supply) trends indicating significant room for gas prices increases in the range closely linked, but shallower (at 70-80%) than those in oil prices. This implies trend price for gas of ca $8-8.25 per thousand cubic feet of gas;
- short-run dynamics trends, indicating a ca 6% upside to gas price relative to oil price in the next 3-6 months, implying a price range of $6.8-6.9 per thousand cubic feet.
