The problem of course is that hurricanes have a nasty way of messing with trading desk profits.
Last year, right up until Ivan left the nasty reminder that hurricanes can cause major damage, the common wisdom was that hurricanes are a one-day wonder. We can all recite “buy the rumor, sell the fact.” Before Ivan, we have to go back to Andrew for the same impact. What makes these occurrences so special?
To use my bowling analogy, Andrew was like picking up the 7-10 split and Ivan was a ball right to the head pocket for a strike. Why? Both had several common characteristics:
- They were big. The major damage is not done by the wind; it’s the wave action on the seabed hundreds of feet down. The pipeline damage and the missing platforms are caused by horizontal mudslides. Category 1 hurricanes don’t do these.
- They were accurate. Damaging one pipeline frequently leaves the ability to shift production to other pipelines. Both Andrew, because of its path tangential to the coastline, and Ivan, because of its path right up the Mississippi channel, went perpendicular to the pipeline routes, crossing and damaging multiple pipelines. A hurricane coming in perpendicular to the Texas Coast may not have the same impact.
- They hit the right spot. I am not enough of an oceanographer or fluid dynamics expert to know for sure, but it seems awfully suspicious that the two hurricanes that did the most damage spent a significant portion of their trajectory through producing regions traveling parallel to and near the point where the shelf drops off to deep water. Most hurricanes come on a perpendicular path across that zone fairly quickly. It is just a hunch, but I wonder if the ocean floor could act a lot like the shoreline to “crest” the subsurface impact of the hurricane forces.
What does this mean about the coming train wreck? I expect production area storage will be more than 70 percent full with the next EIA storage report. This storage is the relief valve for Gulf Coast production. If no one else wants it or there is a pipeline OFO (Operational Flow Orders), production area storage is where the gas gets stuck. I would like to remind people that even when Ivan shut in more than an estimated 4 Bcf per day of production during the week of Sept. 13, production area storage injections averaged over 1 Bcf per day.
If no hurricanes hit this Summer, it is likely that Gulf Coast storage will require 80 Bcf less in injections from June 1 to Oct. 31 of this year than it did last year. That is the equivalent of four weeks of high-end injections.
The dilemma for the gas market is that if a hurricane hits the 7-10 split, gas prices go to $10. If we have a stable summer, we end up in October with no demand and gas prices go to $4. So, being long has an end-of-Summer risk of losing $2.50, being short has a mid-Summer risk of losing $4 or more. Most traders believe they are nimble enough to capture the winner by being long early and then getting out before everyone else does if the bet doesn’t pay off – some may even be right. This type of risk and reward means that everyone will want to play.
The above-normal activity forecasts and the rhetoric around them seem to scream, “Here comes another winner!”
Gutter balls are never expected. A strike will lift all boats (except consumers who haven’t hedged), a string of gutter balls will cause a rush to the exits and I suspect not everyone survives the experience (and consumers that hedged with firm gas are massively over the market).
No wonder traders in other markets think we natural gas guys are thrill-seekers. Here’s to an interesting summer.
This story first appeared in the June 3, 2005 issue of The Desk. www.scudderpublishing.com.