Bloomberg Markets Strategies: Diversifying With Gas

Natural gas tends to be uncorrelated with other assets, so some money managers buy securities pegged to the fuel to diversify their portfolios.

Prices of natural gas can be volatile. The fuel is prone to spikes caused by the need to match supply and demand each day. Sudden cuts in available supply -- or jumps in demand -- can cause prices to soar. In addition, the frequency and magnitude of such jumps are greater than those commonly found in other markets.

So if you’re looking to diversify your portfolio with the fuel, you can use a number of tools on the Bloomberg Professional service to analyze the fundamentals underpinning natural gas markets and better navigate the commodity.

Let’s start with some background on demand and supply. The four main uses of gas are heating, cooking, industrial processes and power generation. Important drivers of demand are weather, gross domestic product and the relative cost of gas compared with other fuels. Cold weather, of course, determines the need for heating. GDP reflects demand for industrial output. The relative cost of gas can spur switching between different fuels for power generation. Nuclear and renewable power generation levels can also affect demand because such plants displace output from gas-fired power stations. For some countries, demand can also come from neighboring nations in the form of cross-border exports.

Domestic Sources

The domestic sources of gas for a given country may include gas in storage and producing fields. Those supplies can be supplemented by imports via pipelines or on special tankers that can carry liquefied natural gas. In the U.S., hydraulic fracturing of shale has increased production of gas by more than 35 percent since the end of 2010. That means the U.S. could become a significant net exporter of gas.

What drives natural gas price volatility? Swings in demand Seasonality Chart function. The chart shows how winter weather can drive volatility in gas prices. The spikes in demand in December 2010, for example, were caused by freezing temperatures across the nation.

Similarly, gas demand surged during the spring of 2013 because of unseasonably cold weather in northern Europe. Gas is typically injected into long-term storage during the summer and then taken out during the winter. In late March 2013, inventories at Rough, the U.K.’s largest gas storage facility, Natural Gas Flows function to track storage data.

EU Market Models

To help anticipate weather patterns and their effect on gas selected. EUMM lets you view models from the Reading, England–based European Centre for Medium-Range Weather Forecasts.

Click on the arrow to the right of Model (WSI) and select ECMWF to display the European Centre’s so-called operational forecast, which predicts one parameter, such as temperature, during the next nine or 10 days.

Unexpected reductions in supply can drive price swings. Gas facilities, which undergo regular planned maintenance, are subject to unplanned outages. The failure of a pump at a U.K. gas terminal in March 2013 caused the shutdown of the BBL pipeline that carries gas from the Netherlands. The shutdown contributed to gas price spikes that month.

Ukraine Dispute

Geopolitical events can cause supply shortages. Consider recent price disputes between Ukraine and Russia. In January 2009, Moscow-based OAO Gazprom, the world’s largest natural gas producer, cut supplies to Ukraine while continuing to transmit gas destined for the European Union through pipelines in Ukraine. The Russian company accused Ukraine of siphoning off some of that gas. On Jan. 7 that year, Gazprom cut all gas transmission through Ukraine. The halt occurred in the middle of the heating season, when temperatures were well below normal. Gazprom provides up to a quarter of Europe’s gas via the Ukraine transmission system. Prices surged by as much as 42 percent.

Europe competes with other demand centers such as Brazil, China, Japan and South Korea for liquefied natural gas cargoes. Following the March 2011 earthquake and tsunami in Japan, all of the country’s nuclear power plants were shut down. Before the Fukushima nuclear plant breach, the country generated 30 percent of its electrical power from nuclear reactors. To meet power demand, Japan increased imports of LNG. Brazil’s LNG imports, meanwhile, increased 14-fold from 2009 to 2014.

LNG Tankers

You can use the Bloomberg Commodity Maps (BMAP) function to Select Vessel Type window. Scroll down to the Tankers section of the list and then click on the box to the left of LNG Tanker so that a check mark appears. Click on Update and then on Search to map LNG tankers around the world. Click on the plus sign on the map to zoom in on a particular area, such as the Persian Gulf. For information about a specific ship, click on a blue tanker icon.

The U.K. became a net importer of gas in 2004, after the North Sea gas fields were depleted at a faster rate than expected. In March 2006, a combination of insufficient LNG infrastructure, technical malfunctions in the North Sea gas fields and the shutdown of the Rough facility because of a fire created a supply shortage in the U.K. Demand at the time was high because temperatures were below freezing.

The market was squeezed to such a degree that National Grid issued a balancing alert. Prices more than quadrupled, rising to a record that equaled 215 pence per therm. That spike represented a move of 31 standard deviations. The probability of such an event in most financial models is zero. While natural gas’s low correlation with financial assets is appealing, its volatility and risk of extreme spikes may discourage portfolio managers from incorporating it into their portfolios.

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