US natural gas futures' forward curve unusually flipped into backwardation this week as prices for next year were boosted by concerns over a sharp increase in demand and the first anticipated fall in production in over a decade. The forward curve for gas futures on the New York Mercantile Exchange is normally in contango, where the far forward calendar strips tend to trade at a higher price than closer-dated strips. A calendar strip is an average of the 12 monthly futures in a year.
The 2017 calendar strip, however, this week traded at $3.09 per million British thermal units, putting it above or in backwardation to 2018 at $3.03 and 2019 at $3.01, suggesting expectations for higher prices next year than the two years that follow. Strips return to their "normal" upward slope in 2020.
The Henry Hub benchmark fell to a 16-year low of $2.61 in 2015 and so far this year has averaged just $1.96. Futures for the balance of 2016 are fetching $2.79. Analysts at Citigroup said in a note that the odd shape of the forward curve - the first backwardation since November 2014, according to Reuters data - was helped by producer hedging pushing down the back of the curve and strong buying from investors boosting 2017 contracts.
"Prices above $3 could be an attractive level for producer hedging due to the belief that plenty of gas production could come online in the $3 range," Citi said. Two dealers familiar with the transactions confirmed that said some producers were using 2017 calendar strips to hedge future output. Many analysts expect US production to fall for the first time since the start of the shale revolution over a decade ago in 2016, and some even think output could fall again in 2017.
"People are starting to build a premium into 2017, feeling that will be the pinch year in which you pay the penalty for all the production declines," said energy consultant Stephen Smith, who runs his own firm in Mississippi. So far in 2016, US drillers have reduced dry gas output in the lower 48 states to 73.1 billion cubic feet per day on average from a record 73.5 bcfd in 2015. Production this week fell to 71.8 bcfd, lowest since December.